College of Accountancy

Subject Code: Management Reporting Module No./Title: – Budgeting: Basis for

Planning and Control

Subject Description: Period of Coverage:

Objectives:
1. To state the essentials of effective budgeting and the components of the master budget.

Content:

A master budget combines all of the smaller budgets within your business and turns them
into one overall budget, so you can get a comprehensive overview of your firm’s finances.
The master budget includes the HR, marketing, and all other departmental budgets to
produce an overall single budget.

Commonly, it’s thought that it is one large budget of the company. However, it’s not the case, it’s in
fact a summary of the divisional budget and is used as a continuous financial plan. Furthermore, it
also includes the financial planning, cash-flow forecast, budgeted profit and loss account, and
balance sheet of your organization. Usually, firm’s produce a master budget yearly.
The one-year budget planning document encompasses all other budgets, it coincides with the fiscal
year and can be split into quarters and further, into months. If you decide that the master budget is
going to be an ongoing documents, i.e. rolling year on year, then usually a month is added to the end
of the budget to facilitate planning. This is called continuous budgeting.

What’s included?

This depends on the scale of your business, however, no matter the size, it remains the most
comprehensive budget planning document. It usually contains two parts; the operating budget and
the financial budget.

The operating budget

The operating budget shows the income that’s generated by the activities of the firm, including
revenues and expenses. The result is a budgeted income statement.
It’s composed of eight supporting planning schedules, they’re interrelated and come together to
develop the income statement. It’s important to note, the operating income isn’t the same as net
income, to get a true net income result, you’ll need to subtract out the financial budget.

The eight supporting schedules you’ll need to produce are;

 Sales budget: this is based on the sales forecast and can be adjusted at managerial
discretion.
  Production schedule: you should determine the number of sales the company
expects to make in the next year, and it should budget how many sales units need to
make to meet the sales budget and inventory requirements.

 Direct materials purchases budget: this refers to the raw materials the firm uses in
its production process.

 Labor budget: this takes into account the manual costs of the work being carried out.

 Overhead budget: this will include fixed and variable overhead costs.

 Finished goods inventory: this is necessary to complete the cost of goods sold
budget and the balance sheet.

 Cost of goods sold budget: this allows you to account for the actual cost of the
products you have produced, it assigns a value to every unit of the product based on
raw materials, direct labor, and overheads.

 Administrative budget: The selling and administrative expense budget deals with
non-manufacturing costs such as freight or supplies.

Operating budgets are prepared first, as information from this is needed to generate the financial
budget.

The financial budget

The financial budget shows the inflows and outflows of cash and other parts of the firm’s financial
position. In-comings and outgoings of cash come from the cash budget and as such, the result of the
financial budget is the budgeted balance sheet.

The three remaining budgets found in the financial budget are;

 Cash budget: this states inflows and outflows of cash, expected borrowing, and
expected to invest – on a monthly basis. Any item that isn’t cash is ignored here.

 Budgeted balance sheet: this gives the ending balances of the asset, liability, and
equity accounts.

 Budget for capital expenditures: this contains budgetary figures for the large,
expensive fixed assets for the firm.

These are the most used budgets within the master budget of a business. To manage your budgets
you should consider an invoice and billing software that also saves you much needed time.

Budget -
*is the quantitative expression of a proposed plan of action by management for a specified period.
*is an aid to coordinating what needs to be done to implement that plan.
Budgets and Managers –

Communicate directions and goals to different departments of a company to help them coordinate
the actions they must pursue to satisfy customers and succeed in the marketplace.
Judge performance by measuring financial results against planned objectives, activities, and
timelines to learn about potential problems.
Motivate employees to achieve their goals.

Budgeting Cycle -

1. Before the start of a fiscal year, managers at all levels take into account past performance, market
feedback, anticipated future changes and other indicators to initiate plans for the next period.

2. Senior managers give subordinate managers a frame of reference against which they will
compare actual results.

3. Managers and management accountants investigate any deviation.

Advantages of Budgets:

1. Promotes coordination and communication among subunits within the company.

2. Provides a framework for judging performance and facilitating learning.

3. Motivates managers and other employees.

Challenges of a Budget:

Top managers want lower-level managers to participate in the budgeting process because they have
more specialized knowledge of day-to-day management, however...
The budgeting process is time-consuming, and
Upper-level management's support is crucial

Time coverage of budgets -

Businesses may also use a rolling budget. This budget is always available for a specified future
period, by continually adding a month, quarter, or year to the period just ended.

To facilitate the budget process, use the 5-step decision making process:

[Link] the problem and uncertainties

[Link] information
[Link] predictions about the future
4. Make decisions by choosing among alternatives
5. Implement the decision, evaluate performance and learn

Once the schedules just discussed and the budgeted income statement are complete, additional
schedules need to be created to complete the budgeted balance sheet and the financial section of
the master budget

The steps are numbered 1-4

1. Prepare the capital expenditures budget.

2. Prepare the cash budget.
3. Prepare the budgeted balance sheet.
4. Prepare the budgeted statement of cash flows.

Budgetary slack -
is the practice of underestimating budgeted revenues or overestimating budgeted costs to make
budgeted targets easier to achieve

Stretch targets -
are targets that are challenging but achievable to focus effort on achieving the targets.

Kaizen Budgeting -
is a practice whereby each budget process incorporates continuous improvement from past results.

Controllability -
is the degree of influence that a manager has over costs, revenues, or related items for which he or
she is being held responsible.

Responsibility Accounting -
helps managers to first focus on whom they should ask to obtain information and not on whom they
should blame. Focuses on gaining information and knowledge, not only on control.

The fundamental purpose of responsibility accounting is to enable future improvement.

Responsibility Centers:

1. Cost – the manager is responsible for costs only

2. Revenue – the manager is accountable for revenues only
3. Profit – the manager is accountable for revenues and costs
4. Investment – the manager is accountable for investments, revenues and costs

Responsibility Center -
a part, segment, or subunit of an organization whose manager is accountable for a specified set of
activities

Budget defined -
is the quantitative expression of a proposed plan of action by management for a specified period.
A ______ is an aid to coordinating what needs to be done to implement that plan.

A ______generally includes both the plan's financial and nonfinancial aspects and serves as a
blueprint for the company to follow in an upcoming period.
Activity based budgeting (ABB) -
A budgeting method that focuses on the budgeted cost of the activity necessary to produce and sell
products and services.

Cash Budget -
Is the schedule of expected cash receipts and disbursements. It predicts the effect on the cash
position at the given level of operations.
Cash available for needs (before any financing)
The beginning cash balance plus the cash receipts equals the total cash available for needs before
any financing. Cash receipts depend on collections of accounts receivable, cash sales, and
miscellaneous recurring sources, such as rental or royalty receipts.

Continuous budget also called rolling budget or rolling forecast

Is a budget that is always available for a specified future period.

Financial Budget -
Part of the master budget that focuses on how operations and planned capital outlays affect cash. It
is made up of the capital expenditures budget, the cash budget, the budgeted balance sheet and the
budgeted statement of cash flows.

Operating budget -
Budgeted income statement and its supporting budgeted schedules.

Financial Planning Models -

are mathematical representations of the relationships among operating activities, financing activities
and other factors that affect the master budget.

Controllable cost -
is any cost primarily subject to the influence of a given responsibility center manager for a given
period.

Master budget -
Expresses management's operating and financial plans for a specified period, usually a fiscal year,
and it includes a set of budgeted financial statements. The master budget is the initial plan of what
the company intends to accomplish in the period and evolves from both the operating and the
financial decisions managers make along the way.

Organization structure -
is the arrangement of lines of responsibility within an organization.

Pro forma statements -

The terminology used to describe budgets varies among companies. For example budgeted financial
statements.
 ABC Company
Sales Budget
For the Year Ended December 31, 20XX
Quarter 1 Quarter 2 Quarter 3 Quarter 4

Forecasted unit sales 5,500 6,000 7,000 8,000

x Price per unit $10 $10 $11 $11

Total gross sales $55,000 $60,000 $77,000 $88,000

- Sales discounts & allowances $1,100 $1,200 $1,540 $1,760

= Total net sales $53,900 $58,800 $75,460 $86,240

ABC Company
Production Budget
For the Year Ended December 31, 20XX
Quarter 1 Quarter 2 Quarter 3 Quarter 4

Forecasted unit sales 5,500 6,000 7,000 8,000

+ Planned ending inv. units 500 500 500 500

= Total production required 6,000 6,500 7,500 8,500

- Beginning F/G inventory 1,000 500 500 500

= Units to be manufactured 5,000 6,000 7,000 8,000

 ABC Company
Direct Materials Budget
For the Year Ended December 31, 20XX
Quarter 1 Quarter 2 Quarter 3 Quarter 4

Product A (units) 5,000 6,000 7,000 8,000

x Resin/unit (lbs) 2 2 2 2

Total resin needed (lbs) 10,000 12,000 14,000 16,000

+ Planned ending inventory 2,000 2,400 2,800 3,200

= Total resin required 12,000 14,400 16,800 19,200

- Beginning inventory 1,600 2,000 2,400 2,800

= Resin to be purchased 10,400 12,400 14,400 16,400

Resin cost per pound $0.50 $0.50 $0.55 $0.55

Total resin cost to purchase $5,200 $6,200 $7,920 $9,020

 ABC Company
Direct Labor Budget
For the Year Ended December 31, 20XX
Quarter 1 Quarter 2 Quarter 3 Quarter 4

Product A (units) 5,000 6,000 7,000 8,000

x Machine operator hrs (0.1) 0.1 0.1 0.1 0.1

=Total machine operator hrs 500 600 700 800

x Other labor hours (0.05) 0.05 0.05 0.05 0.05

= Total other labor hours 250 300 350 400

Machine operator cost/hr $25 $25 $25 $25

Other labor cost/hr $15 $15 $15 $15

Total machine operator cost $12,500 $15,000 $17,500 $20,000

Total other labor cost $3,750 $4,500 $5,250 $6,000

Grand total direct labor cost $16,250 $19,500 $22,750 $26,000

 Delphi Furniture
Manufacturing Overhead Budget
For the Year Ended December 31, 20XX
Quarter 1 Quarter 2 Quarter 3 Quarter 4

Administrative salaries $142,000 $143,000 $144,000 $145,000

Administrative payroll taxes 10,000 10,000 11,000 11,000

Depreciation 27,000 27,000 29,000 29,000

Freight in and out 8,000 7,000 10,000 9,000

Rent 32,000 32,000 32,000 34,000

Supplies 6,000 5,000 7,000 6,000

Travel and entertainment 3,000 3,000 3,000 3,000

Utilities 10,000 10,000 10,000 12,000

Total manufacturing overhead $238,000 $237,000 $236,000 $237,000

Evaluation:
True or False:

1. Budgeting is the process of establishing company-wide objectives that serve as a

deterrent to waste and inefficiency.

2. The effectiveness of the budget program is directly related to its acceptance by all
levels of management.

3. Budgeting always has the effect on human behavior of inspiring managers to higher
levels of performance.

4. One disadvantage of budgeting is that it does not facilitate the coordination of

activities within a business.

5. The sales budget is the first budget prepared and each of the other budgets depends on
it.

6. The quantities of direct materials in the direct materials budget are derived from the
formula: Desired Ending Direct Materials Units + Direct Materials Units Required for
Production – Beginning Direct Materials Units = Required Direct Materials Units to be
Purchased.

7. The manufacturing overhead budget shows only the expected indirect labor costs for
the year.

8. The budgeted income statement indicates the expected profitability of operations for
the next year and provides the basis for evaluating company performance.

9. Long-range planning differs from budgeting in the time period involved, emphasis, and
the amount of detail presented.

10. Budgeting is not used in not-for-profit organizations because it is not necessary for
these organizations to engage in profit planning.

11. Budgets are statements of management's plans stated in financial terms.

12. A budget can facilitate the coordination of activities among the segments of a large
company.

13. Financial budgets must be completed before the operating budgets can be prepared.
14. A production budget should be prepared before the sales budget.

15. The direct materials budget contains both quantity and cost data.
Multiple Choice

1. A formal written statement of management’s plans for a specified future time period,
expressed in financial terms is a(n)
a. accounting plan.
b. budget.
c. research analysis.
d. sales budget.

2. Which of the following is not a benefit of budgeting?

a. It reveals the prevailing business conditions.
b. It results in greater management awareness of the entity’s overall operations.
c. It creates an early warning system of potential problems.
d. It provides definite objectives for evaluating performance at each level of responsibility.

3. All of the following are financial budgets except the

a. budgeted balance sheet.
b. budgeted income statement.
c. capital expenditure budget.
d. cash budget.

4. The master budget includes all of the following except

a. Budgeted Income Statement.
b. Capital Expenditure Budget.
c. Cash Budget.
d. Indirect Labor Budget.

5. If required production units are 75,000, budgeted sales units are 65,000, required
direct materials purchases units are 3,000, and beginning finished goods units are 5,000, then
desired ending finished goods units would be
a. 2,000.
b. 5,000.
c. 12,000.
d. 15,000.

6. Accounting generally has the responsibility for

a. setting company goals.
b. expressing the budget in financial terms.
c. enforcing the budget.
d. administration of the budget.
7. Budgeting is usually most closely associated with which management function?
a. Planning
b. Directing
c. Motivating
d. Controlling

8. Which is true of budgets?

a. They are voted on and approved by stockholders.
b. They are used in the planning, but not in the control, process.
c. There is a standard form and structure for budgets.
d. They are used in performance evaluation.

9. If budgets are to be effective, all of the following must be present except

a. acceptance at all levels of management.
b. research and analysis in setting realistic goals.
c. stockholders' approval of the budget.
d. sound organizational structure.

10. In many companies, responsibility for coordinating the preparation of the budget is
assigned to
a. the company's independent certified public accountants.
b. the company's internal auditors.
c. the company's board of directors.
d. a budget committee.

11. A budget period should be

a. monthly.
b. for a year or more.
c. long-term.
d. long enough to provide an obtainable goal under normal business conditions.

12. If there were 60,000 pounds of raw materials on hand on January 1, 120,000 pounds are
desired for inventory at January 31, and 410,000 pounds are required for January production,
how many pounds of raw materials should be purchased in January?
a. 350,000 pounds
b. 530,000 pounds
c. 290,000 pounds
d. 470,000 pounds

13. The direct materials and direct labor budgets provide information for preparing the
a. sales budget.
b. production budget.
c. manufacturing overhead budget.
d. cash budget.
 14. A master budget consists of
a. an interrelated long-term plan and operating budgets.
b. financial budgets and a long-term plan.
c. interrelated financial budgets and operating budgets.
d. all the accounting journals and ledgers used by a company.

15. Lorie Nursery plans to sell 320 potted plants during April and 240 units in May. Lorie
Nursery keeps 15% of the next month’s sales as ending inventory. How many units should
Lorie Nursery produce during April?
a. 308 Mar Apr. May
b. 332 Sales 320 240
c. 320 EI + 48 36
d. 356 BI - (48)
Prod 308
Prepared by: Maria Corazon S.
Guintu CPA MBA - BSA