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—$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. 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.

The company’s balance sheet 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:

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 $50,000.

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
	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 inventory (40% of the next month’s unit sales)	40,000	20,000	12,000	12,000
	Total needs	105,000	120,000	62,000	227,000
	Less beginning 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
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 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 disbursements	630,000	705,000	635,000	1,970,000
Excess (deficiency) of receipts 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)
Cash balance, ending	$ 50,000	$ 50,000	$ 94,700	$  94,700

3.

Earrings Unlimited

Budgeted Income Statement

For the Three Months Ended June 30

Sales (Part 1 a.)		$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 (Part 2)		5,300
Net income		$  154,700

4.

Earrings Unlimited

Budgeted Balance Sheet

June 30

Assets
Cash	$    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
Capital 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 (part 3)	154,700
Total	734,700
Less dividends declared	15,000
Balance, June 30	$719,700