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MGT402 Cost & Management Accounting GDB 2 Solution Spring 2014

Foot Design Company specializes in making designers shoes in Lahore and Karachi. It sends Shoes to its agent – Shoe Mart. Company sells one article at Rs.900. Until last month, Foot Design paid Shoe Mart a commission of 10% of the shoe price paid by each customer. This commission was Shoe Mart’s only source of revenues. Shoe Mart’s fixed costs are Rs.14, 000 per month (for salaries, rent, and so on), and its variable costs are Rs.20 per shoe purchased.  Foot Design Company has just announced a revised payment schedule for all agents. It will now pay agents a 10% commission per shoe up to a maximum of Rs.50. An article costing more than Rs.500 generates only Rs.50 commission, regardless of the shoe price.

Required:

1.      Under the existing 10% commission structure, how many pairs of shoes must Shoe Mart sell each month to (a) break-even; and (b) earn any operating income of Rs. 7,000?     (1.5)

(For Shoe Mart Sale revenue is 90Rs per unit)
a) Fixed Cost = 14000Rs
Variable Cost = 20Rs
For break even
CM per unit = Sales – Variable Cost
= 90 – 20
= 70Rs
Fix Cost = 14000Rs
Break Even = Fix Cost/CM per unit
= 14000/70
= 200Pairs
b) To earn profit of 7000
Target CM = 14000+7000 = 21000Rs
So Break Even = 21000/70
= 300 Pairs
2.      How does Foot Design’s revised payment schedule affect your answers to (a) and (b) in (1) above?                    (2)
Does this change in the company policy have positive effect on the commission agent’s business? Give your comments?  (1.5)

If Sale Revenue is 50Rs Fix then
Fix Cost = 14000Rs
CM per unit = Sales – Variable Cost
= 50 – 20
= 30RS per unit
Break Even = Fix Cost/CM per unit
= 14000/30
= 467Pairs
For Profit of 7000Rs
Break Even = 21000/30
= 700Pairs

This change in company policy has negative effect on commission agent business as now they  have to sale 467 units to reach break even and same they have to sell more to get profit of 7000Rs.

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