Below is a variable costing income statement for Wilner Glass Company, a maker of bottles for the beverage industry.
For the coming year, the company is considering hiring two additional sales representatives at $80,000 each for base salary plus 5 percent of their sales for commissions.
The company anticipates that each sales representative will generate $900,000 of incremental sales.
Wilner Glass Company
For the Year Ending December 31,2014
|Variable cost of goods sold||$8,000,000|
|Variable selling expense||4,000,000||12,000,000|
|Fixed production expense||2,600,000|
|Fixed selling expense||1,800,000|
|Fixed administrative expense||3,000,000|
a. Calculate the impact on profit of the proposed hiring decision.
Should the company hire the two additional sales representatives?
b. Consider the analysis of the decision performed by the company's chief accountant and compare it to your analysis in part a.
What is the fundamental flaw in the chief accountant's work?
Analysis by Chief Accountant
|Income per dollar of sales in 2014|
|($600,000 / $20,000,000)||0.03|
|Less increase in base salary||160,000|
|Effect on profit||($106,000)|
Variable costing process considers the variable manufacturing cost to be the product cost only. Rest of the cost are expensed in the income statement. It determines the contribution margin required to recover the fixed cost of the firm.
Answer and Explanation:
A) The statement showing the changes in net income if company goes for the sales personnel is as follows:
|Particulars||Current situation||Old situation|
|Less: variable cost of goods sold @40%||8,000,000||8,720,000|
|Less: Variable selling expense @20%||4,000,000||4,360,000|
|Less: commission on sales||-||90,000|
|Less: Fixed production cost||2,600,000||2,600,000|
|Less: Fixed selling expense||1,800,000||1,800,000|
|Less: Fixed administrative expense||3,000,000||3,000,000|
|Less: Fixed salaries||-||160,000|
As the net income is increasing by $470,000, the company should go ahead and hire the sales personnel.
B) As per the company's chief accountant, the company will experience a decrease in net income by $106,000 if it hires the sale personnel. However, there are some flows in the analysis made by the chief accountant.
1) The chief accountant directly takes the ratio of net income to sales. However, net income does not change in the same proportion as the sales change.
2) Since the accountant directly takes the ratio of net income to sales, the already existed fixed component of the cost also changed with the change in the sales which is not the case in actual scenario. Fixed cost remains the same when the sales increase. It increases only by the amount of fixed salary of the new sales personnel.
Due to these two factors, the analysis made by the chief accountant does not reveal the real picture of the decision.
Learn more about this topic:
from Financial Accounting: Help and ReviewChapter 13 / Lesson 5