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—$11 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)	20,200	June (budget)	50,200
February (actual)	26,200	July (budget)	30,200
March (actual)	40,200	August (budget)	28,200
April (budget)	65,200	September (budget)	25,200
May (budget)	100,200

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 $4.10 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	$	210,000
Rent	$	19,000
Salaries	$	108,000
Utilities	$	7,500
Insurance	$	3,100
Depreciation	$	15,000

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

The company plans to purchase $16,500 in new equipment during May and $41,000 in new equipment during June; both purchases will be for cash. The company declares dividends of $15,750 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	$	75,000
Accounts receivable ($28,820 February sales; $353,760 March sales)		382,580
Inventory		106,928
Prepaid insurance		21,500
Property and equipment (net)		960,000
Total assets	$	1,546,008
Liabilities and Stockholders’ Equity
Accounts payable	$	101,000
Dividends payable		15,750
Common stock		820,000
Retained earnings		609,258
Total liabilities and stockholders’ equity	$	1,546,008

The company maintains a minimum cash balance of $51,000. 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 $51,000 in cash.

Required:

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 $51,000.

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

Answer 1

Required Budget as prepared below:

1a
Earings unlimited
Sales Budget
For the quarter ended June 30
	Month
Particulars	April	May	June	Total
Budgeted Unit sales	65,200	100,200	50,200	215,600
Sale Price	11	11	11	11
Budgeted sales	717,200	1,102,200	552,200	2,371,600
1b.
Earings unlimited
Schedule of expected Cash collections
For the quarter ended June 30
	Month
Particulars	April	May	June	Total
Beginning Accounts Receivable
February sales (26,200*11*10%)	28,820			28,820
March sales (40,200*11*70%)	309,540			309,540
March sales (40,200*11*10%)		44,220		44,220
April Credit Sales	143,440	502,040	71,720	717,200
May Credit Sales		220,440	771,540	991,980
June Credit sales			110,440	110,440
Total collections	481,800	766,700	953,700	2,202,200
Account receivable for June Sale			441,760
Account receivable for May Sale			110,220
1c.
Earings unlimited
Merchandise Purchase Budget
For the quarter ended June 30
	Month
Particulars	April	May	June	Total	July
Budgeted Unit Sales	65,200	100,200	50,200	215,600	30,200
Add: Desired Ending merchandise inventory (40% of next month sales)	40,080	20,080	12,080	12,080
Total needs	105,280	120,280	62,280	227,680
Less: beginning merchandise inventory	26,080	40,080	20,080	26,080
Required purchase	79,200	80,200	42,200	201,600
Unit Cost	4.1	4.1	4.1	4.1
Required dollar purchases	$324,720	$328,820	$173,020	$826,560
1d.
Earings unlimited
Schedule of expected Cash payments
For the quarter ended June 30
	Month
Particulars	April	May	June	Total
Beginning Accounts Payable (a)	$101,000			$101,000
April Purchases (b)	$162,360	$162,360		$324,720
May Purchases (c )		$164,410	$164,410	$328,820
June Purchases (d)			$86,510	$86,510	$86,510
Total payments (a+b+c+d)	$263,360	$326,770	$250,920	$841,050
Earings unlimited
Commission
For the quarter ended June 30
	Month
Particulars	April	May	June	Total
Budgeted Unit sales	65,200	100,200	50,200	215,600
Sale Price	11	11	11	11
Budgeted sales	717,200	1,102,200	552,200	2,371,600
Sales commisssions (4% of sales)	28,688	44,088	22,088	94,864
2
Earings unlimited
Cash Budget
For the quarter ended June 30
	Month
Particulars	April	May	June	Total
Beginning Cash balance	75,000	51,502	86,344	75,000
Add: Collection from customers	$481,800	$766,700	$953,700	$2,202,200
cash available for use	$556,800	$818,202	$1,040,044	$2,277,200
Less: cash Disbursements
Merchandise purchase	$263,360	$326,770	$250,920	841,050
Advertising	210,000	210,000	210,000	630,000
Rent	19,000	19,000	19,000	57,000
Salaries	108,000	108,000	108,000	324,000
Commissions	28,688	44,088	22,088	94,864
Utilities	7,500	7,500	7,500	22,500
Equipment purchase		16,500	41,000	57,500
Dividend paid	15,750			15750
Total disbusrement	652,298	731,858	658,508	2,042,664
Cash surplus/Deficit	-95,498	86,344	381,536	234,536
Financing
Borrowing	147,000			147,000
Repayment			-147,000	-147,000
Interest			-2,940	-2,940
Net cash from Financing	147,000	0	-149,940	-2,940
Budgeted ending cash balance	51,502	86,344	231,596	231,596
Earings Unlimited
Budgeted Income Statement
For the three month ended June 30
Particulars	Amount ($)	Amount ($)
Sales		2,371,600
Less: Cost of goods sold (215,600*4.1)		883,960
Variable expenses:
Commissions	94,864
Interest expense	2,940
Insurance (3,100*3)	9,300
		107,104
Contribution Margin		1,380,536
Fixed Expenses:
Advertising	630,000
Rent	57,000
Salaries	324,000
Depreciation (15,000*3)	45,000
Utilities	22,500	1,078,500
Net operating Income		302,036
Dividend Paid		15,750
Net Income		286,286
Earings Unlimited
Budgeted balance Sheet
Jun-30
Assets
Cash	231,596
Accounts Receivable	551,980
Inventory (12,080*4.1)	49,528
Property and equipment Net (960,000+16,500+41,000-45,000)	972,500
Prepaid insurance (21,500-9,300)	12,200
Total assets	1,817,804
Liabilities and Stockholders' Equity
Accounts Payable purchases	86,510
Dividend payable	15,750
Common Stock	820,000
Retained earnings (609,258+286,286)	895,544
Total liabilities and stockholders' equity	1,817,804