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Question

Lionel Corporation manufactures pharmaceutical products sold through a network of sales agents in the United

States and Canada. The agents are currently paid an 18% commission on sales; that percentage was used when Lionel prepared the following budgeted income statement for the fiscal year ending June 30, 2019:

 

Lionel CorporationBudgeted Income StatementFor the Year Ending June 30, 2019($000 omitted)Sales   $30,200 Cost of goods sold      Variable$13,590    Fixed  3,624  17,214 Gross profit   $12,986 Selling and administrative costs      Commissions$5,436    Fixed advertising cost 906    Fixed administrative cost 2,416  8,758 Operating income   $4,228 Fixed interest cost    755 Income before income taxes   $3,473 Income taxes (30%)    1,042 Net income   $2,431 

 

Since the completion of the income statement, Lionel has learned that its sales agents are requiring a 5% increase in their commission rate (to 23%) for the upcoming year. As a result, Lionel's president has decided to investigate the possibility of hiring its own sales staff in place of the network of sales agents and has asked Alan Chen, Lionel's controller, to gather information on the costs associated with this change.

 

Alan estimates that Lionel must hire eight salespeople to cover the current market area, at an average annual payroll cost for each employee of $80,000, including fringe benefits expense. Travel and entertainment expenses is expected to total $770,000 for the year, and the annual cost of hiring a sales manager and sales secretary will be $235,000. In addition to their salaries, the eight salespeople will each earn commissions at the rate of 10% of sales. The president believes that Lionel also should increase its advertising budget by $670,000 if the eight salespeople are hired.

 

Required

1. Determine Lionel's breakeven point (operating profit = 0) in sales dollars for the fiscal year ending June 30, 2019, if the company hires its own sales force and increases its advertising costs. Prove this by constructing a contribution income statement.

2. If Lionel continues to sell through its network of sales agents and pays the higher commission rate, determine the estimated volume in sales dollars that would be required to generate the operating profit as projected in the budgeted income statement.

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