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—$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, 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	$	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.

A listing of the company’s ledger accounts 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:

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

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. (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

SOLUTION

1.	a.	Sales budget:
			April	May	June	Quarter
		Budgeted unit sales.............	65,000	100,000	50,000	215,000
		Selling price per unit............	× $10	× $10	× $10	× $10
		Total sales.............................	$650,000	$1,000,000	$500,000	$2,150,000
	b.	Schedule of expected cash collections:
		February sales (10%)............	$ 26,000			$    26,000
		March sales (70%, 10%).......................	280,000	$ 40,000		320,000
		April sales (20%, 70%, 10%).............	130,000	455,000	$ 65,000	650,000
		May sales (20%, 70%).......................		200,000	700,000	900,000
		June sales (20%)...................			100,000	100,000
		Total cash collections...........	$436,000	$695,000	$865,000	$1,996,000
	c.	Merchandise purchases budget:
		Budgeted unit sales.............	65,000	100,000	50,000	215,000
		Add desired ending merchandise inventory.....	40,000	20,000	12,000	12,000
		Total needs...........................	105,000	120,000	62,000	227,000
		Less beginning merchandise inventory..........................	26,000	40,000	20,000	26,000
		Required purchases..............	79,000	80,000	42,000	201,000
		Cost of purchases at $4 per unit...................................	$316,000	$320,000	$168,000	$  804,000

	d.	Budgeted cash disbursements for merchandise purchases:
		Accounts payable..................	$100,000			$  100,000
		April purchases......................	158,000	$158,000		316,000
		May purchases.......................		160,000	$160,000	320,000
		June purchases.......................			84,000	84,000
		Total cash payments..............	$258,000	$318,000	$244,000	$  820,000

2.	Earrings Unlimited
	Cash Budget
	For the Three Months Ending June 30
	April	May	June	Quarter
Beginning cash balance..................	$ 74,000	$ 50,000	$ 50,000	$   74,000
Add collections from customers....	436,000	695,000	865,000	1,996,000
Total cash available.........................	510,000	745,000	915,000	2,070,000
Less cash disbursements:
Merchandise purchases...............	258,000	318,000	244,000	820,000
Advertising.................................	200,000	200,000	200,000	600,000
Rent............................................	18,000	18,000	18,000	54,000
Salaries........................................	106,000	106,000	106,000	318,000
Commissions (4% of sales).........	26,000	40,000	20,000	86,000
Utilities.......................................	7,000	7,000	7,000	21,000
Equipment purchases..................	0	16,000	40,000	56,000
Dividends paid...........................	15,000	0	0	15,000
Total cash disbursements................	630,000	705,000	635,000	1,970,000
Excess (deficiency) of cash available over disbursements......	(120,000)	40,000	280,000	100,000
Financing:
Borrowings.................................	170,000	10,000	0	180,000
Repayments................................	0	0	(180,000)	(180,000)
Interest ($170,000 × 1% × 3 + $10,000 × 1% × 2)................................	0	0	(5,300)	(5,300)
Total financing................................	170,000	10,000	(185,300)	(5,300)
Ending cash balance.......................	$ 50,000	$ 50,000	$ 94,700	$   94,700

3.	Earrings Unlimited
	Budgeted Income Statement
	For the Three Months Ended June 30
	Sales (see requirement 1a.).............................................		$2,150,000
	Variable expenses:
	Cost of goods sold (@ $4 per unit)............................	$860,000
	Commissions @ 4% of sales.......................................	86,000	946,000
	Contribution margin.......................................................		1,204,000
	Fixed expenses:
	Advertising ($200,000 × 3).........................................	600,000
	Rent ($18,000 × 3)......................................................	54,000
	Salaries ($106,000 × 3)...............................................	318,000
	Utilities ($7,000 × 3)...................................................	21,000
	Insurance ($3,000 × 3)................................................	9,000
	Depreciation ($14,000 × 3).........................................	42,000	1,044,000
	Net operating income.....................................................		160,000
	Interest expense (see requirement 2)..............................		5,300
	Net income.....................................................................		$  154,700

4.	Earrings Unlimited
	Budgeted Balance Sheet
	June 30
	Assets
	Cash (see requirement 2)................................................................................	$    94,700
	Accounts receivable (see below)....................................................................	500,000
	Inventory (12,000 units @ $4 per unit).........................................................	48,000
	Prepaid insurance ($21,000 – $9,000)...........................................................	12,000
	Property and equipment, net ($950,000 + $56,000 – $42,000)................................................................	964,000
	Total assets.....................................................................................................	$1,618,700
	Liabilities and Stockholders’ Equity
	Accounts payable, purchases (50% × $168,000)...........................................	$     84,000
	Dividends payable.........................................................................................	15,000
	Common stock...............................................................................................	800,000
	Retained earnings (see below).......................................................................	719,700
	Total liabilities and stockholders’ equity........................................................	$1,618,700

	Accounts receivable at June 30:
	10% × May sales of $1,000,000...............................	$100,000
	80% × June sales of $500,000..................................	400,000
	Total.........................................................................	$500,000
	Retained earnings at June 30:
	Balance, March 31...................................................	$580,000
	Add net income (see requirement 3)........................	154,700
	Total.........................................................................	734,700
	Less dividends declared..........................................	15,000
	Balance, June 30......................................................	$719,700