Question

Question: Connick Company sells its product for \(22 per unit. Its actual and budgeted sales follow.

	Units	Dollars
January (actual)	18,000	\)396,000
February (actual)	22,500	495,000
March (budgeted)	19,000	418,000
April (budgeted)	18,750	412,500
May (budgeted)	21,000	462,000

All sales are on credit. Recent experience shows that 40% of credit sales is collected in the month of the sale, 35% in the month after the sale, 23% in the second month after the sale, and 2% proves to be uncollectible. The product’s purchase price is \(12 per unit. Of purchases made in a month, 30% is paid in that month and the other 70% is paid in the next month. The company has a policy to maintain an ending monthly inventory of 20% of the next month’s unit sales plus a safety stock of 100 units. The January 31 and February 28 actual inventory levels are consistent with this policy. Selling and administrative expenses for the year are \)1,920,000 and are paid evenly throughout the year in cash. The company’s minimum cash balance for month-end is \(50,000. This minimum is maintained, if necessary, by borrowing cash from the bank. If the balance exceeds \)50,000, the company repays as much of the loan as it can without going below the minimum. This type of loan carries an annual 12% interest rate. At February 28, the loan balance is \(12,000, and the company’s cash balance is \)50,000.

Required

1. Prepare a schedule that shows the computation of cash collections of its credit sales (accounts receivable) in each of the months of March and April.
2. Prepare a schedule showing the computations of budgeted ending inventories (units) for January, February, March, and April.
3. Prepare the merchandise purchases budget for February, March, and April. Report calculations in units and then show the dollar amount of purchases for each month.
4. Prepare a schedule showing the computation of cash payments on product purchases for March and April.
5. Prepare a cash budget for March and April, including any loan activity and interest expense. Compute the loan balance at the end of each month.
6. Refer to your answer in part 5. The cash budget indicates whether the company must borrow additional funds at the end of March. Suggest some reasons that knowing the loan needs in advance would be helpful to management.

Short answer

Answer

1. Total cash receipts for March and April are $431,530 and $425,150.
2. Desired ending inventory from January to April are 4,600, 3,900, 3,850, and 4,300 units.
3. Merchandise to be purchased is $261,600, $227,400 and $230,400.
4. Regular payments for product purchases are$251,340 and$226,680.
5. Cash balance, ending is $58,245and $96,830.
6. It can use the loan to seek financing options ahead of time and negotiate low-interest rates.

Step-by-step solution

Meaning of Participatory budgeting

Top-level management incorporates bottom-level management in the budget formulation in participatory budgeting to better understand the actual situation on the ground, such as resource availability, the time necessary to produce the budget, hindrances linked to certain issues, etc.

(1) Preparing a schedule

Particulars	March	April
Collected from current month’s sales @ 40%	$\mathbf{\$}\mathbf{418}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{0}\mathbf{.}\mathbf{40}\mathbf{=}\mathbf{\$}\mathbf{167}\mathbf{,}\mathbf{200}$	$165,000
Collected from the previous month’s sales @35%	$\mathbf{\$}\mathbf{495}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{0}\mathbf{.}\mathbf{35}\mathbf{=}\mathbf{\$}\mathbf{173}\mathbf{,}\mathbf{250}$	$146,300
Collected from two months age’s sales @23%	$\mathbf{\$}\mathbf{396}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{0}\mathbf{.}\mathbf{23}\mathbf{=}\mathbf{\$}\mathbf{91}\mathbf{,}\mathbf{080}$	$113,850
Total cash receipts	$431,530	$425,150

Note: Since this is not a monetary transaction, we apply the percentages for the cash obtained each month and ignore the uncollectible portion

(2) Preparing a schedule.

Particulars	January	February	March	April
Following month’s sales units	22,500	19,000	18,750	21,000
Desired ending inventory:
20% of the following month’s sales units	4,500	3,800	3,750	4,200
Safety stock	100	100	100	100
Desired ending inventory	4,600	3,900	3,850	4,300

(3) Preparing the merchandise purchases budget

Particulars	February	March	April
Current month’s sales units	22,500	19,000	18,750
Desired ending inventory(from above)	3,900	3,850	4,300
Units required (current month’s sales units + desired to end inventory)	26,400	22,850	23,050
Beginning inventory (previous month's ending inventory from above)	(4,600)	(3,900)	(3,850)
Units to be purchased	21,800	18,950	19,200
The purchase price per unit	$12	$12	$12
Merchandise to be purchased	$261,600	$227,400	$230,400

(4) Preparing a schedule showing the computation of cash payments

Particulars	March	April
Payment of purchases:
30% of this month’s purchases	$\mathbf{\$}\mathbf{227}\mathbf{,}\mathbf{400}\mathbf{\times }\mathbf{30}\mathbf{\%}\mathbf{=}\mathbf{\$}\mathbf{68}\mathbf{,}\mathbf{220}$	$\mathbf{225}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{30}\mathbf{\%}\mathbf{=}\mathbf{\$}\mathbf{67}\mathbf{,}\mathbf{500}$
70% of last month’s purchases	$\mathbf{\$}\mathbf{261}\mathbf{,}\mathbf{600}\mathbf{\times }\mathbf{70}\mathbf{\%}\mathbf{=}\mathbf{\$}\mathbf{183}\mathbf{,}\mathbf{120}$	$\mathbf{227}\mathbf{,}\mathbf{400}\mathbf{\times }\mathbf{70}\mathbf{\%}\mathbf{=}\mathbf{\$}\mathbf{159}\mathbf{,}\mathbf{180}$
Expected payments for products purchases	$251,340	$226,680

(5) Preparing a cash budget for March and April

Particulars	March	April
Cash balance ,beginning	$50,000	$58,245
Total cash receipts	431,705	425,265
Total cash available	$481,705	$483,510
Cash Disbursements
Cash payments for product purchases	$251,340	$226,680
Selling and administration Expense	160,000	160,000
Total cash disbursements	$411,340	$386,680
Excess (deficiency) of cash available over disbursements	$70,365	$96,830
Financing:
Repayments:	(12,000)
Interest: $\left(\$12,000\times 12\%\times \frac{1}{12}=\$\left(120\right)\right)$	$(120)
Total Financing	$(12,120)
Cash balance, ending	$58,245	$96,830
Loan balance	$0	$0

(6) Explaining the reason for taking a loan in advance

Management benefits from determining its borrowing need ahead of time since it can search for financing options and negotiate competitive interest rates. It is the most important reason why knowing the credit requirements in advance will be helpful for the management.