Quantifying

P9-64 A Cash budgets under two alternatives

Each autumn, as a hobby, Hannah Olson, Inc., weaves cotton placemats to sell at a local craft shop. The mats sell for $30 per set of four mats. The shop charges a 20% commission and remits the net proceeds to Olson at the end of December. Olson has woven and sold 26 sets in each of the last two years. She has enough cotton in inventory to make another 26 sets. She paid $8 per set for the cotton. Olson uses a four-harness loom that she purchased for cash exactly two years ago. It is depreciated at the rate of $5 per month. The accounts payable relate to the cotton inventory and are payable by September 30.

Olson is considering buying an eight-harness loom so that she can weave more intricate patterns in linen. The new loom costs $1,000; it would be depreciated at $20 per month. Her bank has agreed to lend her $1,000 at 18% interest, with $200 principal plus accrued interest payable each December 31. Olson believes she can weave 16 linen placemat sets in time for the Christmas rush if she does not weave any cotton mats. She predicts that each linen set will sell for $65. Linen costs $20 per set. Olson’s supplier will sell her linen on credit, payable December 31.

Olson plans to keep her old loom whether or not she buys the new loom. The balance sheet for her weaving business at August 31 is as follows:

Requirements

1. Prepare a combined cash budget for the four months ending December 31, for two alternatives: weaving the placemats in cotton using the existing loom and weaving the placemats in linen using the new loom. For each alternative, prepare a budgeted income statement for the four months ending December 31 and a budgeted balance sheet at December 31.

2. On the basis of financial considerations only, what should Olson do? Give your reason.

3. What nonfinancial factors might Olson consider in her decision?

Exercise 2

P9-66A Budgeted income statement

The budget committee of Hilton Fashions, an upscale women’s clothing retailer, has assembled the following data. As the business manager, you must prepare the budgeted income statements for May and June.

a. Sales in April were $50,000. You forecast that monthly sales will increase 8% in May and an additional 4% in June.

b. Hilton Fashions maintains inventory of $11,000 plus 20% of sales revenues budgeted for the following month. Monthly purchases average 50% of sales revenues in that same month. Actual inventory on April 30 is $21,800. Sales budgeted for July are $55,000.

c. Monthly salaries amount to $3,000. Sales commissions equal 5% of sales for that month. Combine salaries and commissions into a single figure.

d. Other monthly expenses are as follows:

Rent expense………………….. $3,200, paid as incurred

Depreciation expense………….. $500

Insurance expense……………….. $300, expiration of prepaid amount

Income tax………………. 20% of operating income

Requirement

Prepare Hilton Fashions’ budgeted income statements for May and June. Show cost of goods sold computations.

Exercise 3

P10-56B Prepare and interpret a performance report

The company sold 70,000 bubble kits during March and its actual operating income was as follows:

Requirements

1. Prepare an income statement performance report for October.

2. What accounts for most of the difference between actual operating income and master budget operating income?

3. What is Popping Bubbles’ master budget variance for operating income? Explain why the income statement performance report provides Popping Bubbles’ managers with more useful information than the simple master budget variance. What insights can Popping Bubbles’ managers draw from this performance report?

Exercise 4

E10-43B Prepare a flexible budget performance report

Stone Canyon Muffins sells its muffins to restaurants and coffee houses for an average selling price of $27 per case. The following information relates to the budget for Stone Canyon Muffins for this year (all figures are annual totals unless otherwise noted):