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—$15 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)   21,800   June (budget)   51,800
February (actual)   27,800   July (budget)   31,800
March (actual)   41,800   August (budget)   29,800
April (budget)   66,800   September (budget)   26,800
May (budget)   101,800        

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 $4.90 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   $   290,000     
Rent   $   27,000     
Salaries   $   124,000     
Utilities   $   11,500     
Insurance   $   3,900     
Depreciation   $   23,000     

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

The company plans to purchase $20,500 in new equipment during May and $49,000 in new equipment during June; both purchases will be for cash. The company declares dividends of $21,750 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   $   83,000
Accounts receivable ($41,700 February sales; $501,600 March sales)      543,300
Inventory      130,928
Prepaid insurance      25,500
Property and equipment (net)      1,040,000
Total assets   $   1,822,728
Liabilities and Stockholders’ Equity
Accounts payable   $   109,000
Dividends payable      21,750
Common stock      980,000
Retained earnings      711,978
Total liabilities and stockholders’ equity   $   1,822,728

The company maintains a minimum cash balance of $59,000. 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 $59,000 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 $59,000.

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

Solution 1a:

Sales Budget - Earrings Unlimited
Particulars	April	May	June	Total
Budgeted Sales units	66800	101800	51800	220400
Selling price per unit	$15.00	$15.00	$15.00	$15.00
Total Sales	$1,002,000.00	$1,527,000.00	$777,000.00	$3,306,000.00

Solution 1b:

Schedule of expected cash collection - Earrings Unlimited
Particulars	April	May	June	Total
Cash received for Feburary Sale	$41,700.00			$41,700.00
Cash received for March Sale	$438,900.00	$62,700.00		$501,600.00
Cash received for April Sale	$200,400.00	$701,400.00	$100,200.00	$1,002,000.00
Cash received for May Sale		$305,400.00	$1,068,900.00	$1,374,300.00
Cash received for June Sale			$155,400.00	$155,400.00
Budgeted Cash Collection	$681,000.00	$1,069,500.00	$1,324,500.00	$3,075,000.00

Solution 1c:

Merchandise Purchase Budget - Earrings Unlimited
Particulars	April	May	June	Total
Sales units	66800	101800	51800	220400
Add: Desired ending inventory (40% of next month sales)	40720	20720	12720	12720
Total needs	107520	122520	64520	233120
Less: Opening Inventory	26720	40720	20720	26720
Estimated purchase for earrings (In pairs)	80800	81800	43800	206400
Cost per pair	$4.90	$4.90	$4.90	$4.90
Budgeted purchases (in dollars)	$395,920.00	$400,820.00	$214,620.00	$1,011,360.00

Solution 1d:

Budgeted Cash disbursement for merchandise purchases - Earrings Unlimited
Particulars	April	May	June	Total
Accounts Payable	$109,000.00			$109,000.00
April Purchases	$197,960.00	$197,960.00		$395,920.00
May Purchases		$200,410.00	$200,410.00	$400,820.00
June Purchases			$107,310.00	$107,310.00
Total cash payments	$306,960.00	$398,370.00	$307,720.00	$1,013,050.00