Question

Durianx Inc. distributes a electronic chessboards The following information was gathered to prepare the budget for the third quarter.

• Each unit of chessboard is budgeted to sell for an average price of $175. Unit sales are expected to be as follows:

June	9,600 Units
July	9,700 Units
August	10,500 Units
September	11,900 Units
October	12,000 Units

•Sales are made for cash and on credit. The following collection pattern is used to estimate monthly cash collections:

Cash sales	30%
Credit sales—month of sale	40%
Credit sales—month after sale	26%
Uncollectible	4%
Total	100%

•The company tries to maintain an inventory of 20% of the following month's sales. The company expects to have 1,940 Units on hand on June 30. Durianx pays an average of $125 per Units.

•The company pays for 60% of its purchases in the month of purchase and the remaining 40% in the month after purchase.

•The following monthly selling and administrative expenses are planned for t­­he quarter.

	July	Aug	Sept
Depreciation	$10,000	$20,000	$20,000
Rent	30,000	30,000	30,000
Advertising	50,000	50,000	50,000
Salaries	350,000	350,000	370,000
Bad debts	67,900	73,500	83,300

•On August 1^st , the company plans to purchase $500,000 of new office equipment and a delivery truck. Additional depreciation is already accounted for in the above selling and administrative expenses.

• Durianx will collect the full $436,800 accounts receivable balance of June 30^th in July. Durianx will pay the $481,000 of June Accounts Payable in July.

•Durianx wants to maintain a minimum cash balance of $40,000. An open line of credit at a local bank allows the company to borrow up to $500,000 per quarter in $1,000 increments.

•All borrowing is done at the beginning of the month, and all repayments are made at the end of a month in $1,000 increments. Accrued interest on the loan is paid only when principal is repaid. The interest rate is 12% per year. This means that if the loan is not reimbursed during the quarter then no interest expense is paid during that time.

•Durianx's tax rate is 30%.

•The June 30 balance sheet is budgeted as follows:

	June 30
Cash	$  70,000
Accounts receivable	436,800
Inventory	242,500
Plant & equipment	600,000
Accumulated depreciation	(150,000)
Total assets	$ 1,199,300
Accounts payable	$ 481,000
Common stock	200,000
Retained earnings	518,300
Total liabilities and equities	$ 1,199,300

Required (Please answer A AND B)

1. Prepare all components of Durianx's master budget for the third quarter (Sales Budget, Selling and Administrative Expense Budget, Inventory Purchases Budget, Ending Inventory Budget, Cash Receipts Budget, Cash Payments for Inventory Budget, and Cash Budget)

Prepare a pro-forma income statement for the third quarter.

Prepare a pro-forma balance sheet as of September 30.

2. Sales manager proposes to decrease the selling price of each unit by $20, to $155. The decrease in the selling price will result in an increase in the number of unit sold by 15%.
   1. Which type of expense do you expect to increase with 15% increase in number of units sold? Which type of expense do you expect to remain unchanged? Explain and give one example for each type of expense.
   2. What will be the net effect on Cash and Net income before income taxes for the quarter ending September 30th? Would you recommend management to implement this proposal? Explain

Answer 1

A: Preparation of Budgets and Proforma Income Statement and Balance Sheet

1.

Sales Budget
Month	Units	Unit Price	Sales Value
July	9,700	175	$                                         1,697,500
August	10,500	175	$                                         1,837,500
September	11,900	175	$                                         2,082,500
	32,100		$                                         5,617,500

2.

Selling and Administrative Expenses Budget
Month	Depreciation	Rent	Advertising	Salaries	Bad Debts
July	10,000	30,000	50,000	350,000	67,900
August	20,000	30,000	50,000	350,000	73,500
September	20,000	30,000	50,000	370,000	83,300
	50,000	90,000	150,000	1,070,000	224,700

3.

Inventory Purchase Budget (In Units and in Dollars)
	July	August	September
Next Month's Sales	10,500	11,900	12,000
Ratio of Closing Inventory to Next Month's Sales	20%	20%	20%
Closing Inventory	2,100	2,380	2,400
Consumption of Units	9,700	10,500	11,900
Opening Inventory (Closing of Preceeding Month)	1940	2100	2380
Purchase of Units (Consumption of Units - Opening Inventory +Closing Inventory)	9,860	10,780	11,920
Purchase in Dollars	$                           1,232,500	$                1,347,500	$                                         1,490,000

4.

Ending Inventory Budget
	July	August	September
Next Month's Sales	10,500	11,900	12,000
Ratio of Closing Inventory to Next Month's Sales	20%	20%	20%
Closing Inventory	2,100	2,380	2,400

5.

Cash Receipts Budget
	Sales	Total Sales Value	July	August	September
June	9600	$                                      1,680,000	$                              436,800	$                                  -	$                                                          -
July	9700	$                                      1,697,500	$                           1,188,250	$                    441,350	$                                                          -
August	10500	$                                      1,837,500		$                1,286,250	$                                             477,750
September	11900	$                                      2,082,500	$                                            -	$                                  -	$                                         1,457,750
TOTAL CASH RECEIPTS	$                           1,625,050	$                1,727,600	$                                         1,935,500

6.

Cash Payments for Inventory Budget
	Purchase (In Units)	Total Purchase Value	July	August	September
June	9620	$                                      1,202,500	$                           481,000.0	$                                 -	$                                                         -
July	9860	$                                      1,232,500	$                           739,500.0	$                493,000.0	$                                                         -
August	10780	$                                      1,347,500	$                                           -	$                808,500.0	$                                         539,000.0
September	11920	$                                      1,490,000	$                                           -	0	$                                         894,000.0
TOTAL CASH PAYMENTS FOR INVENTORY PURCHASES	$                       1,220,500.0	$             1,301,500.0	$                                     1,433,000.0

7.

Cash Budget
	July	August	September
Opening Cash Balance	$                           70,000	$                                            44,550	$                                 40,650
Cash Receipts	$                     1,625,050	$                                      1,727,600	$                           1,935,500
Cash Payments:
Inventory Purchases	$                  (1,220,500)	$                                    (1,301,500)	$                        (1,433,000)
Selling And Administrative Expenses (Excluding Depreciation and Bad Debts)	$                      (430,000)	$                                        (430,000)	$                            (450,000)
Purchase of New Office Equipment and Deliver Truck	$                                      -	$                                        (500,000)	$                                            -
Balance	$                           44,550	$                                        (459,350)	$                                 93,150
Add: Borrowing	$                                      -	$                                          500,000	$                                            -
Repayment:	$                                      -	$                                                        -	$                                            -
Closing Cash Balance	$                           44,550	$                                            40,650	$                                 93,150

8.

Income Statement
Sales	$          5,617,500
COGS	$        (4,012,500)
Gross Income	$          1,605,000
Less:
Depreciation	$              (50,000)
Rent	$              (90,000)
Advertising	$           (150,000)
Salaries	$        (1,070,000)
Bad Debts	$           (224,700)
Interest	$              (10,000)
Total Expenses	$        (1,594,700)
Net Income Before Tax	$                10,300
Less: Tax @ 30%	$                (3,090)
Net Income After Tax	$                  7,210

Working Note:

a. Interest Expense for 2 Months has been calculated as Borrowings are made in the beginning of the Months.

9.

Balance Sheet
Cash	93,150
Accounts Receivables	541,450
Inventory	300,000
Plant and Equipment	1,100,000
Less: Accumulated Depreciation	(200,000)
TOTAL ASSETS	1,834,600
Borrowings from Bank	500,000
Tax Payable	3,090
Accrued Interest Payable	10,000
Accounts Payable	596,000
Common Stock	200,000
Retained Earnings	525,510
TOTAL LIABILITIES AND EQUITIES	1,834,600

Working Note:

a. For Accounts Receivable only the 26% Sales of September will be Receivable.
b. For Accounts Payable only 40% Purchases of September will be Payable.
c. Borrowings from Bank remains unpaid at the end of Quarter.
d. Since there is no Repayment of Borrowings Accrued Interest reamins Unpaid.
e.Borrowings are made in Increments of $ 1,000 Therefore Requirement was for $ 499,350 but Borrowing was done for $ 500,000.

B.

Due to Increase in Decrease in Selling Price there will be an increase in Quantity Sold. This will lead to change in Number of Units Purchase which is a Variable Component means it changes in Proprtion to the Change in Sales Units.
The Fixed Charges like Rent, Advertising, Salaries will remains unchanged as are Fixed Expenses i.e. No effect due to Changes in Sales.

C. Net Effect on Cash and Net Income :

Cash Budget
	July	August	September
Opening Cash Balance	$                           70,000	$                                            40,000	$                            (271,349)
Cash Receipts	$                     1,647,118	$                                      1,759,684	$                           1,971,445
Cash Payments:
Inventory Purchases	$                  (1,353,250)	$                                    (1,534,900)	$                        (1,690,475)
Selling And Administrative Expenses (Excluding Depreciation and Bad Debts)	$                      (430,000)	$                                        (430,000)	$                            (450,000)
Purchase of New Office Equipment and Deliver Truck	$                                      -	$                                        (500,000)	$                                            -
Balance	$                        (66,133)	$                                        (665,217)	$                            (440,379)
Add: Borrowing	$                        106,132	$                                          393,868	$                                            -
Repayment:	$                                      -	$                                                        -	$                                            -
Closing Cash Balance	$                           40,000	$                                        (271,349)	$                            (440,379)

Income Statement
Sales	$          5,721,825
COGS	$        (4,614,375)
Gross Income	$          1,107,450
Less:
Depreciation	$              (50,000)
Rent	$              (90,000)
Advertising	$           (150,000)
Salaries	$        (1,070,000)
Bad Debts	$           (228,873)
Interest	$              (11,061)
Total Expenses	$        (1,599,934)
Net Income Before Tax	$           (492,484)
Less: Tax @ 30%	$              147,745
Net Income After Tax	$           (344,739)