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 as 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 – $10 per pair.  Actual sales of earrings for the last three months and budgeted sales for the next six months are shown below (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 are paid for in the month of purchase and 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 the sale.  Bad debts have been negligible.

(over)

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

                  Depreciation                                   $14,000

       Additional information:

• Insurance is paid on an annual basis.  The cost is $3,000.  It is paid in November.
• 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 balance in accounts payable on March 31^st is $100,000.  This will be paid in April.
• The company declares dividends of $15,000 each quarter.  They are paid in the first month of the following quarter.
• The cash balance as of March 31^st is $74,000
• The number of units in ending inventory as of March 31^st is 26,000.
• The company maintains a minimum cash balance of $50,000.
• All borrowing is done at the beginning of a month and any repayments are made at the end of a month.
• The annual interest rate on borrowings is 12%.  Interest is compounded and paid at the end of each quarter on all loans outstanding during the quarter.

Required:

1. Prepare a master budget for the three-month period ending June 30.  Include the following detailed budgets:
   1. A sales budget, by month and in total.
   2. A schedule of expected cash collections from sales, by month and in total.
   3. A merchandise purchases budget in units and in dollars.  Show the budget by month and in total.
   4. 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. Write an executive summary to the Controller of Earrings Unlimited commenting on the budgets you have prepared and making suggestions on some things that could be done to improve the company’s cash flow.

Answer 1

1.

a)

Prepare sales budget as follows:

Sales Budget
Particulars	April	May	June	Total
Budgeted Sales (in units) [A]	65000	100000	50000	215000
Selling price per unit [B]	$10	$10	$10
Budgeted Sales (in dollars) [ C = A × B]	$650,000	$1,000,000	$500,000	2150000

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b)

Prepare Schedule of Expected Cash Collection from sales as follows:

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c)

Prepare Merchandise purchases budget:

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d)

Prepare Schedule of expected cash disbursement for merchandise purchases as follows:

Working:

	March
Budgeted Sales (in units)	40,000
Add: Desired Ending Inventory [65,000*40%]	26,000
Total Needs	66,000
Less: Beginning Inventory [40,000*40%]	16,000
Required Purchase (in units)	50,000
Purchase price per unit	$4
Total Cost of Merchandise Purchase	$200,000

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Prepare Cash budget for April-June quartes as follows: