Chapter 23, Problem 5AP

a.

To determine

Prepare the budgeted income statement of Company R for the month May.

Explanation of Solution

Budget:

Budget is an effective tool to achieve the financial and operational goals of the business. Budget is the key element of the financial planning and it assists managers to control the business costs. Management should set the budgeted amount at reasonable and achievable levels.

Prepare the budgeted income statement of Company R for the month May as follows:

Budgeted income statement of Company R for the month of May
Particulars	$
Budgeted sales	72,000
Less: Cost of goods sold (2)	43,200
Gross profit (1)	28,800
Less: Operating , administrative and selling expense:
Variable selling & administrative costs (3)	3,600
Fixed selling & administrative costs	12,000
Budgeted pretax operating income	13,200
Interest expense	4,500
Pretax income	8,700
Less: Income taxes (4)	3,045
Budgeted net income	5,655

Table (1)

Therefore, the budgeted net income of Company R for the month of May is $5,655.

Working note:

Calculate the amount of gross profit

$\begin{array}{c}\text{Gross profit = Budgeted sales }\times \text{ Gross profit margin}\\ \text{=\$72,000}\times \frac{40}{100}\\ =\$28,800\end{array}$ (1)

Calculate the cost of goods sold

$\begin{array}{c}\text{Cost of goods sold = Budgeted sales }-\text{Gross profit (1)}\\ \text{=\$72,000}-\$28,800\\ =\$43,200\end{array}$ (2)

Calculate the variable selling, and administrative costs

$\begin{array}{c}\begin{array}{l}\text{Variable selling }\\ \text{and administrative costs}\end{array}\}\text{ = Budgeted sales }\times \text{Percentage on sakes}\\ \text{=\$72,000}\times \frac{5}{100}\\ =\$3,600\end{array}$ (3)

Calculate the income tax expense

$\begin{array}{c}\text{Income tax expense = Pretax income }\times \text{Income tax rate}\\ \text{=\$8,700}\times \frac{35}{100}\\ =\$3,045\end{array}$ (4)

b.

To determine

Prepare the cash budget of Company R for the month May.

Explanation of Solution

Prepare the cash budget of Company R for the month May as follows:

Cash budget of Company R for the month of May
Particulars	$	$
Beginning cash, May 1		25,000
Add:
Collections on March sales (5)	6,500
Collections on April sales (6)	25,200
Collections on May sales (7)	21,600	53,300
Total cash available		78,300
Less:
Payments on April payables (8)	4,800
Payments on May payables (9)	33,600
Variable selling & administrative costs (3)	3,600
Fixed selling & administrative costs (10)	8,000
Debt service payments	5,000	55,000
Ending cash, May 31		23,300

Table (2)

Therefore, the ending cash balance at the end of the May is $23,300.

Working note:

Calculate the cash received from the March sales

$\begin{array}{c}\begin{array}{l}\text{Cash received from}\\ \text{ the March sales}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Sales made on March }\times \\ \text{10 percent in the second month following the sales}\end{array}\right]\\ =\$65,000\times \frac{10}{100}\\ =\$6,500\end{array}$ (5)

Calculate the cash received from the April sales

$\begin{array}{c}\begin{array}{l}\text{Cash received from}\\ \text{ the April sales}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Sales made on April }\times \\ \text{60 percent in the month of following the sales}\end{array}\right]\\ =\$42,000\times \frac{60}{100}\\ =\$25,200\end{array}$ (6)

Calculate the cash received from the May sales

$\begin{array}{c}\begin{array}{l}\text{Cash received from}\\ \text{ the May sales}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Sales made on May }\times \\ \text{30 percent in the month of sales}\end{array}\right]\\ =\$72,000\times \frac{30}{100}\\ =\$21,600\end{array}$ (7)

Calculate the cash paid for the merchandise purchase for the month April

$\begin{array}{c}\begin{array}{l}\text{Cash paid for the merchandise}\\ \text{ purchase for the month April}\end{array}\}=\left[\begin{array}{l}\text{Purchase in the month of April }\times \\ \left(\begin{array}{l}\text{20 percent of th purcahse in the given month }\\ \text{are paid in the following month}\end{array}\right)\end{array}\right]\\ =\$24,000\times \frac{20}{100}\\ =\$4,800\end{array}$

Note: The purchase in the given month that are paid in the following month is 20% $\left(\text{100\%}-80\%\right)$ (8)

Calculate the cash paid for the merchandise purchase for the month May

$\begin{array}{c}\begin{array}{l}\text{Cash paid for the merchandise}\\ \text{ purchase for the month May}\end{array}\}=\left[\begin{array}{l}\text{Purchase in the month of May }\times \\ \left(\text{80 percent of th purcahse in the given month }\right)\end{array}\right]\\ =\$42,000\times \frac{80}{100}\\ =\$33,600\end{array}$ (9)

Calculate the fixed selling and administrative costs

$\begin{array}{c}\begin{array}{l}\text{Fixed selling and}\\ \text{ administrative costs }\end{array}\}\text{= }\left[\begin{array}{l}\text{Fixed selling and administrative costs }-\\ \left(\begin{array}{l}\text{Deprciation expense included in the fixed cost }\\ \text{of selling and administrative expense}\end{array}\right)\end{array}\right]\\ =\$12,000-\$4,000\\ =\$8,000\end{array}$ (10)

c.

To determine

Explain the budgeted cash flow of Company R in May differs from its budgeted net income.

Explanation of Solution

Net income: The bottom line of income statement which is the result of excess of earnings from operations (revenues) over the costs incurred for earning revenues (expenses) is referred to as net income.

Accrual accounting: The method of accounting which recognizes revenues before they are received, and recognizes expenses before they are paid, is referred to as accrual accounting.

Explain the budgeted cash flow of Company R in May differs from its budgeted net income as follows:

In the budgeted income statement, all the revenues and expenses are recorded under the accrual basis of accounting. Under accrual basis, the revenues are recognized even if the cash is not received, and expenses are incurred even if cash is not paid. Additionally, the non-cash (depreciation and amortization expense) items are recorded in the income statement for arriving the net income or (loss). At the same time, the cash flow budget only repots all the cash transactions which are responsible for inflow and outflow of cash. Hence, the budgeted cash flow of Company R differs from its budgeted net income.