Question

Lois Bragg owns a small restaurant in Boston. Ms. Bragg provided her accountant with the following summary information regarding expectations for the month of June. The balance in accounts receivable as of May 31 is $40,000. Budgeted cash and credit sales for June are $100,000 and $250,000, respectively. Credit sales are made through Visa and MasterCard and are collected rapidly. Eighty percent of credit sales is collected in the month of sale, and the remainder is collected in the following month. Ms. Bragg's suppliers do not extend credit. Consequently, she pays suppliers on the last day of the month. Cash payments for June are expected to be $330,000. Ms. Bragg has a line of credit that enables the restaurant to borrow funds on demand; however, they must be borrowed on the last day of the month. Interest is paid in cash also on the last day of the month. Ms. Bragg desires to maintain a $15,000 cash balance before the interest payment. Her annual interest rate is 9 percent.

A. Compute the amount of funds Ms. Bragg needs to borrow for June.

B.Determine the amount of interest expense the restaurant will report on the June pro forma income statement.

C.What amount will the restaurant report as interest expense on the July pro forma income statement?

Answer 1

a) Calculation of amount to be borrowed (Amount in $)

1) Cash Collections
2) Collection from May's receivables balance	40,000
3) Collection from June's credit sales ($250,000*80%)	200,000
4) Cash Sales from June	100,000
5) Total Cash Receipts (2+3+4)		340,000
6) Desired Cash balance	15,000
7) Cash disbursements	330,000
8) Total cash needs		345,000
9) Cash shortage (Amount needed to be borrowed) (8-5)		5,000

Therefore the amount of funds that Ms. Bragg needs to borrow for June is $5,000.

b) The amount of interest expense the restaurant will report on the June pro forma income statement is zero ($0) because the amount is borrowed on the last day of June. Hence there will be no accrual of interest on the last day of June.

Interest Expense (June) = $0

c) The amount of interest expense that will be reported on the July pro forma income statement will be equal to 9% of the amount borrowed for one month. The interest expense for July is calculated as follows:-

Interest Expense (July) = Amount borrowed * 9% * 1/12 months

= $5,000 * 9% * 1/12 = $37.50