You have just been hired as a new management trainee by Earrings Unlimited, a di

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):

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:

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:

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.

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.

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

Explanation / Answer

Working Note-

April= Sales were predicted to be 69000@ 19 so 69000*19=1311000 of which 20% would be received in the current month 70% in the next month and 10%following that

So therefore cash flows for the month of april are = 20%of current month 69000 + 70%of sales in march and 10% of sales in February. = 20%of 69000+ 70% of 44000 + 10% of 30000. = 13800+30800+3000= 47600units @ 19= 904400

Similarly for may = 20%of 104000+70% of 69000+10%44000= 20800+48300+4400=73500units@19=

1396500

June= 20%of 54000(june) + 70%of104000(may) + 10%69000(April)= 10800+72800+6900=90500units

90500units @19= 1719500.

Cash Budget uptil June end Particulars April May June Sales 904400 1396500 1719500 Raw Material -457800 -573000 -372000 Sales Commission -52440 -79040 -41040 Advertising -400000 -400000 -400000 Rent -38000 -38000 -38000 Salaries -146000 -146000 -146000 utilities -17000 -17000 -17000 Depreciation(not a cash
flow) Equipment Purchased -26000 -60000 Dividend of quarter ended
march -30000 Total Cash Flows (1) -236840 117460 645460 Add- opening Bal (2) 94000 70000 70000 equals to closing (1+2) -142840 187460 715460 Therefore loan requirement
would be 142840+70000
since minimum cash bal of
70000is to be maintained
and the cash flow for the
month of april is negative
142840 212840 Repay
187460-70000= 117460 -2128(1%interest)=115332 Repay
the balance loan
212840-117460=95380-975(1%interest)=94405 Less - Interest -2128 -975 Closing Bal 70000 70000 620080

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