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)	24,000	June (budget)	54,000
February (actual)	30,000	July (budget)	34,000
March (actual)	44,000	August (budget)	32,000
April (budget)	69,000	September (budget)	29,000
May (budget)	104,000

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 $6.00 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	$	400,000
Rent	$	38,000
Salaries	$	146,000
Utilities	$	17,000
Insurance	$	5,000
Depreciation	$	34,000

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

The company plans to purchase $26,000 in new equipment during May and $60,000 in new equipment during June; both purchases will be for cash. The company declares dividends of $30,000 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	$	94,000
Accounts receivable ($57,000 February sales; $668,800 March sales)		725,800
Inventory		165,600
Prepaid insurance		31,000
Property and equipment (net)		1,150,000
Total assets	$	2,166,400
Liabilities and Stockholders’ Equity
Accounts payable	$	120,000
Dividends payable		30,000
Common stock		1,200,000
Retained earnings		816,400
Total liabilities and stockholders’ equity	$	2,166,400

The company maintains a minimum cash balance of $70,000. 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 $70,000 in cash.

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

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 $70,000.

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

-A budgeted balance sheet as of June 30.

Answer 1

1. Cash Budget

Particulars	April	May	June	Total
Beginning Cash Balance (A)	94,000	70,960	260,420	425,380
Cash Collection from debtors (Note 1)	904,400	1,396,500	1,719,500	4,020,400
Total Cash Receipts (B)	904,400	1,396,500	1,719,500	4,020,400
Cash Purchases (Note 2)	249,000	252,000	138,000	639,000
Cash Payment to creditors (Note 2)	120,000	249,000	252,000	621,000
Purchase of new equipment		26,000	60,000	86,000
Payment of Dividend	30,000			30,000
Sales Commission (4% of sales)	1,311,000*4%= 52,440	1,976,000*4%= 79,040	1,026,000*4%= 41,040	172,520
Advertising	400,000	400,000	400,000	1,200,000
Rent	38,000	38,000	38,000	114,000
Salaries	146,000	146,000	146,000	438,000
Utilities	17,000	17,000	17,000	51,000
Total Cash Payments (C)	1,052,440	1,207,040	1,092,040	3,351,520
Preliminary Cash Balance (D=A+B-C)	-54,040	260,420	887,880	1,094,260
Borrownigs/ Repaid	125,000	0	-125,000	0
Interest paid	0	0	125,000*1%*3=3,750	3,750
Ending Cash Balance	70,960	260,420	759,130	1,090,510

Note 1 Collection from Debtors

Particulars	April	May	June	Total
Sales	69,000*19=1,311,000	104,000*19=1,976,000	54,000*19=1,026,000	4,313,000
Collection from debtors in the month of sales @20%	1,311,000*20%= 262,200	1,976,000*20%= 395,200	1,026,000*20%= 205,200	862,600
Collection from debtors in the following month of sales @70%	44,000*19*70%= 585,200 ( Debtors of March Collected)	1,311,000*70%= 917,700	1,976,000*70%= 1,383,200	2,886,100
Collection from debtors in the second month of sales @10%	30,000*19*10%= 57,000 (Debtors of February collected)	44,000*19*10%= 83,600 ( Debtors of March Collected)	1,311,000*10%= 131,100	271,700
Total Cash Collected	904,400	1,396,500	1,719,500	4,020,400

Note 2: Cash Purchases and payments to Creditors

Particulars	April	May	June	Total
Total Purchases	83,000*6= 498,000	84,000*6= 504,000	46,000*6= 276,000	1,278,000
Cash Purchases @50%	249,000	252,000	138,000	639,000
Credit Purchases @ 50%	249,000	252,000	138,000	639,000
Payment to Creditors	120,000	249,000	252,000	621,000

Note 3. Goods to be purchase

Particulars	April	May	June	Total
Opening Stock (A)	165,600/6= 27,600	41,600	21,600	90,800
Sales (B)	69,000	104,000	54,000	227,000
Closing Stock (C)	104,000*40%= 41,600	54,000*40%= 21,600	34,000*40%= 13,600	76,800
Purchases to be made (C+B-A)	83,000	84,000	46,000	213,000

2. Budgeted Income Statement

Particulars	Amount	Total
Sales (Note 1 above) (A)		4,313,000
Variable Cost
Cost of goods sold (Note 4 below)	1,362,000
Sales Commission (Cash Budget above)	172,520
Total Variable Cost (B)		1,534,520
Contribution Margin (C=A-B)		2,778,480
Fixed Cost
Advertising (400,000*3)	1,200,000
Rent (38,000^3)	114,000
Salaries (146,000*3)	438,000
Utilities (17,000*3)	51,000
Insurance (5,000*3)	15,000
Depreciation (34,000*3)	102,000
Total Fixed Cost		1,920,000
Operating Profit		858,480
Interest		3,750
Dividend		30,000
Net Profit		824,730

Note 4 : Cost of Goods Sold= Opening Stock +Purchases- Closing Stock

=165,600+ 1,278,000 (Note 2 above) - 13,600 (Note 3 above)*6= 1,362,000

3. Budgeted Balance Sheet as of June 30

Assets
Cash (Cash Budget above)	$	759,130
Accounts Receivable (197,600 of May and 820,800 of June)		1,018,400
Inventory (13,600*6)		81,600
Prepaid Insurance (31,000-15,000)		16,000
Property & Equipment (1,150,000-102,000+26,000+60,000)		1,134,000
Total Assets	$	3,009,130
Liabilities and Stockholder's Equity
Accounts Payable (Note 2 above)	$	138,000
Dividend Payable		30,000
Common Stock		1,200,000
Retained Earnings (816,400+ 824,730)		1,641,130
Total liabilities and stockholder's equity	$	3,009,130