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) 22,400 June (budget) 52,400 February (actual) 28,400 July (budget) 32,400 March (actual) 42,400 August (budget) 30,400 April (budget) 67,400 September (budget) 27,400 May (budget) 102,400 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 $5.2 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 $ 320,000 Rent $ 30,000 Salaries $ 130,000 Utilities $ 13,000 Insurance $ 4,200 Depreciation $ 26,000 Insurance is paid on an annual basis, in November of each year. The company plans to purchase $22,000 in new equipment during May and $52,000 in new equipment during June; both purchases will be for cash. The company declares dividends of $24,000 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 $ 86,000 Accounts receivable ($45,440 February sales; $542,720 March sales) 588,160 Inventory 140,192 Prepaid insurance 27,000 Property and equipment (net) 1,070,000 Total assets $ 1,911,352 Liabilities and Stockholders’ Equity Accounts payable $ 112,000 Dividends payable 24,000 Common stock 1,040,000 Retained earnings 735,352 Total liabilities and stockholders’ equity $ 1,911,352 The company maintains a minimum cash balance of $62,000. 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 $62,000 in cash. Required: 1. Prepare a master budget for the three-month period ending June 30. Include the following detailed budgets:

Answer 1

Since, master budget involves preparation of multiple budgets, I have prepared the first four.

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Budget 1)

The sales budget is prepared as below:

	April	May	June	Total
Budgeted Unit Sales (A)	67,400	102,400	52,400	222,200
Selling Price Per Unit (B)	16	16	16	16
Total Sales (A*B)	$1,078,400	$1,638,400	$838,400	$3,555,200

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Budget 2)

The schedule of expected cash collections is given as follows:

	April	May	June	Total
February Sales	45,440 (28,400*16*10%)	0	0	45,440
March Sales	474,880 (42,400*16*70%)	67,840 (42,400*16*10%)	0	542,720
April Sales	215,680 (67,400*16*20%)	754,880 (67,400*16*70%)	107,840 (67,400*16*10%)	1,078,400
May Sales	0	327,680 (102,400*16*20%)	1,146,880 (102,400*16*70%)	1,474,560
June Sales	0	0	167,680 (52,400*16*20%)	167,680
Total Cash Collections	$736,000	$1,150,400	$1,422,400	$3,308,800

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Budget 3)

The merchandise purchases budget is prepared as follows:

	April	May	June	Total
Budgeted Unit Sales	67,400	102,400	52,400	222,200
Add Desired Ending Inventory	40,960 (102,400*40%)	20,960 (52,400*40%)	12,960 (32,400*40%)	12,960
Total Units Needed	108,360	123,360	65,360	235,160
Less Opening Inventory	26,960 (67,400*40%)	40,960 (102,400*40%)	20,960 (52,400*40%)	26,960
Total Purchases Needed (C)	81,400	82,400	44,400	208,200
Cost Per Unit (D)	5.2	5.2	5.2	5.2
Total Merchandise Purchases (C*D)	$423,280	$428,480	$230,880	$1,082,640

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Budget 4)

The schedule of expected cash disbursements for merchandise purchases is given as below:

	April	May	June	Total
Accounts Payable	112,000	0	0	112,000
April Purchases	211,640 (423,280*1/2)	211,640 (423,280*1/2)	0	423,280
May Purchases	0	214,240 (428,480*1/2)	214,240 (428,480*1/2)	428,480
June Purchases	0	0	115,440 (230,880*1/2)	115,440
Total Cash Disbursement for Merchandise Purchases	$323,640	$425,880	$329,680	$1,079,200