You work as an accountant with Storz ,a medical equipment company ,which manufactures and supplies penlights,thermometers,stethoscopes,blood pressure monitors and other measuring instruments to hospitals and medical clinics.
Currently Storz sells its products to hospitals and clinics throughout Australia through a network of
independent sales agents .These sales agents are currently paid an 18% commission on sales .This rate of commission has been used when the following budgeted Income Statement for the next year was prepared.
BUDGETED INCOME STATEMENT
Cost of goods sold
Fixed 2,800,000 20,200,000
Gross Profit 9,800,000
Selling and administrative expenses
Fixed advertising expense 800,000
Fixed administrative expense 3,200,0009,400,000
Net Income before tax 400,000
Since the above statement was completed Storz’s management has learned that the independent
sales agents are demanding that the commission rate be increased to 20% of sales for the next year.
As this would be the fourth increase in commission in six years Storz management has decided to
investigate the possibility of hiring its own full time sales staff to sell its products instead of using
the independent sales agents .
The Financial Controller of Storz estimates that the company would need to hire eight salespeople
to cover its current market .The total salaries and benefits of these employees is estimated to be $700,000 .These salespeople would also be paid commissions of 10% of sales.Travel and entertainment expenses are expected to total $400,000 for the year.The company would also need to hire a sales manager and support staff whose salaries and fringe benefits are expected to total $200,000 per year.It is also expected that the fixed advertising budget would need to increase by $500,000 per year.
A further complication has occurred with respect to the penlights which are sold independent of the above medical equipment .Here these are currently sold independently by the penlights division direct to all parties –public and private hospitals,clinics and individual doctors at a price of $6 each.
There are currently 20,000 of these penlights being sold per month and the unit costs are :
Direct materials 1.00
Direct labour 1.20
Variable overhead 0.80
Fixed overhead 0.50
Storz has received a one off offer from the government run clinics to supply their clinics with 5,000 of the penlights . Their offer is that they would pay all manufacturing costs plus a fixed fee of $1,000.
Storz wants to know whether it should accept the offer from the government run clinics .Details of the two options are as follows:
Sales each month to: Option A Reject offer Option B Accept offer
Regular customers 20,000 units 15,000 units
Government run clinics 0 units 5,000 units
Another issue has come up with respect to the penlights-there is an opportunity to outsource the production and distribution of the penlight directly from an outside supplier.If this was to happen
the fixed marketing costs would continue but the variable marketing costs would be slashed by 20%.
The variable manufacturing costs would be eliminated and the fixed manufacturing overhead cost
would continue at 50% of present levels .
Prepare a report which addresses the following:
a. A budgeted income statement for the two options: paying 20% commission to sales agents or the
company hiring its own sales staff.
b. Calculate the breakeven point for each of the options.
c. Calculate the indifference point between the two options
d. Based on the current budgeted level of sales which option is preferred?
e. Should the offer from the government run clinics for the penlights be accepted? Provide
calculations to back up your conclusion.
f. What is the maximum cost Storz would be prepared to accept to outsource the manufacture of
g. What other factors should be considered apart from price when deciding whether to outsource?