Master Budget Problem – The Observer Company

    Master Budget Problem
    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 20×2 will increase by 10% each month over the previous month’s sales. Then
    (beginning in April 20×2) 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, 20×1 is as
    follows:

    Observer
    Company- Balance Sheet – 31-Dec-20×1

    Assets:

    Cash

    $ 35,000

    Accounts Receivable

    270,000

    Marketable securities

    15,000

    Inventory

    154,000

    Building & Equipment (net of accumulated
    depreciation)

    626,000

    Total Assets

    1,100,000

    Liabilities and Stockholder’s Equity:

    Accounts payable

    $ 176,400

    Bond interest payable

    12,500

    Property taxes payable

    3,600

    Bonds payable (due in 20×6)

    300,000

    Common Stock

    500,000

    Retained Earnings

    $ 107,500

    Total L & SE

    $ 1,100,000

    As Assistant Controller for the
    Observer Company you are now preparing a monthly budget for Quarter 1 of 20×2.
    In this process, the following information has been accumulated:
    (1) Projected Sales for December
    20×1 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 (Includes depreciation on new
    equipment purchased at beginning of
    Quarter 1)
    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 short-term 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: Complete the Observer
    Company’s Master Budget for Quarter 1 of 20×2 using the Excel spreadsheet provided.

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