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Planning Cash Needs: Analysis of Variances and Possible Explanations for AudioFile

Part A

AudioFile Products Ltd. is a retailer that sells sound systems.  The company is planning its cash needs for the month of January, 2021. In the past, AudioFile has had to borrow money during the post-Christmas season to offset a significant decline in sales.  The statement of financial position showed the following at December 31, 2020.

Assets

Current

Cash

$     50,000

Accounts receivable

390,000

Inventory

180,000

620,000

PPE, net

6,000,000

$6,620,000

Liabilities

Current

Operating loan

$1,500,000

Accounts payable

208,000

1,708,000

Non-current borrowings

4,000,000

5,708,000

Shareholders’ Equity

Share capital

280,000

Retained earnings

632,000

912,000

$6,620,000

Other information:

  1. Sales are 10% for cash and 90% on credit. January sales are projected to be $400,000, or $2,000 per unit on average. The gross profit ratio is estimated at 25%.
  2. Credit sales are collected over a three-month period with 40% collected in the month of sale, 30% in the following month, and 30% in the second month following sale. November 2020 credit sales totaled $300,000 and December credit sales totaled $500,000. January sales are projected to be $400,000.
  3. 40% of a month’s inventory purchases are paid for in the same month. The remaining 60% are paid in the following month. Accounts payable at December 31, 2020 relate solely to inventory purchases.
  4. The company maintains its ending inventory levels at 60% of the cost of the merchandise to be sold in the following month. February 2021 sales are budgeted at $250,000. Gross profit ratio will remain unchanged.
  5. Variable expenses besides cost of goods sold related to commissions on sales and amount to 2.5% of sales each month. These are paid in the month incurred.
  6. Fixed expenses total $60,000 per month. This is composed of $30,000 of depreciation, $25,000 of salaries and benefits, and $5,000 of utilities and maintenance expenses. All non-depreciation items are paid in cash by the end of each month.
  7. The company pays a $10,000 monthly cash dividend to shareholders.
  8. Interest on the operating loan and non-current debt is 6% per year, calculated on the balance at the start of each month. Interest is paid in cash each month.
  9. The non-current loan is repayable at $20,000 per month.
  10. The corporate income tax rate is 10% of income before income taxes. Income taxes will be paid in cash in April 2021. No income taxes were owing at December 31, 2020.
  11. Budgeted PPE cash purchases for January are $50,000. Depreciation will be unaffected.
  12. Management wants to maintain a cash balance of $50,000 at the end of each month. The maximum operating loan is limited to $1,500,000. Shares will be issued to make up any cash deficiency.

Required: 

  1. (10 marks) Record the above information in a budget transaction worksheet.
  2. (4 marks) Prepare a statement of financial position at January 31, 2021 and a budgeted income statement, statement of changes in equity, and statement of cash flows for the month ended January 31, 2021. Show all calculations. Prepare the income statement in contribution margin format.

Part B

Assume the actual results for January 2021 are as follows, and that no additional staff were hired:

Sales (220 units) $420,000

Commissions expense 12,600

Cost of goods sold 327,600

Depreciation 30,000

Income tax recovered 815

Interest expense 25,208

Salaries expense 27,000

Utilities and maintenance 5,000

Required: (6 marks) Analyze the variances and suggest one possible explanation for each one.

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