Question

1.

You have just been hired as a new management trainee by Earrings Unlimited, a distributor of earrings to various retail outlets located in shopping malls across the country. In the past, the company has done very little in the way of budgeting and at certain times of the year has experienced a shortage of cash. Since you are well trained in budgeting, you have decided to prepare a master budget for the upcoming second quarter. To this end, you have worked with accounting and other areas to gather the information assembled below. The company sells many styles of earrings, but all are sold for the same price—$10 per pair. Actual sales of earrings for the last three months and budgeted sales for the next six months follow (in pairs of earrings): January (actual) 20,000 June (budget) 50,000 February (actual) 26,000 July (budget) 30,000 March (actual) 40,000 August (budget) 28,000 April (budget) 65,000 September (budget) 25,000 May (budget) 100,000 The concentration of sales before and during May is due to Mother’s Day. Sufficient inventory should be on hand at the end of each month to supply 40% of the earrings sold in the following month. Suppliers are paid $4 for a pair of earrings. One-half of a month’s purchases is paid for in the month of purchase; the other half is paid for in the following month. All sales are on credit. Only 20% of a month’s sales are collected in the month of sale. An additional 70% is collected in the following month, and the remaining 10% is collected in the second month following sale. Bad debts have been negligible. Monthly operating expenses for the company are given below: Variable: Sales commissions 4 % of sales Fixed: Advertising $ 200,000 Rent $ 18,000 Salaries $ 106,000 Utilities $ 7,000 Insurance $ 3,000 Depreciation $ 14,000 Insurance is paid on an annual basis, in November of each year. The company plans to purchase $16,000 in new equipment during May and $40,000 in new equipment during June; both purchases will be for cash. The company declares dividends of $15,000 each quarter, payable in the first month of the following quarter. The company’s balance sheet as of March 31 is given below: Assets Cash $ 74,000 Accounts receivable ($26,000 February sales; $320,000 March sales) 346,000 Inventory 104,000 Prepaid insurance 21,000 Property and equipment (net) 950,000 Total assets $ 1,495,000 Liabilities and Stockholders’ Equity Accounts payable $ 100,000 Dividends payable 15,000 Common stock 800,000 Retained earnings 580,000 Total liabilities and stockholders’ equity $ 1,495,000 The company maintains a minimum cash balance of $50,000. All borrowing is done at the beginning of a month; any repayments are made at the end of a month. The company has an agreement with a bank that allows the company to borrow in increments of $1,000 at the beginning of each month. The interest rate on these loans is 1% per month and for simplicity we will assume that interest is not compounded. At the end of the quarter, the company would pay the bank all of the accumulated interest on the loan and as much of the loan as possible (in increments of $1,000), while still retaining at least $50,000 in cash. Required: Prepare a master budget for the three-month period ending June 30. Include the following detailed schedules: 1. a. A sales budget, by month and in total. b. A schedule of expected cash collections, by month and in total. c. A merchandise purchases budget in units and in dollars. Show the budget by month and in total. d. A schedule of expected cash disbursements for merchandise purchases, by month and in total. 2. A cash budget. Show the budget by month and in total. Determine any borrowing that would be needed to maintain the minimum cash balance of $50,000. 3. A budgeted income statement for the three-month period ending June 30. Use the contribution approach. 4. A budgeted balance sheet as of June 30.

Answer 1

Part 1 A

Sales budget
	April	May	June	Quarter
Budgeted unit sales	65000	100000	50000	215000
Selling price per unit	10	10	10	10
Total sales	$650000	$1000000	$500000	$2150000

Part 1 B

Schedule of Expected Cash Collections
	April	May	June	Quarter
February sales (26000*10=260000)*10%	26000			26000
March sales (40000*10=400000)*70%, 10%	280000	40000		320000
April sales 650000*20%, 70%, 10%	130000	455000	65000	650000
May sales 1000000*20%, 70%		200000	700000	900000
June sales 500000*20%			100000	100000
Total Cash Collections	$436000	$695000	$865000	$1996000

Part 1 C

Merchandise Purchases Budget
	April	May	June	Quarter
Budgeted unit sales	65000	100000	50000	215000
Plus: desired ending inventory (40%)	40000	20000	12000	12000
Total needs	105000	120000	62000	227000
Minus: Beginning inventory	26000	40000	20000	26000
Required to purchase	79000	80000	42000	201000
Cost of purchase @$4 /unit	$316000	$320000	$168000	$804000

Desired Ending Inventory: 40% of the next month's unit sale

Part 1 D

schedule of expected cash disbursements for merchandise purchases
	April	May	June	Quarter
Accounts payable	100000			100000
April purchases	108000	158000		316000
May purchases		160000	160000	320000
June purchases			84000	84000
Total cash payments	$258000	$318000	$244000	$820000

Part 2

EARRINGS LIMITED CASH BUDGET FOR THE THREE MONTHS ENDING JUNE 30
	April	May	June	Quarter
Cash balance (beginning)	$74000	$50000	$50000	$74000
Plus: collections from customer	436000	695000	865000	1996000
Total cash balance	510000	745000	915000	2070000
Minus: disbursements
Merchandise purchases	258000	318000	244000	820000
Advertising	200000	200000	200000	600000
Rent	18000	18000	18000	54000
Salaries	106000	106000	106000	318000
Commissions (4% of sales)	26000	40000	20000	86000
Utilities	7000	7000	7000	21000
Equipment purchases	0	16000	40000	56000
Dividends paid	15000	0	0	15000
Total disbursements	630000	705000	635000	1970000
Excess (deficiency) of receipts over disbursement	(120000)	40000	280000	100000
Financing:
Borrowings	170000	10000		180000
Repayments			180000	180000
Interests			5300	5300
Total financing	170000	10000	1853000	3653000
Cash balance ending	$50000	$5000	$94700	$94700

Part 3

EARRINGS UNLIMITED BUDGETED INCOME STATEMENT FOR THE THREE MONTHS ENDED JUNE 30
Sales in units		215000
Sales		$2150000
Variable expenses:
Cost of goods sold	860000
Commissions	86000	946000
Contribution margin		1204000
Fixed expenses:
Advertising	600000
Rent	54000
Salaries	318000
Utilities	21000
Insurance	9000
Depreciations	42000	1044000
Net operating income		160000
Minus: operating expense		5300
Net income		$154700

Part 4

EARRINGS UNLIMITED BUDGETED BALANCE SHEET JUNE 30
Assets:
Cash	94700
Accounts receivable	500000
Inventory (12000*4)	48000
Prepaid insurance (21000-9000)	12000
Property and equipment, net (950000+56000-42000)	964000
Total assets	$1618700
Liabilities and equity:
Accounts payable, purchases	500000
Dividends payable	15000
Capital stock, no par	800000
Retained earnings	719700
Total liabilities and equity	$1618700

Accounts receivable at June 30:
May sales (100000*10*10%)	100000
June sales (50000*10*8%)	400000
Total	500000
Retained earnings at June 30:
Balance, March 31	580000
Plus: net income	154700
Total	7347000
Minus: dividends declared	15000
Balance June 30	719700