Question

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—$10 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) 20,000 June (budget) 50,000
February (actual) 26,000 July (budget) 30,000
March (actual) 40,000 August (budget) 28,000
April (budget) 65,000 September (budget) 25,000
May (budget) 100,000

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 $4 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 $ 200,000
Rent $ 18,000
Salaries $ 106,000
Utilities $ 7,000
Insurance $ 3,000
Depreciation $ 14,000

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

The company plans to purchase $16,000 in new equipment during May and $40,000 in new equipment during June; both purchases will be for cash. The company declares dividends of $15,000 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 $ 74,000
Accounts receivable ($26,000 February sales; $320,000 March sales) 346,000
Inventory 104,000
Prepaid insurance 21,000
Property and equipment (net) 950,000

Total assets $ 1,495,000

Liabilities and Stockholders’ Equity
Accounts payable $ 100,000
Dividends payable 15,000
Common stock 800,000
Retained earnings 580,000

Total liabilities and stockholders’ equity $ 1,495,000


The company maintains a minimum cash balance of $50,000. 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 $50,000 in cash.

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

Answer 1

To prepare a comprehensive master budget, several detailed budgets need to be created including sales, production, raw material purchases, direct labor, manufacturing overhead, selling and administrative expenses, cash, income statement, and balance sheet budgets.

Step-by-step explanation:

To prepare a master budget for the three-month period ending June 30, we need to create several detailed budgets:

1. Sales budget: This budget projects the quantity of earrings that will be sold each month. It considers actual sales data from the previous months and also takes into account the concentration of sales during May due to Mother's Day. Based on the provided information, we can calculate the sales budget for each month.
2. Production budget: This budget determines how many earrings need to be produced each month to meet the projected sales. It takes into account the desired ending inventory and the current inventory levels.
3. Raw material purchases budget: This budget calculates the quantity of raw materials (earrings) that need to be purchased each month based on the production budget and the desired ending inventory.
4. Direct labor budget: This budget estimates the labor costs associated with producing the earrings. It considers the quantity of earrings to be produced and the labor cost per unit.
5. Manufacturing overhead budget: This budget includes all the other manufacturing costs (excluding direct labor and materials), such as utilities, rent, and depreciation.
6. Selling and administrative expense budget: This budget includes all the variable and fixed costs associated with selling the earrings, such as sales commissions and advertising expenses.
7. Cash budget: This budget forecasts the cash inflows and outflows for each month, including receipts from customers, payments to suppliers, and other expenses. It helps identify any potential cash shortages or surpluses.
8. Budgeted income statement: This statement summarizes the expected revenues, expenses, and net income for the three-month period based on the budgeted sales and expenses.
9. Budgeted balance sheet: This sheet presents the projected assets, liabilities, and equity at the end of the three-month period based on the budgeted activities.