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 comprehensive budgets for the upcoming second quarter in order to show management the benefits that can be gained from an integrated budgeting program. 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)	22,000	June (budget)	52,000
February (actual)	28,000	July (budget)	32,000
March (actual)	42,000	August (budget)	30,000
April (budget)	67,000	September (budget)	27,000
May (budget)	102,000

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 $5 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, with no discount, and payable within 15 days. The company has found, however, that 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	$	300,000
Rent	$	28,000
Salaries	$	126,000
Utilities	$	12,000
Insurance	$	4,000
Depreciation	$	24,000

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

The company plans to purchase $21,000 in new equipment during May and $50,000 in new equipment during June; both purchases will be for cash. The company declares dividends of $22,500 each quarter, payable in the first month of the following quarter.

A listing of the company’s ledger accounts as of March 31 is given below:

Assets
Cash	$	84,000
Accounts receivable ($44,800 February sales;    $537,600 March sales)		582,400
Inventory		134,000
Prepaid insurance		26,000
Property and equipment (net)		1,050,000
Total assets	$	1,876,400
Liabilities and Stockholders’ Equity
Accounts payable	$	110,000
Dividends payable		22,500
Common stock		1,000,000
Retained earnings		743,900
Total liabilities and stockholders’ equity	$	1,876,400

The company maintains a minimum cash balance of $60,000. 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 $60,000 in cash.

Required:
1.	Prepare a master budget for the three-month period ending June 30. Include the following detailed budgets:

a.	A sales budget, by month and in total.
	Earrings Unlimited Sales Budget April May June Quarter Budgeted unit sales 67,000 102,000 52,000 221,000 Selling price per unit $16 $16 $16 $16 Total sales $1,072,000 $1,632,000 $832,000 $3,536,000

               

b.	A schedule of expected cash collections from sales, by month and in total.
	Earrings Unlimited Schedule of Expected Cash Collections April May June Quarter February sales $44,800 0 0 $44,800 March sales 470,400 67,200 537,600 April sales 214,400 750,400 107,200 1,072,000 May sales 326,400 1,142,400 1,468,800 June sales 166,400 166,400 Total cash collections $729,600 $1,144,000 $1,416,000 $3,289,600

               

c.

A merchandise purchases budget in units and in dollars. Show the budget by month and in total. (Round "Unit cost" answers to 2 decimal places.)

Earrings Unlimited Merchandise Purchases Budget April May June Quater Budgeted unit sales 67,000 102,000 52,000 221,000 Add: Desired ending merchandise inventory 40,800 20,800 12,800 12,800 Total needs 107,800 122,800 64,800 233,800 Less: Beginning merchandise inventory 26,800 40,800 20,800 26,800 Required purchases 81,000 82,000 44,000 207,000 Unit cost $5.00 $5.00 $5.00 $5.00 Required dollar purchases $405,000 $410,000 $220,000 $1,035,000

               

d.	A schedule of expected cash disbursements for merchandise purchases, by month and in total.
	Earrings Unlimited Budgeted Cash Disbursements for Merchandise Purchases April May June Quarter Accounts payable $110,000 $110,000 April purchases 202,500 202,500 405,000 May purchases 205,000 205,000 410,000 June purchases 110,000 110,000 Total cash payments $312,500 $407,500 $315,000 1,035,000

               

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 $60,000 (Cash deficiency, repayments and interest should be indicated by a minus sign.)

        

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

2.

Earrings Unlimited
Cash Budget
For the Three Months Ending June 30
	April	May	June	Quarter
Beginning cash balance $	84000	60720	244940	84000
Add collections from customers	729600	1144000	1416000	3289600
Total cash available	813600	1204720	1660940	3373600
Less cash disbursements:
Merchandise purchases	312500	407500	315000	1035000
Advertising	300000	300000	300000	900000
Rent	28000	28000	28000	84000
Salaries	126000	126000	126000	378000
Commissions	42880	65280	33280	141440
Utilities	12000	12000	12000	36000
Equipment purchases	0	21000	50000	71000
Dividends paid	22500	0	0	22500
Total cash disbursements	843880	959780	864280	2667940
Excess (deficiency) of cash available over disbursements	-30280	244940	796660	705660
Financing:
Borrowings	91000	0	0	91000
Repayments	0	0	-91000	-91000
Interest	0	0	-2730	-2730
Total financing	91000	0	-93730	-2730
Ending cash balance $	60720	244940	702930	702930

Interest = $91000 x 1% x 3 months = $2730

3.

Earrings Unlimited
Budgeted Income Statement
For the Three Months Ending June 30
Sales		3536000
Variable expenses:
Cost of goods sold (221000 x $5)	1105000
Commissions	141440
Total variable expenses		1246440
Contribution margin		2289560
Fixed expenses:
Advertising	900000
Insurance ($4000 x 3)	12000
Depreciation ($24000 x 3)	72000
Rent	84000
Utilities	36000
Salaries	378000
Total fixed expenses		1482000
Net operating income		807560
Interest expense		2730
Net income		804830

4.

Earrings Unlimited
Budgeted Balance Sheet
June 30
Assets
Cash	702930
Accounts receivable	828800
Inventory (12800 x $5)	64000
Prepaid insurance ($26000 - $12000)	14000
Property and equipment, net ($1050000 + $71000 - $72000)	1049000
Total assets	2658730
Liabilities and Stockholders' Equity
Accounts payable	110000
Dividends payable	22500
Common stock	1000000
Retained earnings ($743900 + $804830 - $22500)	1526230
Total liabilities and stockholders' equity	2658730