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:

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

Master Budget - this includes all the lower level budgets eg. sales budget, production budget, cash collection forecast etc.

First of all, we will compute the sales and accounts receivables balance which will be required for the purpose of balance sheet. -

Accounts Receivables -

817,280 of accounts receivables consists of 80% of the june sale and 10% of the sale in May.

80% of 819,200 = 655,360 and 10% of 1,619,200 = 161,920 total 655360+161920 = 817280.

Purchase Budget - (number of Pairs required to be Purchased and value of purchase)

to compute the purchase pairs, we simply need to take the units sold+closing inventory. The total of these must have been purchased if there would not be any oopening units. if there is any openings units we need to deduct the same to reach to the units purchased. this is what we did above.

Schedule of cash payment to suppliers-

Cash Budget -

.

Note 1 - depreciation is not a cash expenditue hence excluded. Also, insurance is paid in November only hence excluded.

NOte 2 - In Apr, the balance remainign is 32,472 but the minimum required is 56,000. The shortage is 56,000-32472 = 23,528. Hence we need to borrow in multiple of 1,000 i.e. 24,000. This will be borrowed on 1st of May as given and interest will be paid @1% for May and June month. Interest will be 24,000*1%*2months = 480.

Note 3 - Closing will become opening in the next month.

Budgeted Income statement -

Balance Sheet -

PLease let me know if you any questions. The question is a bit lengthy and we had to make all these multiple schedules to compute the final balance sheet numbes.

Ask if there is anything.

Thanks