Question

Building Your Skills Case [LO8-2, LO8-4, LO8-8, LO8-9, LO8-10]

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—$16 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)	22,000	June (budget)	52,000
February (actual)	28,000	July (budget)	32,000
March (actual)	42,000	August (budget)	30,000
April (budget)	67,000	September (budget)	27,000
May (budget)	102,000

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 $5.00 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	$	300,000
Rent	$	28,000
Salaries	$	126,000
Utilities	$	12,000
Insurance	$	4,000
Depreciation	$	24,000

Insurance is paid on an annual basis, in November of each year.

The company plans to purchase $21,000 in new equipment during May and $50,000 in new equipment during June; both purchases will be for cash. The company declares dividends of $22,500 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	$	84,000
Accounts receivable ($44,800 February sales; $537,600 March sales)		582,400
Inventory		134,000
Prepaid insurance		26,000
Property and equipment (net)		1,050,000
Total assets	$	1,876,400
Liabilities and Stockholders’ Equity
Accounts payable	$	110,000
Dividends payable		22,500
Common stock		1,000,000
Retained earnings		743,900
Total liabilities and stockholders’ equity	$	1,876,400

The company maintains a minimum cash balance of $60,000. 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 $60,000 in cash.

Required:

Prepare a master budget for the three-month period ending June 30. Include the following detailed schedules:

1. calculations not needed for this question

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 $60,000.

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	67000	102000	52000	221000
Selling price per unit	16	16	16
Total sales	1072000	1632000	832000	3536000

Part 1 B

Schedule of Expected Cash Collections:

	April	May	June	Quarter
February sales (28000*16=448000)*10%	44800			44800
March sales (42000*16=672000)*70%, 10%	470400	67200		537600
April sales 1072000*20%, 70%, 10%	214400	750400	107200	1072000
May sales 1632000*20%, 70%		326400	1142400	1468800
June sales 832000*20%			166400	166400
Total Cash Collections	729600	1144000	1416000	3289600

Part 1 C

Merchandise Purchases Budget:

	April	May	June	Quarter
Budgeted unit sales	67000	102000	52000	221000
Plus: desired ending inventory (40%)	40800	20800	12800	12800
Total needs	107800	122800	64800	233800
Minus: Beginning inventory	26800	40800	20800	26800
Required to purchase	81000	82000	44000	207000
Cost of purchase @$5 /unit	405000	410000	220000	1035000

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

Part 1 D

Budgeted cash disbursements for merchandise purchases:

	April	May	June	Quarter
Accounts payable	110000			110000
April purchases	202500	202500		405000
May purchases		205000	205000	410000
June purchases			110000	110000
Total cash payments	312500	407500	315000	1035000

Part 2

EARRINGS LIMITED CASH BUDGET FOR THE THREE MONTHS ENDING JUNE 30
	April	May	June	Quarter
Cash balance (beginning)	84000	60720	244940	84000
Plus: collections from customer	729600	1144000	1416000	3289600
Total cash balance	813600	1204720	1660940	3373600
Minus: disbursements
Merchandise purchases	312500	407500	315000	1035000
Advertising	300000	300000	300000	900000
Rent	28000	28000	28000	84000
Salaries	126000	126000	126000	378000
Commissions (4% of sales)	42880	65280	33280	141440
Utilities	12000	12000	12000	36000
Equipment purchases	0	21000	50000	71000
Dividends paid	22500	0	0	22500
Total disbursements	843880	959780	864280	2667940
Excess (deficiency) of receipts over disbursement	-30280	244940	796660	705660
Financing:
Borrowings	91000			91000
Repayments			-91000	-91000
Interests			-2730	-2730
Total financing	91000			-2730
Cash balance ending	60720	244940	702930	702930

Part 3

EARRINGS UNLIMITED BUDGETED INCOME STATEMENT FOR THE THREE MONTHS ENDED JUNE 30
Sales in units		221000
Sales		3536000
Variable expenses:
Cost of goods sold (134000+1035000-(12800*5))	1105000
Commissions	141440	1246440
Contribution margin		2289560
Fixed expenses:
Advertising	900000
Rent	84000
Salaries	378000
Utilities	36000
Insurance	12000
Depreciations	72000	1482000
Net operating income		807560
Minus: operating expense		2730
Net income		804830

Part 4

EARRINGS UNLIMITED BUDGETED BALANCE SHEET JUNE 30
Assets:
Cash	702930
Accounts receivable (1632000*10%)+(83200*80%)	229760
Inventory (12800*5)	64000
Prepaid insurance (26000-12000)	14000
Property and equipment, net (1050000+71000-72000)	1049000
Total assets	2059690
Liabilities and equity:
Accounts payable, purchases	110000
Dividends payable	22500
Capital stock, no par	1000000
Retained earnings	1526230
Total liabilities and equity	2059690

Retained earnings at June 30:
Balance, March 31	743900
Plus: net income	804830
Total	1548730
Minus: dividends declared	22500
Balance June 30	1526230