Master Budgeting

Chapter 8

Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
 8-2

Learning Objective 1

Understand why
organizations budget
and the processes they
use to create budgets.
 8-3

The Basic Framework of Budgeting

A budget is a detailed quantitative plan for
acquiring and using financial and other resources
over a specified forthcoming time period.
1. The act of preparing a budget is called
budgeting.
2. The use of budgets to control an
organization’s activities is known
as budgetary control.
 8-4

Difference Between Planning and

Control
Planning
Planning –– Control
Control ––
involves
involves developing
developing involves
involves the
the steps
steps taken
taken
objectives
objectives and
and by
by management
management to to
preparing
preparing various
various increase
increase the
the likelihood
likelihood that
that
budgets
budgets to
to achieve
achieve the
the objectives
objectives setset down
down
those
those objectives.
objectives. while
while planning
planning areare attained
attained
and
and that
that all
all parts
parts ofof the
the
organization
organization areare working
working
together
together toward
toward that
that goal.
goal.
 8-5

Advantages of Budgeting
Define goals
and objectives
Communicate
plans

Advantages
Coordinate Means of allocating
activities resources

Uncover potential
bottlenecks
 8-6

Responsibility Accounting
Managers should be held
responsible for those items -
and only those items - that
they can actually control
to a significant extent.
Responsibility accounting
enables organizations to react
quickly to deviations from their
plans and to learn from
feedback.
 8-7

Choosing the Budget Period

Operating Budget

2014 2015 2016 2017

Operating
Operating budgets
budgets ordinarily
ordinarily AA continuous
continuous budget
budget is
is aa
cover
cover aa one-year
one-year period
period 12-month
12-month budget
budget that
that rolls
rolls
corresponding to a company’s
corresponding to a company’s forward one month (or quarter)
fiscal year. Many companies forward one month (or quarter)
fiscal year. Many companies as the current month (or quarter)
divide their annual budget as the current month (or quarter)
divide their annual budget is
into four quarters. is completed.
completed.
into four quarters.
 8-8

Self-Imposed Budget
Top M anagem ent

M id d le M id d le
M anagem ent M anagem ent

S u p e r v is o r S u p e r v is o r S u p e r v is o r S u p e r v is o r
A self-imposed budget or participative budget is a budget that is
prepared with the full cooperation and participation of managers
at all levels.
 8-9

Advantages of Self-Imposed Budgets

1.
1. Individuals
Individuals at
at all
all levels
levels of
of the
the organization
organization are
are viewed
viewed as
as
members
members of of the
the team
team whose
whose judgments
judgments are
are valued
valued by
by top
top
management.
management.
2.
2. Budget
Budget estimates
estimates prepared
prepared by
by front-line
front-line managers
managers are
are
often
often more
more accurate
accurate than
than estimates
estimates prepared
prepared by
by top
top
managers.
managers.
3.
3. Motivation
Motivation isis generally
generally higher
higher when
when individuals
individuals participate
participate
in
in setting
setting their
their own
own goals
goals than
than when
when the
the goals
goals are
are
imposed
imposed from
from above.
above.
4.
4. A
A manager
manager who
who is
is not
not able
able to to meet
meet aa budget
budget imposed
imposed
from
from above
above can
can claim
claim that
that itit was
was unrealistic.
unrealistic. Self-imposed
Self-imposed
budgets
budgets eliminate
eliminate this
this excuse.
excuse.
 8-10

Self-Imposed Budgets
Self-imposed budgets should be reviewed
by higher levels of management to
prevent “budgetary slack.”
Most companies issue broad guidelines in
terms of overall profits or sales. Lower
level managers are directed to prepare
budgets that meet those targets.
 8-11

Human Factors in Budgeting

The success of a budget program depends on three
important factors:
1.Top management must be enthusiastic and
committed to the budget process.
2.Top management must not use the budget to
pressure employees or blame them when
something goes wrong.
3.Highly achievable budget targets are usually
preferred when managers are rewarded based on
meeting budget targets.
 8-12

The Master Budget: An Overview

Sales
Sales budget
budget

Selling
Selling and
and
Ending
Ending inventory
inventory administrative
administrative
Production
Production budget
budget
budget
budget budget
budget

Direct
Direct materials
materials Direct
Direct labor
labor Manufacturing
Manufacturing
budget
budget budget
budget overhead
overhead budget
budget

Cash
Cash Budget
Budget

Budgeted
Budgeted Budgeted
Budgeted
income
income balance
balance sheet
sheet
statement
statement
 8-13

Seeing the Big Picture

To help you see the “big picture” keep in mind
that the 10 schedules in the master budget are
designed to answer the 10 questions shown on
the next screen.
 8-14

Seeing the Big Picture

1. How much sales revenue will we earn?
2. How much cash will we collect from customers?
3. How much raw material will we need to purchase?
4. How much manufacturing costs will we incur?
5. How much cash will we pay to our suppliers and our direct laborers, and how
much cash will we pay for manufacturing overhead resources?
6. What is the total cost that will be transferred from finished goods inventory to
cost of good sold?
7. How much selling and administrative expense will we incur and how much
cash will be pay related to those expenses?
8. How much money will we borrow from or repay to lenders – including
interest?
9. How much operating income will we earn?
10. What will our balance sheet look like at the end of the budget period?
 8-15

The Master Budget: An Overview

A master budget is based on various estimates

and assumptions. For example, the sales
budget requires three estimates/assumptions
as follows:
1.What are the budgeted unit sales?
2.What is the budgeted selling price per unit?
3.What percentage of accounts receivable will
be collected in the current and subsequent
periods.
 8-16

The Master Budget: An Overview

When Microsoft Excel© is used to create a
master budget, these types of assumptions
can be depicted in a Budget Assumptions
tab, thereby enabling Excel-based budget to
answer “what-if” questions.
 8-17

Break for 10 min

 8-18

Learning Objective 2

Prepare a sales budget,

including a schedule of
expected cash
collections.
 8-19

Budgeting Example
 Royal Company is preparing budgets for the
quarter ending June 30th.
 Budgeted sales for the next five months are:
 April 20,000 units
 May 50,000 units
 June 30,000 units
 July 25,000 units
 August 15,000 units
 The selling price is $10 per unit.
 8-20

The Sales Budget

The individual months of April, May, and June are
summed to obtain the total budgeted sales in units
and dollars for the quarter ended June 30th
 8-21

Expected Cash Collections

• All sales are on account.
• Royal’s collection pattern is:
 70% collected in the month of sale,
 25% collected in the month following sale,
 5% uncollectible.
• In April, the March 31st accounts receivable
balance of $30,000 will be collected in full.
 8-22

Expected Cash Collections

 8-23

Expected Cash Collections

From
From the
the Sales
Sales Budget
Budget for
for April.
April.
 8-24

Expected Cash Collections

From
From the
the Sales
Sales Budget
Budget for
for May.
May.
 8-25

Quick Check 
What will be the total cash collections for
the quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000
 8-26

Quick Check 
What will be the total cash collections for
the quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000
 8-27

Expected Cash Collections

 8-28

Learning Objective 3

Prepare a production
budget.
 8-29

The Production Budget

Sales Production
Budget Budget
ed
and l et
p
Expected
o m
C
Cash
Collections

The production budget must be adequate to

meet budgeted sales and to provide for
the desired ending inventory.
 8-30

The Production Budget

• The management at Royal Company wants
ending inventory to be equal to 20% of the
following month’s budgeted sales in units.

• On March 31st, 4,000 units were on hand.

 Let’s prepare the production budget.

IfIf Royal
Royal was
was aa merchandising
merchandising company
company itit would
would prepare
prepare aa
merchandise
merchandise purchase
purchase budget
budget instead
instead of
of aa production
production budget.
budget.
 8-31

The Production Budget

 8-32

The Production Budget

Budgeted May sales 50,000

Desired ending inventory % 20%
March 31
Desired ending inventory 10,000
ending inventory.
 8-33

Quick Check 
What is the required production for May?
a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units
 8-34

Quick Check 
What is the required production for May?
a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units
 8-35

The Production Budget

 8-36

The Production Budget

Assumed ending inventory.

 8-37

Learning Objective 4

Prepare a direct
materials budget,
including a schedule of
expected cash
disbursements for
purchases of materials.
 8-38

The Direct Materials Budget

• At Royal Company, five pounds of material
are required per unit of product.
• Management wants materials on hand at the
end of each month equal to 10% of the
following month’s production.
• On March 31, 13,000 pounds of material are
on hand. Material cost is $0.40 per pound.

Let’s prepare the direct materials budget.

 8-39

The Direct Materials Budget

From
From production
production budget.
budget.
 8-40

The Direct Materials Budget

 8-41

The Direct Materials Budget

March 31 inventory.

10% of following month’s Calculate the materials to

production needs. be purchased in May.
 8-42

Quick Check 
How
How much
much materials
materials should be purchased
purchased in
May?
May?
a.
a. 221,500
221,500 pounds
pounds
b.
b. 240,000
240,000 pounds
pounds
c.
c. 230,000
230,000 pounds
pounds
d.
d. 211,500
211,500 pounds
pounds
 8-43

Quick Check 
How
How much
much materials
materials should be purchased
purchased in
May?
May?
a.
a. 221,500
221,500 pounds
pounds
b.
b. 240,000
240,000 pounds
pounds
c.
c. 230,000
230,000 pounds
pounds
d.
d. 211,500
211,500 pounds
pounds
 8-44

The Direct Materials Budget

 8-45

The Direct Materials Budget

Assumed ending inventory.

 8-46

Expected Cash Disbursement for

Materials
• Royal pays $0.40 per pound for its materials.
• 60% of a month’s purchases is paid for in the
month of purchase; the 40%is paid in the
following month.
• The March 31 accounts payable balance is
$12,000.

Let’s calculate expected cash disbursements.
 8-47

Expected Cash Disbursement for

Materials
 8-48

Expected Cash Disbursement for

Materials

Compute the expected cash

disbursements for materials
for the quarter.

140,000 lbs. × $0.40/lb. = $56,000

 8-49

Quick Check 
What
What areare the
the total
total cash
cash disbursements
disbursements for
for
the
the quarter?
quarter?
a.
a. $185,000
$185,000
b.
b. $$ 68,000
68,000
c.
c. $$ 56,000
56,000
d.
d. $201,400
$201,400
 8-50

Quick Check 
What are the total cash disbursements for
the quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400
 8-51

Expected Cash Disbursement for

Materials
 8-52

Learning Objective 5

Prepare a direct labor

budget.
 8-53

The Direct Labor Budget

• At Royal, each unit of product requires 0.05 hours (3
minutes) of direct labor.
• The Company has a “no layoff” policy so all employees will
be paid for 40 hours of work each week.
• For purposes of our illustration assume that Royal has a “no
layoff” policy, workers are paid at the rate of $10 per hour
regardless of the hours worked.
• For the next three months, the direct labor workforce will be
paid for a minimum of 1,500 hours per month.
 Let’s prepare the direct labor budget.
 8-54

The Direct Labor Budget

From production budget.

 8-55

The Direct Labor Budget

 8-56

The Direct Labor Budget

Greater
Greater of
of labor
labor hours
hours required
required
or
or labor
labor hours
hours guaranteed.
guaranteed.
 8-57

The Direct Labor Budget

 8-58

Quick Check 
What would be the total direct labor cost for
the quarter if the company follows its no lay-
off policy, but pays $15 (time-and-a-half) for
every hour worked in excess of 1,500 hours
in a month?
a. $79,500
b. $64,500
c. $61,000
d. $57,000
 8-59

Quick Check 
What would be the total direct labor cost for
the quarter if the company follows its no lay-
off policy, but pays $15 (time-and-a-half) for
every hour worked in excess April ofMay
1,500Junehours
Quarter
Labor hours required 1,300 2,300 1,450
in a month?Regular hours paid 1,500 1,500 1,500 4,500
a. $79,500 Overtime hours paid - 800 - 800

b. $64,500 Total regular hours 4,500 $10 $ 45,000

Total overtime hours 800 $15 $ 12,000
c. $61,000 Total pay $ 57,000
d. $57,000
 8-60

Learning Objective 6

Prepare a manufacturing
overhead budget.
 8-61

Manufacturing Overhead Budget

• At
At Royal,
Royal, manufacturing
manufacturing overhead
overhead is is applied
applied to to
units
units of
of product
product onon the
the basis
basis of
of direct
direct labor
labor hours.
hours.
• The
The variable
variable manufacturing
manufacturing overhead
overhead rate rate is
is $20
$20
per
per direct
direct labor
labor hour
hour..
• Fixed
Fixed manufacturing
manufacturing overhead
overhead isis $50,000
$50,000 per per
month,
month, which
which includes
includes $20,000
$20,000 of of noncash
noncash costscosts
(primarily
(primarily depreciation
depreciation ofof plant
plant assets).
assets).

 Let’s
Let’s prepare
prepare the
the manufacturing
manufacturing overhead
overhead budget.
budget.
 8-62

Manufacturing Overhead Budget

Direct
Direct Labor
Labor Budget.
Budget.
 8-63

Manufacturing Overhead Budget

Total mfg. OH for quarter $251,000

= $49.70 per hour *
Total labor hours required 5,050

* rounded
 8-64

Manufacturing Overhead Budget

Depreciation
Depreciation is
is aa noncash
noncash charge.
charge.
 8-65

Ending Finished Goods Inventory

Budget
Production costs per unit Quantity Cost Total
Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $ 10.00 0.50
Manufacturing overhead 0.05 hrs. $ 49.70 2.49
$ 4.99
Budgeted finished goods inventory
Ending inventory in units 5,000
Unit product cost $ 4.99
Ending finished goods inventory $ 24,950

Direct
Direct materials
materials
budget
budget and
and information.
information.
 8-66

Ending Finished Goods Inventory

Budget
Production costs per unit Quantity Cost Total
Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $ 10.00 0.50
Manufacturing overhead 0.05 hrs. $ 49.70 2.49
$ 4.99
Budgeted finished goods inventory
Ending inventory in units 5,000
Unit product cost $ 4.99
Ending finished goods inventory $ 24,950

Direct
Direct labor
labor budget.
budget.
 8-67

Ending Finished Goods Inventory

Budget
Production costs per unit Quantity Cost Total
Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $10.00 0.50
Manufacturing overhead 0.05 hrs. $49.70 2.49
$ 4.99
Budgeted finished goods inventory
Ending inventory in units 5,000
Unit product cost $ 4.99
Ending finished goods inventory ?

Total mfg. OH for quarter $251,000

= $49.70 per hour
Total labor hours required 5,050
 8-68

Ending Finished Goods Inventory

Budget
Production costs per unit Quantity Cost Total
Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $ 10.00 0.50
Manufacturing overhead 0.05 hrs. $ 49.70 2.49
$ 4.99
Budgeted finished goods inventory
Ending inventory in units 5,000
Unit product cost $ 4.99
Ending finished goods inventory $ 24,950

Production
Production Budget.
Budget.
 8-69

Learning Objective 7

Prepare a selling and

administrative expense
budget.
 8-70

Selling and Administrative Expense

Budget
• At Royal, the selling and administrative expense budget is
divided into variable and fixed components.
• The variable selling and administrative expenses are $0.50
per unit sold.
• Fixed selling and administrative expenses are $70,000 per
month.
• The fixed selling and administrative expenses include
$10,000 in costs – primarily depreciation – that are not cash
outflows of the current month.

Let’s prepare the company’s selling and administrative

expense budget.
 8-71

Selling and Administrative Expense

Budget

Calculate the selling and administrative

cash expenses for the quarter.
 8-72

Quick Check 
What are the total cash disbursements for
selling and administrative expenses for the
quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000
 8-73

Quick Check 
What are the total cash disbursements for
selling and administrative expenses for the
quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000
 8-74

Selling Administrative Expense Budget

 8-75

Learning Objective 8

Prepare a cash budget.

 8-76

Format of the Cash Budget

The cash budget is divided into four sections:
1. Cash receipts section lists all cash inflows excluding cash
received from financing;
2. Cash disbursements section consists of all cash payments
excluding repayments of principal and interest;
3. Cash excess or deficiency section determines if the
company will need to borrow money or if it will be able to
repay funds previously borrowed; and
4. Financing section details the borrowings and repayments
projected to take place during the budget period.
 8-77

The Cash Budget

Assume the following information for Royal:
 Maintains a 16% open line of credit for $75,000.
 Maintains a minimum cash balance of $30,000.
 Borrows on the first day of the month and repays
loans on the last day of the month.
 Pays a cash dividend of $49,000 in April.
 Purchases $143,700 of equipment in May and
$48,300 in June (both purchases paid in cash).
 Has an April 1 cash balance of $40,000.
 8-78

The Cash Budget

Schedule
Schedule of
of Expected
Expected
Cash
Cash Collections.
Collections.
 8-79

The Cash Budget

Schedule
Schedule of
of Expected
Expected
Cash
Cash Disbursements.
Disbursements.
Direct
Direct Labor
Labor
Budget.
Budget.
Manufacturing
Manufacturing
Overhead
Overhead Budget.
Budget.

Selling
Selling and
and Administrative
Administrative
Expense
Expense Budget.
Budget.
 8-80

The Cash Budget

Because
Because Royal
Royal maintains
maintains
aa cash
cash balance
balance of of $30,000,
$30,000,
the
the company
company mustmust borrow
borrow
$50,000
$50,000 on
on its
its line-of-credit.
line-of-credit.
 8-81

The Cash Budget

Because
Because Royal
Royal maintains
maintains
aa cash
cash balance
balance of of $30,000,
$30,000,
the
the company
company mustmust borrow
borrow
$50,000
$50,000 on
on its
its line-of-credit.
line-of-credit.

Ending
Ending cash
cash balance
balance for
for April
April
is
is the
the beginning
beginning May
May balance.
balance.
 8-82

The Cash Budget

 8-83

Quick Check 
What is the excess (deficiency) of cash
available over disbursements for June?
a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000
 8-84

Quick Check 
What is the excess (deficiency) of cash
available over disbursements for June?
a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000
 8-85

The Cash Budget

$50,000
$50,000 ×× 16%
16% ×× 3/12
3/12 == $2,000
$2,000
Borrowings
Borrowings on
on April
April 11 and
and
repayment
repayment on
on June
June 30.
30.
 8-86

The Budgeted Income Statement

Cash Budgeted
Budget Income
Statement
t ed
e
pl
om
C

With interest expense from the cash

budget, Royal can prepare the budgeted
income statement.
 8-87

Learning Objective 9

Prepare a budgeted
income statement.
 8-88

The Budgeted Income Statement

Sales
Sales Budget.
Budget.
Royal Company
Budgeted Income Statement
For the Three Months Ended June 30
Ending
Ending Finished
Finished
Sales (100,000 units @ $10) $ 1,000,000 Goods
Goods Inventory.
Inventory.
Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin 501,000
Selling
Selling and
and
Selling and administrative expenses 260,000
Operating income 241,000 Administrative
Administrative
Interest expense 2,000 Expense
Expense Budget.
Budget.
Net income $ 239,000

Cash
Cash Budget.
Budget.
 8-89

Learning Objective 10

Prepare a budgeted
balance sheet.
 8-90

The Budgeted Balance Sheet

Royal reported the following account
balances prior to preparing its budgeted
financial statements:
• Land - $50,000
• Common stock - $200,000
• Retained earnings - $146,150 (April 1)
• Equipment - $175,000
 8-91

Royal Company
Budgeted Balance Sheet
June 30
Assets:
Cash $ 43,000
Accounts receivable 75,000
Raw materials inventory 4,600
Finished goods inventory 24,950
Land 50,000
Equipment 367,000
Total assets 564,550

Liabilities and Stockholders' Equity

Accounts payable $ 28,400
Common stock 200,000
Retained earnings 336,150
Total liabilities and stockholders' equity $ 564,550
 8-92

Royal Company
Budgeted Balance Sheet
June 30
Beginning balance $146,150
Assets: Add: net income 239,000
Cash $ 43,000 dividends
Deduct: (49,000)
Accounts receivable 75,000balance
Ending $336,150
Raw materials inventory 4,600
Finished goods inventory 24,950
Land 50,000
Equipment 367,000
Total assets 564,550

Liabilities and Stockholders' Equity

Accounts payable $ 28,400
Common stock 200,000
Retained earnings 336,150
Total liabilities and stockholders' equity $ 564,550
 8-93

End of Chapter 8