Master Budget Problem – Chapter 11 ACC 8110 – Fall 2001
Facts: The Observer Company is a small, rapidly growing wholesaler of consumer electronic products including small kitchen appliances and power tools. A sales forecast supplied by the Marketing Department predicts that sales during Quarter 1 of 2002 will increase by 10% each month over the previous month’s sales. Then (beginning in April 2002) sales are expected to remain constant for the next several months. The Company is going to put some new equipment in operation just after the New Year begins. They hope to finance it largely with cash and the sale of marketable securities, but if necessary they can get a short-term loan from the Karch Bank. Observer’s Balance Sheet at December 31, 2001 is as follows:
Observer Company/ Balance Sheet/ 31-Dec-01 Assets: Cash Accounts Receivable Marketable securities Inventory Building (net of accumulated depreciation) Total Assets Liabilities and Stockholder's Equity: Accounts payable Bond interest payable Property taxes payable Bonds payable (due in 2006) Common Stock Retained Earnings Total L & SE $ $ 176,400 12,500 3,600 300,000 500,000 107,500 $ 1,100,000 $ 35,000 270,000 15,000 154,000 626,000 1,100,000
As Assistant Controller for the Observer Company you are now preparing a monthly budget for Quarter 1 of 2002. In this process, the following information has been accumulated: (1) Projected Sales for December 2001 are $400,000. Credit sales typically are 75% of total sales. Observer’s credit experience
indicates that 10% of credit sales are collected during the month of sale, and the remainder is collected during the following month. (2) Observer’s cost of goods sold is normally 70% of sales. Inventory is purchased on account and 40% of each month’s purchases are paid during the month of purchase. The remainder is paid during the following month. To have adequate amounts of inventory on hand Observer has a policy that inventory at the end of each month should equal half of the next month’s projected cost of goods sold. (3) Observer’s other monthly expenses are estimated as follows: Sales Salaries $21,000 Advertising & promotion $16,000 Administrative salaries $21,000 Depreciation $25,000 Interest on Bonds $2,500 Property taxes $900 Sales Commissions --- 1 percent of current month’s sales (4) The Company President has indicated that Observer will be investing $125,000 in equipment to be used in the firm’s warehouse just after the New Year begins. This equipment purchase will be financed from the company’s cash and marketable securities. However, the President noted that Observer should keep a minimum cash balance of $25,000. If necessary, the remainder of the equipment purchased will be financed using short-term credit from the Karch Bank. The minimum period for such a loan is 3 months with shortterm interest rates being 10% per year. If a loan is needed the President has decided that it should be paid off at the end of the Quarter 1, if possible. (5) Observer’s Board of Directors has indicated an intention to declare and pay cash dividends of $50,000 on the last day of each quarter. (6) The interest on any short-term borrowing will be paid when the loan is repaid. Interest on Observer’s Bonds is paid semiannually on January 31 and July 31 for the preceding six-month period. (7) Property taxes are paid semi-annually on February 28 and August 31 for the preceding six-month period. Required: Prepare Observer Company’s Master Budget for Quarter 1 of 2002 using the schedules and statements provided.