Question

You have just been hired as a new management trainee by Earrings Unlimited, a distributor of earring 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 comprehensive budgets for the upcoming second quarter in order to show management the benefits that can be gained from an integrated budgeting program. 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- $13 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)... 20,800 June (budget)... 50,800
February (actual)... 26,800 July (budget)... 30,800
March (actual)... 40,800 August (budget ... 28,800
April (budget)... 65,800 September (budget) 25,800
May (budget)... 100,800

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 $7 for a pair of earrings. One-half of a month�s purchases are paid for in the month of purchase; the other half is paid for in the following month. All sales are on credit, with no discount, and payable within 15 days. The company has found, however, that 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..................6% of sales

Fixed:
Advertising.....................$199,200
Rent................................17,200
Salaries........................105,200
Utilities.........................6,200
Insurance......................2,200
depreciation.................13,200

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

The company plans to purchase $15,400 in new equipment during May and $39,200 in new equipment during June; both purchases will be for cash. The company declares dividends of $11,000 each quarter, payable in the first month of the following quarter.

A listing of the company�s ledger accounts as of March 31 is given below:

Assets
Cash.............................................................................$ 130,400
Accounts Receivable($34,840 February sales; $424,320
March Sales)................................. 459,1600
Inventory...................................................................... 184,240
Prepaid insurance......................................................... 21,800
Property and equipment(net)....................................... 861,200
Total Assets................................................................. $1,656,800

Liabilities and Stockholders� Equity
Accounts Payable.........................................................$ 177,800
Dividends Payable......................................................... 11,000
Capital stock................................................................. 880,000
Retained Earnings......................................................... 588,000
Total liabilities and stockholders� equity $1,656,800

The company maintains a minimum cash balance of $55,000. 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 $55,000 in cash.

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

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

1. a. A sales budget, by month and in total
b. A schedule of expected cash collections from sales, 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.

Answer 1

Concepts and reason

Budgeting: Budgeting is a management accounting process. Various activities are performed to prepare a budget. Under the process of budgeting, budgets are prepared which act as a tool for decision making. Budgets are used by the management for taking various vital decisions.

Budgeting is an important process for any business. It aids coordination amongst various departments of an entity. Budgeting is important for tracking and improving performance of an entity. Under the process of budgeting the first and foremost budget that is created is a sales budget.

In course of ordinary business, the process of budgeting includes:

• Estimating the future sales level

• Estimating the cash inflows and outflows in future

• Estimating the future day to day operations of the business entity

• Incorporating estimates made into the financial statements

Fundamentals

Budget: A quantitative financial plan for a period of time. It is prepared for future accounting periods. A budget is revised and modified on regular basis based upon the actual circumstances.

Master Budget: The combination of all budgets at various functional level is known as master budget. Master budget is usually prepared for the entire year. A master budget forms to be a very important management tool as it is used for evaluating the performance of various responsibility centers.

Sales Budget: The most important component of a master budget. A sales budget estimates the sales for a defined period in units as well in value. A sales budget is prepared after considering various economic conditions, past performances, activity level, production capacity of the entity etc.

Prepare a sales budget, by month and in total as shown below:

Calculate cash collections from sales as shown below:

Prepare a merchandise purchases budget in units and dollars as shown below:

Prepare a schedule of expected cash disbursement for merchandise purchases, by month and in total as shown below:

Prepare a schedule of expected cash disbursement for merchandise purchases, by month and in total as shown below:

Ans: Part 1.a

Sales budget in total is 2,826,200.

Part 1.b

Total collections are 2,626,000.

Part 1.c

Total required dollar purchases are $1,423,800.

Part 1.d

Total cash disbursements are $1,451,800.

Part 2

Ending balance of cash in April, May and June is $55,376, $55,352 and $81,428,

respectively.