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The annual planning at Century Office Systems, Inc. had been arduous but produced a number of important marketing initiatives for the next year. Most notably, company executives had decided to restructure its product-marketing team into two separate groups: (1) Corporate Office System and (2) Home Office System. Angela Blake was assigned responsibility for the Home Office Systems group, which would market the company's word-processing hardware and software for home and office-at-home use by individuals. Her marketing plan, which included a sales forecast for next year of $25 million, was the result of a detailed market analysis and negotiations with individuals both inside and outside the company. Discussions with the sales director indicated that 40% of the company sales force would be dedicated to selling products of the Home Office Systems group. Sales representative would receive a 15% commission on sales of Home Office Systems. Under the new organizational structure, the Home Office Systems group would be charged with 40% of the budgeted sales force expenditure. The sales director's budget for salaries and fringe benefits of the sales force and noncommission selling costs for both the Corporate and Home Office Systems groups was $7.5 million.
The advertising and promotion budget contained three elements: trade magazine advertising, cooperative newspaper advertising with Century Office Systems, Inc. dealers, and sales promotion materials including product brochures, technical manuals, catalogs, and point-of-purchase displays. Trade magazine ads and sales promotion material were to be developed by the company's advertising and public relations agency. Production and media placement costs were budgeted at $300,000. Cooperative advertising allowance policy stated that the company would allocate 5% of company sales to dealers to promote its office systems. Dealers always used their complete cooperative advertising allowances.
Meetings with manufacturing and operations personnel indicated that the direct costs of material and labor and direct factory overhead to produce the Home Office System product line represented 50% of sales. The accounting department would assign $600,000 in indirect manufacturing overhead (for example, depreciation, maintenance) to the product line and $300,000 for administrative overhead (clerical, telephone, office space, and so forth). Freight for the product line would average 8% of sales.
Blake's staff consisted of two product managers and a marketing assistant. Salaries and fringe benefits for Ms. Blake and her staff were $250,000 per year.
a. Prepare a pro forma income statement for the Home Office Systems group given the information provided.
b. Prepare a pro forma income statement for the Home Office Systems group given annual sales of only $20 million.
c. At what level of dollar sales will the Home Office Systems group break even?
1. Pro forma income statement for Home Office Systems group (Sales @ $25 million).
Home Office Systems Group
Pro Forma Income Statement for next year
less: Variable Costs
Manufacturing costs 50.00% $12,500,000
Freight 8.00% $2,000,000
Sales commissions 15.00% $3,750,000
Cooperative advertising 5.00% $1,250,000
Total variable costs 19,500,000
Gross Contribution $5,500,000
less: Direct Fixed Costs
The solution explains how to prepare a pro forma income statement.