Below is a variable costing income statement for Wilner Glass Company, a maker of bottles for the b

Question:

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

Income Statement

For the Year Ending December 31,2014

Sales $20,000,000
Less:
Variable cost of goods sold $8,000,000
Variable selling expense 4,000,000 12,000,000
Contribution margin 8,000,000
Less:
Fixed production expense 2,600,000
Fixed selling expense 1,800,000
Fixed administrative expense 3,000,000
7,400,000
Net income $600,000

Required:

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

Incremental sales $1,800,000
Income per dollar of sales in 2014
($600,000 / $20,000,000) 0.03
54,000
Less increase in base salary 160,000
Effect on profit ($106,000)

Variable costing:

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
Sales 20,000,000 21,800,000
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
Contriution Margin 8,000,000 8,630,000
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
Net Income 600,000 1,070,000

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.


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Variable Costing: Method, Formula & Advantages

from Financial Accounting: Help and Review

Chapter 13 / Lesson 5
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