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—$18 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)	22,800	June (budget)	52,800
February (actual)	28,800	July (budget)	32,800
March (actual)	42,800	August (budget)	30,800
April (budget)	67,800	September (budget)	27,800
May (budget)	102,800

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 $5.4 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, 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	$	340,000
Rent	$	32,000
Salaries	$	134,000
Utilities	$	14,000
Insurance	$	4,400
Depreciation	$	28,000

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

The company plans to purchase $23,000 in new equipment during May and $54,000 in new equipment during June; both purchases will be for cash. The company declares dividends of $25,500 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	$	88,000
Accounts receivable ($51,840 February sales;$616,320 March sales)		668,160
Inventory		146,448
Prepaid insurance		28,000
Property and equipment (net)		1,090,000
Total assets	$	2,020,608
Liabilities and Stockholders’ Equity
Accounts payable	$	114,000
Dividends payable		25,500
Common stock		1,080,000
Retained earnings		801,108
Total liabilities and stockholders’ equity	$	2,020,608

The company maintains a minimum cash balance of $64,000. 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 $64,000 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.

	Sales Budget April May June Quarter Budgeted unit sales 67,800 102,800 52,800 223,400 Selling price per unit $18 $18 $18 $18 Total sales $1,220,400 $1,850,400 $950,400 $4,021,200

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 $51,840 0 0 $51,840 March sales 539,280 77,040 0 616,320 April sales 244,080 854,280 122,040 1,220,400 May sales 0 370,080 1,295,280 1,665,360 June sales 0 0 190,080 190,080 Total cash collections $835,200 $1,301,400 $1,607,400 $3,744,000

c. A merchandise purchases budget in units and in dollars. Show the budget by month and in total. (Round unit cost of purchases to 1 decimal place.)

Earrings Unlimited Merchandise Purchases Budget April May June Quater Budgeted unit sales 67,800 102,800 52,800 223,400 Add: Desired ending merchandise inventory 41,120 21,120 13,120 13,120 Total needs 108,920 123,920 65,920 236,520 Less: Beginning merchandise inventory 27,120 41,120 21,120 27,120 Required purchases 81,800 82,800 44,800 209,400 Unit cost $5.4 $5.4 $5.4 $5.4 Required dollar purchases $441,720 $447,120 $241,920 $1,130,760

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 $114,000 $0 $0 $114,000 April purchases 220,860 220,860 0 441,720 May purchases 0 223,560 223,560 447,120 June purchases 0 0 120,960 120,960 Total cash payments $334,860 $444,420 $344,520 1,123,800

2. A cash budget. Show the budget by month and in total. (Cash deficiency, repayments and interest should be indicated by a minus sign.)

Earrings Unlimited Cash Budget For the Three Months Ending June 30 April May June Quarter Beginning cash balance $88,000 $64,024 $303,988 $88,000 Add collections from customers 835,200 1,301,400 1,607,400 3,744,000 Total cash available 923,200 1,365,424 1,911,388 3,832,000 Less cash disbursements: Merchandise purchases 334,860 444,420 344,520 1,123,800 Advertising 340,000 340,000 340,000 1,020,000 Rent 32,000 32,000 32,000 96,000 Salaries 134,000 134,000 134,000 402,000 Commissions 48,816 74,016 38,016 160,848 Utilities 14,000 14,000 14,000 42,000 Equipment purchases 0 23,000 54,000 77,000 Dividends paid 25,500 0 0 25,500 Total cash disbursements 929,176 1,061,436 956,536 2,947,148 Excess (deficiency) of cash available over disbursements (5,976) 303,988 954,852 884,852 Financing: Borrowings 70,000 0 0 70,000 Repayments 0 0 (70,000) (70,000) Interest 0 0 (2,100) (2,100) Total financing 70,000 0 (72,100) (2,100) Ending cash balance $64,024 $303,988 $882,752 $882,752

3. A budgeted income statement for the three-month period ending June 30. Use the contribution approach

	Earrings Unlimited Budgeted Income Statement For the Three Months Ended June 30 Variable expenses: 0 0 Fixed expenses: 0 0 0

4. A budgeted balance sheet as of June 30

	Earrings Unlimited Budgeted Balance Sheet June 30 Assets Total assets $0 Liabilities and Stockholders’ Equity Total liabilities and stockholders’ equity $0

Answer 1