The Master Budget
Chapter 9
Objective 1
Describe how and why managers
use budgets
2
Budgeting
• A plan for a specific period of time
• Quantitative expression of a plan
• Helps management determine how to use resources
(materials and manpower)
• Used to estimate future costs and revenues
3
Rolling (or Continuous) Budget
A budget that is continuously updated so that
the next 12 months of operations are always
budgeted
4
Participative Budgeting
• Involves many levels of management
• Benefits
– (Lower level) managers have more detailed knowledge for
creating realistic budgets
– Mangers are more motivated by budgets they helped to
create
• Disadvantages
– More people involved: more complex & time consuming
– Intentional slack built into the budget
• Uncertainty about future
• To look better easily
• To self protect from budget cut 5
Starting Point for Developing
the Budgets
1. Prior year’s budgeted figures or actual results
– Modify to reflect new changes internally & externally
– Potential problem: increase in budgeted expense year-
after-year
2. Zero-based budgeting
– Begin with a budget of zero and manager must justify
every dollar they put in the budget
– Potential problem: time consuming & labor intensive
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Benefits of Budgeting
• Planning: The budgeting process forces managers to
spend time planning for the future, rather than only
concerning themselves with daily operations.
• Coordination and Communications: Budgets
communicate operational and financial plans to
employees at all levels in the company, and thus can
make the company more effective and efficient.
• Benchmarking: Provides a benchmark that motivates
employees and helps managers evaluate performance.
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Master Budget
• Comprehensive planning document for entire
organization
• Consists of all supporting budgets needed to
create the company’s budgeted financial
statements
8
Operating Budgets Operating
budgets are
Sales budget needed to
run the daily
operations of
Production budget the company
Direct materials Manufacturing
Direct labor budget
budget overhead budget
Operating expense
budget
Budgeted income
statement 9
Financial Budgets
Focus on how operations and planned capital outlays affect
cash. Using the budgeted income statement, capital
expenditure budget, and cash budget, managers make the
budgeted balance sheet.
Budgeted income statement
Capital
Cash Budgeted balance
expenditures
budget sheet
budget
10
Financial budget
Objective 2
Prepare the operating budgets
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Sales Budget
• The sales budget is the starting place for budgeting.
Managers multiply the expected number of unit sales
by the expected price per unit to arrive at the
expected total sales revenue.
• Plan for sales revenues in future periods
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Sales Budget (Exhibit 9-5)
Tucson Tortilla
Sales Budget
For the Quarter Ended March 31
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S9-3
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S9-3 Sales Budget
Dukes Gibbs
SportsCompany
Medicine, Inc.
Sales Budget
ForFor
thethe Months
Months of April
of July through
through June
September
July August September Quarter
Unit sales (Basic) 240 250 75 565
Sales price x $105 x $105 x $105 x $105
Sales revenue (Basic) $25,200 $26,250 $7,875 $59,325
Unit sales (Extended) 170 230 90 490
Sales price x $160 x $160 x $160 x $160
Sales revenue (Extended) $27,200 $36,800 $14,400 $78,400
Total sales revenue $52,400 $63,050 $22,275 $137,725
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Production Budget
Once managers have estimated how many units they
expect to sell, they can figure out how many units they
need to produce. Most manufactures maintain some
ending finished goods inventory, or safety stock.
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Production Budget (Exhibit 9-6)
S9-4
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S9-4 Production budget
Trader Cycles
Production Budget
For the Months of April through June
Month
April May June Quarter
Unit sales (from Sales Budget) 1,000 1,180 1,320 3,500
Plus: Desired end inventory 354 396 360 360
Total needed 1,354 1,576 1,680 3,860
Less: Beginning inventory 220 354 396 220
Units to produce 1,134 1,222 1,284 3,640
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Direct Materials Budget
20
Direct Materials Budget (Exhibit 9-7)
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S9-5
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S9-5 Direct materials budget
The Bakery by the Bay
Direct Materials Budget
For the Months of July through September
Month
July August September Quarter
Units to be produced
1,460 1,920 1,760 5,140
× Quantity (pounds) of DM needed
0.50 0.50 0.50 0.50
per unit
Quantity (pounds) needed for
730 960 880 2,570
production
Plus: Desired end inventory of DM 96 88 74 74
Total quantity (pounds) needed 826 1,048 954 2,644
Less: Beginning inventory of DM 100 96 88 100
Quantity (pounds) to purchase 726 952 866 2,544
× Cost per pound × $2.00 × $2.00 × $2.00 × $2.00
Total cost of DM purchases $ 1,452 $ 1,904 $ 1,732 $ 5,088
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Direct Labor Budget
24
Direct Labor Budget (Exhibit 9-8)
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S9-6
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S9-6 Direct Labor Budget
Cameron Manufacturing
Direct Labor Budget
For the Months of January through March
Month
January February March Quarter
Units to be produced
(from production budget) 560 600 860 2,020
× Direct labor hours per unit 6.0 6.0 6.0 6.0
Total hours required 3,360 3,600 5,160 12,120
× Direct labor cost per hour $16.00 $16.00 $16.00 $16.00
Total Direct labor cost $53,760 $57,600 $82,560 $193,920
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Manufacturing Overhead Budget
• To prepare MOH budget, it is very important to
know cost behavior
• Dependent on cost behavior
– VC increases as production level increases
– FC stays the same regardless of production level
• Mixed costs are needed to be separated into
variable and fixed components using methods in
Ch6.
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Manufacturing Overhead Budget
(Exhibit 9-9)
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S9-7
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S9-7 Manufacturing Overhead Budget
Probe Corporation
Manufacturing Overhead Budget
For the Months of April through June
Month
April May June Quarter
Variable MOH Cost:
Budgeted direct labor hours 490 770 660 1,920
Indirect labor—Variable
$1.60 $1.60 $1.60 $1.60
($1.60 per direct labor hour)
Total variable MOH $ 784 $1,232 $1,056 $ 3,072
Fixed MOH Costs:
Total fixed MOH $ 3,000 $ 3,000 $ 3,000 $ 9,000
Total manufacturing overhead $ 3,784 $ 4,232 $ 4,056 $ 12,072
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Operating Expenses Budget
• Operating expenses include expenses in every area of the
value chain except production
• Some operating expenses are variable (based on no. of
units sold)
‒ Bad debt expense
‒ Sales commission
‒ Shipping costs
• Some operating expenses are fixed
‒ Office rent & salaries
‒ Depreciation of equipment in non-manufacturing process
‒ Advertising, etc.
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Operating Expenses Budget (Exhibit 9-10)
33
S9-8
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S9-8 Operating Expenses Budget
Davenport Corporation
Operating Expenses
Expenses Budget
Budget
For the Months of July through September
Month
July August September Quarter
Sales units (from Sales Budget) 1,210 1,440 1,700 4,350
Variable Operating Expenses:
Variable operating expenses
$ 6.00 $ 6.00 $ 6.00 $ 6.00
( $6.00 per unit)
Variable operating expenses $ 7,260 $8,640 $10,200 $ 26,100
Fixed Operating Expenses:
Salaries $ 5,100 $ 5,100 $ 5,100 $ 15,300
Office rent 3,300 3,300 3,300 9,900
Depreciation 2,200 2,200 2,200 6,600
Fixed operating expenses $ 10,600 $ 10,600 $ 10,600 $ 31,800
Total operating expenses $ 17,860 $ 19,240 $ 20,800 $ 57,900
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Budgeted Manufacturing Cost per Unit
(Exhibit 9-11)
*Production volume is budgeted to be 400,000 cases for the year.
*Predetermined MOH rate is calculated for the entire year (rather than monthly):
Estimated MOH costs for the year / Estimated no. of units produced for the year
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Budgeted Income Statement
(Exhibit 9-12)
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S9-9
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S9-9 Budgeted Income Statement
Bell Simpson
Budgeted Income Statement
For the month ended January 31
Sales (800 units x $2,350) $ 1,880,000
Cost of goods sold (800 units x $1,400) 1,120,000
Gross profit $ 760,000
Operating expenses (800 units x $1.10) + $7,700 8,580
Operating income $751,420
Less: Interest expense 3,700
Less: Provision for income tax 299,088*
Net income $448,632
*(751,420 – 3,700) x 40% = 299,088
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Objective 3
Prepare the financial budgets
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Financial Budgets
Focus on how operations and planned capital outlays affect
cash. Using the budgeted income statement, capital
expenditure budget, and cash budget, managers make the
budgeted balance sheet.
Budgeted income statement
Capital
Cash Budgeted balance
expenditures
budget sheet
budget
41
Financial budget
Financial Budget Components
• Capital expenditures budget
‒ When to invest in additional property, plant, equipment?
• Cash collections budget
‒ When to receive cash from sales?
• Cash payments budget
‒ When to pay for DM purchases, DL costs, MOH costs, operating
expenses, capital expenditures, and income taxes?
• Combined cash budget
= cash collections budget + cash payments budget + financing
arrangements
• Budgeted balance sheet
42
Capital Expenditure Budget
(Exhibit 9-13)
Shows the company’s plans to invest in new property,
plant, or equipment (capital investments)
43
Cash Collections Budget (Exhibit 9-14)
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S9-10
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S9-10 Cash Collections Budget
Emerald Service
Cash Collections Budget
For the Months of January through March
Month
January February March 1st Quarter
Cash sales (20% of Sales) $3,100 $2,400 $2,800 $8,300
Collections on Credit Sales:
30% in the month of the sale 3,720 2,880 3,360 $ 9,960
60% in the month after the sale 5,040 7,440 5,760 $ 18,240
6% two months after the sale 792 504 744 $ 2,040
Total cash collections $ 12,652 $ 13,224 $ 12,664 $ 38,540
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Building a Cash Payments Budget
(Exhibit 9-15)
Depreciation & bad debt expenses are non-cash
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S9-11
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S9-11 Cash Payments Budget
Stately Corporation
Cash Payments Budget
For the Month
Month
Cash payments for direct materials purchases
$ 48,400
- Month of purchase
Cash payments for direct materials purchases
35,550
- Month after purchase (from last month)
Cash payments for direct labor 35,000
Cash payments for manufacturing overhead 38,000
Cash payments for operating expenses 42,600
Cash payments for income taxes 7,600
Total cash payments $ 207,150
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Combined Cash Budget (Exhibit 9-16)
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Budgeted Balance Sheet (Exhibit 9-17)
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Notes to the budgeted balance sheet
Note A: Accounts Receivable, Net of Allowance
Jan Credit Sales (from sales budget) $480,000
(+) 15% of Dec’s Credit Sales 75,000
(=) Accounts Receivable, Jan 31 $555,000
(-) AFDA (assume $750 credit balance prior to additional $4,800 (5,550)
bad debt expense from operating expanse budget)
(=) Accounts Receivable, net of Allowance, Jan 31 $549,450
Note B: Prepaid Property Tax & Insurance
Jan payment (from cash payments budget for MOH) $18,000
(-) Jan costs (from MOH budget) (3,000)
(=) Prepaid property tax & insurance, Jan 31 $15,000
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Notes to the budgeted balance sheet
Note C: Property, Plant, Equipment
PPE, Dec 31 (assumed) $6,225,000
(+) Jan investment (from capital expenditure budget) 125,000
(=) PPE, Jan 31 6,350,000
Note D: Accumulated Depreciation
Accumulated Depreciation, Dec 31 (assumed) $1,904,000
(+) Jan Depreciation on factory facilities (from MOH budget) 10,000
(+) Jan Depreciation on offices (from operating expenses budget) 6,000
(=) Accumulated Depreciation, Jan 31 1,920,000
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Notes to the budgeted balance sheet
Note E: Accounts Payable
Jan DM purchases to be paid in Feb (from Cash Payments $211,125
Budget)
Accounts Payable, Jan 31 $211,125
Note F: Stockholders’ Equity
Common stock & Retained Earnings, Dec 31 (Assumed) $4,720,555
(+) Jan net income (from budgeted income statement) 63,180
(=) Stockholder’s equity, Jan 31 4,783,735
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Objective 4
Prepare budgets for a merchandiser
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Service Companies
Compared with that for
a manufacturer, the key
difference is that
• No merchandise inventory service companies do
not have production
• Operating budgets budget, DM, DL, and
MOH budget.
– Sales budget
– Operating expenses budget
– Budgeted income statement
• Financial budgets are the same (Capital
expenditure budget, Cash budgets, Budgeted
balance sheet)
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Merchandising Companies
• Cost of goods sold, inventory and purchases
budget:
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