Question

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)	21,200	June (budget)	51,200
February (actual)	27,200	July (budget)	31,200
March (actual)	41,200	August (budget)	29,200
April (budget)	66,200	September (budget)	26,200
May (budget)	101,200

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 $4.60 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	$	260,000
Rent	$	24,000
Salaries	$	118,000
Utilities	$	10,000
Insurance	$	3,600
Depreciation	$	20,000

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

The company plans to purchase $19,000 in new equipment during May and $46,000 in new equipment during June; both purchases will be for cash. The company declares dividends of $19,500 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	$	80,000
Accounts receivable ($43,520 February sales; $527,360 March sales)		570,880
Inventory		121,808
Prepaid insurance		24,000
Property and equipment (net)		1,010,000
Total assets	$	1,806,688
Liabilities and Stockholders’ Equity
Accounts payable	$	106,000
Dividends payable		19,500
Common stock		920,000
Retained earnings		761,188
Total liabilities and stockholders’ equity	$	1,806,688

The company maintains a minimum cash balance of $56,000. 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 $56,000 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 $56,000.

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

1.a. Sales Budget by month and in total

Particulars	April	May	June	Total
Sales in units( in pairs)	66200	101200	51200	218600
Selling price per unit(per pair)	$ 16	$ 16	$ 16	$ 16
Sales	$ 10,59,200	$ 16,19,200	$ 8,19,200	$ 34,97,600

b. Schedule of expected cash collections by month and in total

Particulars	April	May	June	Total
20% of Sales of the month collected In the same month	$ 211840 ($16*0.2*66200 units)	$ 323840 ($16*0.2*101200 units)	$ 163840 ($16*0.2*51200 units)	$ 699520
70% of sales is collected in the month Following the month of sales	$ 461440 ($16*0.7*41200 units)	$ 741440 ($16*0.7*66200 units)	$ 1133440 ($16*0.7*101200 units)	$2336320
10% of sales is collected in the second Month Following the month of sales	$ 43520 ($16*0.1*27200 units)	$ 65920 ($16*0.1*41200 units)	$ 105920 ($16*0.1*66200 units)	$ 215360
Collection Amount in dollars	$ 716,800	$ 11,31,200	$ 1403,200	$ 32,51,200

c. Merchandise Purchase Budget in units and dollars by the month and in total

Particulars	April	May	June	Total
Sales(units)	66200	101200	51200	218600
Add: Closing stock (units) (40% of the next month’s sales)	40480 (40%* 101200 Units)	20480 (40%*51200 Units)	12480 (40%*31200 Units)	12480
	106680	121,680	63680	231080
Less: Opening stock (units)	-26480 (Note 2)	-40480	-20480	-26480
Purchases (in units)	80200 pairs	81200 pairs	43200 pairs	204600 pairs
Purchase cost /pair	$ 4.60	$ 4.60	$ 4.60	$ 4.60
Total Merchandise Purchase In dollars	$ 3,68,920	$ 373520	$ 198720	$ 941160

Note 1: Sales+Closing stock of the month-opening stock of the month=Purchases of the month

Note 2: Opening Stock of April

= Closing stock of March

=40% of the sales of the month of April=0.4*66200 units=26480 units

d. Schedule of expected cash disbursements for merchandise purchase

Particulars	April	May	June	Total
Payment is made for 50% of the purchases in the same month	$ 184460 ($ 368920 *0.5)	$ 186760 $ 373520 *0.5)	$ 99360 $ 198720 *0.5)	$ 470580
50% of the amount for merchandise Purchase is made in the next month	$ 117760 (Note 3 Below)	$ 184460	$ 186760	$ 488980
Total Disbursements for Purchases	$ 302220	$ 371,220	$ 286120	$ 959,560

Note 3: March month’s purchases

Sales                        41200 units

Add: closing stock 26480 units

Less: opening stock16480 units( closing stock of February= 40% of march sales)

Purchases in units 51200 units

Purchases in dollars= 51200 units*$ 4.60=$ 235,520

50% of the merchandise purchase are paid in april=$ 117,760