Chapter 23, Problem 5BP

a.

To determine

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

Budgeted income statement of Company S for the month of May
Particulars	$
Budgeted sales	100,000
Less: Cost of goods sold (2)	60,000
Gross profit (1)	40,000
Less: Operating , administrative and selling expense:
Variable selling & administrative costs (3)	5,000
Fixed selling & administrative costs	10,000
Budgeted pretax operating income	25,000
Interest expense	3,000
Pretax income	22,000
Less: Income taxes (4)	5,500
Budgeted net income	16,500

Table (1)

Therefore, the budgeted net income of Company S for the month of May is $16,500.

Working note:

Calculate the amount of gross profit

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

Calculate the cost of goods sold

$\begin{array}{c}\text{Cost of goods sold = Budgeted sales }-\text{Gross profit (1)}\\ \text{=\$100,000}-\$40,000\\ =\$60,000\end{array}$ (2)

Calculate the variable selling, and administrative costs

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

Calculate the income tax expense

$\begin{array}{c}\text{Income tax expense = Pretax income }\times \text{Income tax rate}\\ \text{=\$22,000}\times \frac{25}{100}\\ =\$5,500\end{array}$ (4)

b.

To determine

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

Explanation of Solution

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

Cash budget of Company S for the month of May
Particulars	$	$
Beginning cash, May 1		30,000
Add:
Collections on March sales (5)	9,000
Collections on April sales (6)	20,000
Collections on May sales (7)	40,000	69,000
Total cash available		99,000
Less:
Payments on April payables (8)	6,250
Payments on May payables (9)	45,000
Variable selling & administrative costs (3)	5,000
Fixed selling & administrative costs (10)	7,000
Debt service payments	4,000	67,250
Ending cash, May 31		31,750

Table (2)

Therefore, the ending cash balance at the end of the May is $31,750.

Working note:

Calculate the cash received from the March sales

$\begin{array}{c}\begin{array}{l}\text{Cash received from}\\ \text{ the March sales}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Sales made on March }\times \\ \text{10 percent in the second month following the sales}\end{array}\right]\\ =\$90,000\times \frac{10}{100}\\ =\$9,000\end{array}$ (5)

Calculate the cash received from the April sales

$\begin{array}{c}\begin{array}{l}\text{Cash received from}\\ \text{ the April sales}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Sales made on April }\times \\ \text{50 percent in the month of following the sales}\end{array}\right]\\ =\$40,000\times \frac{50}{100}\\ =\$20,000\end{array}$ (6)

Calculate the cash received from the May sales

$\begin{array}{c}\begin{array}{l}\text{Cash received from}\\ \text{ the May sales}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Sales made on May }\times \\ \text{40 percent in the month of sales}\end{array}\right]\\ =\$100,000\times \frac{40}{100}\\ =\$40,000\end{array}$ (7)

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

$\begin{array}{c}\begin{array}{l}\text{Cash paid for the merchandise}\\ \text{ purchase for the month April}\end{array}\}=\left[\begin{array}{l}\text{Purchase in the month of April }\times \\ \left(\begin{array}{l}\text{25 percent of th purcahse in the given month }\\ \text{are paid in the following month}\end{array}\right)\end{array}\right]\\ =\$25,000\times \frac{25}{100}\\ =\$6,250\end{array}$

Note: The purchase in the given month that are paid in the following month is 25% $\left(\text{100\%}-75\%\right)$ (8)

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

$\begin{array}{c}\begin{array}{l}\text{Cash paid for the merchandise}\\ \text{ purchase for the month May}\end{array}\}=\left[\begin{array}{l}\text{Purchase in the month of May }\times \\ \left(\text{75 percent of th purcahse in the given month }\right)\end{array}\right]\\ =\$60,000\times \frac{75}{100}\\ =\$45,000\end{array}$

(9)

Calculate the fixed selling and administrative costs

$\begin{array}{c}\begin{array}{l}\text{Fixed selling and}\\ \text{ administrative costs }\end{array}\}\text{= }\left[\begin{array}{l}\text{Fixed selling and administrative costs }-\\ \left(\begin{array}{l}\text{Deprciation expense included in the fixed cost }\\ \text{of selling and administrative expense}\end{array}\right)\end{array}\right]\\ =\$10,000-\$3,000\\ =\$7,000\end{array}$ (10)

c.

To determine

Explain the primary benefits of preparing and using a budget.

Explanation of Solution

Explain the primary benefits of preparing and using a budget as follows:

• Budget indicates the possible problems in the upcoming period, such as insufficient amount of the raw materials or labor needed for the production.
• It ensures the cooperation of different departments within a company to meet the expected production levels.
• Budget can be used at the time when the company sets the financial and operating goals. Company should evaluate the actual performance, and set the budgeted amount at reasonable and achievable levels.