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—$19 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)	23,000	June (budget)	53,000
February (actual)	29,000	July (budget)	33,000
March (actual)	43,000	August (budget)	31,000
April (budget)	68,000	September (budget)	28,000
May (budget)	103,000

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 $5.50 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	$	350,000
Rent	$	33,000
Salaries	$	136,000
Utilities	$	14,500
Insurance	$	4,500
Depreciation	$	29,000

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

The company plans to purchase $23,500 in new equipment during May and $55,000 in new equipment during June; both purchases will be for cash. The company declares dividends of $26,250 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	$	89,000
Accounts receivable ($55,100 February sales; $653,600 March sales)		708,700
Inventory		149,600
Prepaid insurance		28,500
Property and equipment (net)		1,100,000
Total assets	$	2,075,800
Liabilities and Stockholders’ Equity
Accounts payable	$	115,000
Dividends payable		26,250
Common stock		1,100,000
Retained earnings		834,550
Total liabilities and stockholders’ equity	$	2,075,800

The company maintains a minimum cash balance of $65,000. 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 $65,000 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 $65,000.

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	Total
Budgeted unit sales	68,000	103,000	53,000	224,000
Unit sales price	$ 19	$ 19	$ 19	$ 19
Budgeted dollar sales	$ 1,292,000	$ 1,957,000	$ 1,007,000	$ 4,256,000

b. Schedule of Expected Cash Collections:

	April	May	June	Total
Collections of sales of	$	$	$	$
February	55,100			55,100
March	571,900	81,700		653,600
April	258,400	904,400	129,200	1,292,000
May		391,400	1,369,900	1,761,300
June			201,400	201,400
Totals	$ 885,400	$ 1,377,500	$ 1,700,500	$ 3,963,400

c. Merchandise Purchases Budget:

	April	May	June	Total
Budgeted unit sales	68,000	103,000	53,000	224,000
Add: Desired ending inventory ( 40% of next month sales)	41,200	21,200	13,200	13,200
Total needs	109,200	124,200	66,200	237,200
Less: Beginning inventory	27,200	41,200	21,200	27,200
Budgeted unit purchases	82,000	83,000	45,000	210,000
Cost per unit	$ 5.50	$ 5.50	$ 5.50	$ 5.50
Budgeted dollar pruchases	$ 451,000	$ 456,500	$ 247,500	$ 1,155,000

d. Schedule of Expected Cash Disbursements for Merchandise Purchases:

	April	May	June	Total
Cash disbursements of purchases of	$	$	$	$
March	115,000	0	0	115,000
April	225,500	225,500		451,000
May		228,250	228,250	456,500
June			123,750	123,750
Totals	340,500	453,750	352,000	1,146,250

2. Earrings Unlimited

Cash Budget

For the quarter ended June 30

	April	May	June	Total
	$	$	$	$
Beginning cash balance	89,000	65,470	353,940	89,000
Add: Cash receipts	885,400	1,377,500	1,700,500	3,963,400
Total cash available	974,400	1,442,970	2,054,440	4,052,400
Less: Cash disbursements for
Merchandise Purchases	340,500	453,750	352,000	1,146,250
Sales Commissions	51,680	78,280	40,280	170,240
Advertising	350,000	350,000	350,000	1,050,000
Rent	33,000	33,000	33,000	99,000
Salaries	136,000	136,000	136,000	408,000
Utilities	14,500	14,500	14,500	43,500
Equipment	0	23,500	55,000	78,500
Dividends	26,250	0	0	26,250
Total cash disbursement	951,930	1,089,030	980,780	3,021,740
Cash surplus ( deficiency)	22,470	353,940	1,073,660	1,030,660
Financing
Borrowing	43,000	0	0	43,000
Repayment	0	0	43,000	(43,000)
Interest	0	0	1,290	1,290
Total financing	43,000	43,000
Ending cash balance	65,470	353,940	1,029,370	1,029,370

3. Earrings Unlimited

Budgeted Income Statement

For the quarter ended June 30

	$	$
Sales		4,256,000
Less: Variable Costs
Cost of Goods Sold	1,232,000
Sales Commission Expense	170,240
Total Variable Costs		1,402,240
Contribution Margin		2,853,760
Less: Fixed Operating Expenses
Advertising Expense	1,050,000
Rent Expense	99,000
Salaries Expense	408,000
Utilities Expense	43,500
Insurance Expense	13,500
Depreciation Expense	87,000
Total Fixed Operating Expenses		1,701,000
Net Operating Income		1,152,760
Interest Expense		1,290
Net Income		1,151,470

4. Earrings Unlimited

Budgeted Balance Sheet

June 30

Assets	$
Cash	1,029,370
Accounts Receivable ($ 195,700 May sales, $ 805,600 June sales)	1,001,300
Inventory ( 13,200 units at $ 5.50 per unit)	72,600
Prepaid Insurance	15,000
Property and Equipment, net	1,091,500
Total Assets	$ 3,209,770
Liabilities and Stockholders' Equity	$
Accounts Payable	123,750
Dividends Payable	26,250
Common Stock	1,100,000
Retained Earnings	1,959,770
Total Liabilities and Stockholders' Equity	3,209,770