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 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—$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 $4.6 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, 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		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.

A listing of the company’s ledger accounts 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.

2. A cash budget. Show the budget by month and in total. (Cash deficiency, repayments and interest should be indicated by a minus sign.)

  

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

Required Budgets and working notes are as prepared below:

Earings unlimited
Cash Budget
For the quarter ended June 30
	Month
Particulars	April	May	June	Total
Beginning Cash balance	80,000	56,472	320,684	80,000
Add: Collection from customers	$716,800	$1,131,200	$1,403,200	$3,251,200
cash available for use	$796,800	$1,187,672	$1,723,884	$3,331,200
Less: cash Disbursements
Merchandise purchase	$290,460	$371,220	$286,120	947,800
Advertising	260,000	260,000	260,000	780,000
Rent	24,000	24,000	24,000	72,000
Salaries	118,000	118,000	118,000	354,000
Commissions	42,368	64,768	32,768	139,904
Utilities	10,000	10,000	10,000	30,000
Equipment purchase		19,000	46,000	65,000
Dividend paid	19,500			19500
Total disbusrement	764,328	866,988	776,888	2,408,204
Cash surplus/Deficit	32,472	320,684	946,996	922,996
Financing
Borrowing	24,000			24,000
Repayment			-24,000	-24,000
Interest			-480	-480
Net cash from Financing	24,000	0	-24,480	-480
Budgeted ending cash balance	56,472	320,684	922,516	922,516
Earings Unlimited
Budgeted Income Statement
For the three month ended June 30
Particulars	Amount ($)	Amount ($)
Sales		3,497,600
Less: Cost of goods sold (218,600*4.6)		1,005,560
Variable expenses:
Commissions	139,904
Interest expense	480
Insurance (3,600*3)	10,800
		151,184
Contribution Margin		2,340,856
Fixed Expenses:
Advertising	780,000
Rent	72,000
Salaries	354,000
Depreciation (20,000*3)	60,000
Utilities	30,000	1,296,000
Net operating Income		1,044,856
Dividend Paid		19,500
Net Income		1,025,356
Earings Unlimited
Budgeted balance Sheet
Jun-30
Assets
Cash	922,516
Accounts Receivable	817,280
Inventory (12,480*4.6)	57,408
Property and equipment Net (1,010,000+19,000+46,000-60,000)	1,015,000
Prepaid insurance (24,000-10,800)	13,200
Total assets	2,825,404
Liabilities and Stockholders' Equity
Accounts Payable purchases	99,360
Dividend payable	19,500
Common Stock	920,000
Retained earnings (761,188+1,025,356)	1,786,544
Total liabilities and stockholders' equity	2,825,404

Working Notes:

1a
Earings unlimited
Sales Budget
For the quarter ended June 30
	Month
Particulars	April	May	June	Total
Budgeted Unit sales	66,200	101,200	51,200	218,600
Sale Price	16	16	16	16
Budgeted sales	1,059,200	1,619,200	819,200	3,497,600
1b.
Earings unlimited
Schedule of expected Cash collections
For the quarter ended June 30
	Month
Particulars	April	May	June	Total
Beginning Accounts Receivable
February sales (27,200*16*10%)	43,520			43,520
March sales (41,200*16*70%)	461,440			461,440
March sales (41,200*16*10%)		65,920		65,920
April Credit Sales	211,840	741,440	105,920	1,059,200
May Credit Sales		323,840	1,133,440	1,457,280
June Credit sales			163,840	163,840
Total collections	716,800	1,131,200	1,403,200	3,251,200
Account receivable for June Sale			655,360
Account receivable for May Sale			161,920
1c.
Earings unlimited
Merchandise Purchase Budget
For the quarter ended June 30
	Month
Particulars	April	May	June	Total	July
Budgeted Unit Sales	66,200	101,200	51,200	218,600	31,200
Add: Desired Ending merchandise inventory (40% of next month sales)	40,480	20,480	12,480	12,480
Total needs	106,680	121,680	63,680	231,080
Less: beginning merchandise inventory	26,480	40,480	20,480	26,480
Required purchase	80,200	81,200	43,200	204,600
Unit Cost	4.6	4.6	4.6	4.6
Required dollar purchases	$368,920	$373,520	$198,720	$941,160
1d.
Earings unlimited
Schedule of expected Cash payments
For the quarter ended June 30
	Month
Particulars	April	May	June	Total
Beginning Accounts Payable (a)	$106,000			$106,000
April Purchases (b)	$184,460	$184,460		$368,920
May Purchases (c )		$186,760	$186,760	$373,520
June Purchases (d)			$99,360	$99,360	$99,360
Total payments (a+b+c+d)	$290,460	$371,220	$286,120	$947,800
Earings unlimited
Commission
For the quarter ended June 30
	Month
Particulars	April	May	June	Total
Budgeted Unit sales	66,200	101,200	51,200	218,600
Sale Price	16	16	16	16
Budgeted sales	1,059,200	1,619,200	819,200	3,497,600
Sales commisssions (4% of sales)	42,368	64,768	32,768	139,904