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) 23,400     June (budget) 53,400

February (actual) 29,400    July (budget) 33,400

March (actual) 43,400      August (budget) 31,400

April (budget) 68,400      September (budget) 28,400

May (budget) 103,400  

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 $5.70 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 $370,000

Rent $35,000

Salaries $140,000

Utilities $15,500

Insurance $4,700

Depreciation $31,000

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

The company plans to purchase $24,500 in new equipment during May and $57,000 in new equipment during June; both purchases will be for cash. The company declares dividends of $27,750 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                                       $91,000

Accounts receivable ($47,040 February sales; $555,520 March sales) 602,560

Inventory                                  155,952

Prepaid insurance                           29,500

Property and equipment (net)                1,120,000

Total assets                               $1,999,012

Liabilities and Stockholders’ Equity

Accounts payable                           $117,000

Dividends payable                           27,750

Common stock                               1,140,000

Retained earnings                           714,262

Total liabilities and stockholders’ equity $1,999,012

The company maintains a minimum cash balance of $67,000. 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 $67,000 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 $67,000.

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:

	April	May	June	Quarter
Unit Sales	68,400	103,400	53,400	225,200
Selling Price	$ 16	$ 16	$ 16	$ 16
Dollar Sales	$ 1,094,400	$ 1,654,400	$ 854,400	$ 3,603,200

b. Schedule of expected cash collections:

	April	May	June	Quarter
Collection of
February Sales	47,040			47,040
March Sales	486,080	69,440		555,520
April Sales	218,880	766,080	109,440	1,094,400
May Sales		330,880	1,158,080	1,488,960
June Sales			170,880	170,880
Totals	$ 752,000	$ 1,166,400	$ 1,438,400	$ 3,356,800

c. Merchandise Purchases Budget:

	April	May	June	July
Sales in units	68,400	103,400	53,400	33,400
Desired ending inventory	41,360	21,360	13,360
Total inventory needs	109,760	124,760	66,760
Less: Beginning inventory	27,360	41,360	21,360
Budgeted purchases in units	82,400	83,400	45,400
Unit cost	$ 5.70	$ 5.70	$ 5.70
Budgeted Dollar Purchases	$ 469,680	$ 475,380	$ 258,780

d. Schedule of Expected Cash Disbursements for Merchandise Purchases:

	April	May	June	Quarter
Cash disbursements for the purchases of
March	117,000			117,000
April	234,840	234,840		469,680
May		237,690	237,690	475,380
June			129,390	129,390
Totals	$ 351,840	$ 472,530	$ 367,080	$ 1,191,450

2.

Earrings Unlimited
Cash Budget
For the Quarter ended June 30
	April	May	June	Quarter
	$	$	$	$
Beginning cash balance	91,000	67,134	109,828	91,000
Add: Cash receipts	752,000	1,166,400	1,438,400	3,356,800
Total cash available	843,000	1,233,534	1,548,228	3,447,800
Less: Cash Disbursements for
Merchandise Purchases	351,840	472,530	367,080	1,191,450
Sales Commissions	43,776	66,176	34,176	144,128
Advertising	370,000	370,000	370,000	1,110,000
Rent	35,000	35,000	35,000	105,000
Salaries	140,000	140,000	140,000	420,000
Utilities	15,500	15,500	15,500	46,500
Purchase of Equipment	0	24,500	57,000	81,500
Dividends	27,750	0	0	27,750
Total Cash Disbursements	983,866	1,123,706	1,018,756	3,126,328
Cash Surplus ( Deficiency)	(140,866)	109,828	529,472	321,472
Financing:
Borrowing	208,000			208,000
Repayment			(208,000)	(208,000)
Interest			(6,240)	(6,240)
Total Financing	208,000	208,000	(214,240)	(6,240)
Ending Cash Balance	67,134	109,828	315,232	315,232

Income Statement:

Earrings Unlimited
Budgeted Income Statement
For the quarter ended June 30
	$	$
Sales		3,603,200
Less: Variable Expenses
Variable Cost of Goods Sold ( 225,200 x 5.70)	1,283,640
Sales Commission Expense	144,128	1,427,768
Contribution Margin		2,175,432
Fixed Expenses
Advertising Expense	1,110,000
Salaries Expense	420,000
Rent Expense	105,000
Insurance Expense	14,100
Utilities Expense	46,500
Depreciation Expense	93,000	1,788,600
Income from Operations		386,832
Less: Interest Expense		6,240
Net Income		380,592

3. Balance Sheet:

Earrings Unlimited
Budgeted Balance Sheet
June 30
Assets	$
Cash	315,232
Accounts Receivable	848,960
Inventory	76,152
Prepaid Insurance	15,400
Property and Equipment, net	1,108,500
Total Assets	$ 2,364,244
Liabilities and Stockholders' Equity	$
Accounts Payable	129,390
Dividends Payable	27,750
Common Stock	1,140,000
Retained Earnings	1,067,104
Total Liabilities and Stockholders' Equity	$ 2,364,244