Chapter 8
Master Budgeting
Learning objectives
1. Understand why organizations budget
2. Prepare operating budgets
Sales budget
Production budget
Direct materials budget
Direct labor budget
Manufacturing overhead budget
Ending finished goods inventory budget
Selling and administrative budget
3. Prepare financial budgets
Budgeted income statement
Cash budget
Budget
A budget is a plan for using limited resources:
The goals were trying to achieve in a specific
period
How we plan to achieve these goals
The act of preparing a budget is called
budgeting
The use of budgets to control an organizations
activities is known as budgetary control
Three Purposes of Budgeting
Planning
Planning involves developing objectives and preparing various budgets
to achieve those objectives
Budgets force managers to think ahead regarding how to achieve
various financial goals
The budgeting process leads to the best way to use available resources
Coordination
Budgets highlight linkages among departments and force them to
communicate and to work toward company goals
Control
Budgets define goals and objectives that can serve as benchmark for
evaluating actual performance
Detect problem areas
Evaluate managers performance
Choosing a Budget Period
Annual operating budget covers a one-year period
corresponding to a companys fiscal year
Many companies divide their annual budget into four quarters
A continuous budget is a 12-month budget that rolls
forward one month (or quarter) as the current month (or
quarter) is completed
Operating Budget
2014
2015
2016
2017
Preparing the Master
Budget*
* master budget full package of operating
budgets for all areas of operations + financial
budgets
An Overview of Master Budget
Operating budgets
Sales
Sales budget
budget
Ending
Ending
inventory
inventory
budget
budget
Direct
Direct materials
materials
budget
budget
Production
Production budget
budget
Direct
Direct labor
labor
budget
budget
Selling
Selling and
and
administrative
administrative
budget
budget
Manufacturing
Manufacturing
overhead
overhead budget
budget
Cash
Cash Budget
Budget
Not required
Budgeted
Budgeted
income
income
statement
statement
Financial budgets
7
Budgeted
Budgeted
balance
balance sheet
sheet
Sales Budget
Starting point for master budget
How much sales revenue will we earning in the following year?
Based on:
The budgeted price you expect to charge
Expected future unit sales (estimates from Marketing)
Budgeted Sales Revenue = Budgeted price *
Budget unit sales
Example: Royal Company
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 budgeted selling price is $10 per unit.
The sales budget for the second quarter is
April
May
June
Quarter
Budgeted
sales in units
20,000
50,000
30,000
100,000
Selling price
$10
$10
$10
$10
Budget sales
revenue
$200,000
$500,000
$300,000
$1,000,000
Production Budget
How many units do we need to produce?
Budgeted production depends on:
expected sales in units (from the sales budget)
firms inventory policy for finished goods
Sales
Sales budget
budget
Production
Production budget
budget
Ending Inventory = Beginning Inventory for the following period
10
Production Budget
Example: The management at Royal Company wants ending inventory
to be equal to 20% of the following months budgeted sales in units
Beginning Inventory in April = Ending Inventory in March = 20,000*20%=4,000
Budgeted sales in July is 25,000 units
April
11
May
50,000
June
30,000
Quarter
Sales in units
20,000
100,000
+Desired ending
inventory
50,000*20% 30,000*20%
=10,000
=6,000
25,000*20%
=5,000
=Total requirements
30,000
56,000
35,000
105,000
-beginning inventory
4,000
10,000
6,000
4,000
=Units to be produced
26,000
46,000
29,000
101,000
5,000
From the Sales
budget
based on
inventory policy
=ending inventory
from previous
quarter
Exercise: Production Budget
April
Desired ending inventory
Beginning inventory
Budgeted sales
Budgeted production
May
June
(1)
(4)
(6)
1,000
(3)
(5)
10,000
15,000
20,000
(2)
15,500
21,000
Inventory policy: desired ending inventory for current month = 10%
of expected sales for next month.
Required: Fill in the missing numbers
12
Budgets for Inputs (DL, DM and Overhead)
Direct Materials Budget
Based on estimates of materials per unit of product, and
prices of materials
Direct Labor Budget
Based on estimates of DL hours per unit of product, and
wage per hour
Manufacturing Overhead
Based on estimates of fixed overhead and variable
overhead per unit of product
Production
Production budget
budget
Direct
Direct materials
materials
budget
budget
13
Direct
Direct labor
labor
budget
budget
Manufacturing
Manufacturing
overhead
overhead budget
budget
Direct Materials Budget
The direct materials budget details
the raw materials that must be
purchased to fulfill the production
budget and to provide for adequate
inventories
Production
Production budget
budget
Direct
Direct materials
materials budget
budget
Example: at Royal Company, 5 pounds of materials are
required per unit of product.
Management wants materials on hand at the end of each
month equal to 10% of the following months production.
On March 31, 13,000 pounds of materials are on hand.
Material cost is $0.40 per pound.
14
Direct Materials Budget for Royal Company
April
May
June
Quarter
Units to be produced
26,000
46,000
29,000
101,000
Materials per unit (lbs)
Production needs
(26000*5) =
130,000
230,000
145,000
505,000
Add: Desired ending
Inventory
230,000*10%
=23,000
145,000*10%
=14,500
11,500
(assumed)
11,500
Total needed
153,000
244,500
156,500
516,500
Less: Beginning Inventory
13,000
23,000
14,500
13,000
Materials to be purchased
140,000
221,500
142,000
503,500
140,000*0.4
=56,000
221,500*0.4
=88,600
142,000*0.4=
56,800
503,500*0.4
=201,400
Cost of materials
purchased
Desired ending inventory = 10% of the following months production needs
On March 31, 13,000 pounds of materials are on hand.
Material cost is $0.40 per pound.
15
Direct Labor Budget
The direct labor budget shows the
direct labor-hours required to satisfy
the production budget
Production
Production budget
budget
Direct
Direct labor
labor budget
budget
At Royal, each unit of product requires 0.05 hours (3
minutes) of direct labor.
Because of no-layoff policy, the direct labor workforce
will be paid for a minimum of 1,500 hours per month for
the next three months
Workers are paid at the rate of $10 per hour regardless
of the hours worked.
16
Direct Labor Budget for Royal Company
April
May
June
Quarter
26,000
46,000
29,000
101,000
Direct Labor per unit (hrs)
0.05
0.05
0.05
0.05
Labor hours required
1,300
2,300
1,450
5050
Guaranteed labor hours
1,500
1,500
1,500
Labor hours paid
1,500
2,300
1,500
5,300
Hourly wage rate
$10
$10
$10
$10
1500*10=
$15,000
2300*010=
$23,000
1500*10=
$15,000
5300*10=
$53,000
Units to be produced
Total direct labor costs
17
Manufacturing Overhead Budget
The manufacturing overhead
budget includes budgeted variable
overhead cost and fixed overhead
cost
18
Production
Production budget
budget
Manufacturing
Manufacturing overhead
overhead
budget
budget
At Royal, manufacturing overhead is applied to units
of product on the basis of direct labor hours
The variable manufacturing overhead rate is $20 per
direct labor hour
Fixed manufacturing overhead is $50,000 per month
(primarily depreciation of plant assets)
Manufacturing Overhead Budget for Royal Company
April
May
June
Quarter
1,300 DLH
2,300 DLH
1,450 DLH
(1300+2300
+1450)=
5,050 DLH
$ 20 per DLH
$ 20 per DLH
$ 20 per DLH
$20 per DLH
Budgeted variable
manufacturing
overhead cost
$26,000
$46,000
$29,000
$101,000
Budgeted fixed
manufacturing
overhead cost
$50,000
$50,000
$50,000
$150,000
Budgeted total
manufacturing
overhead cost
$76,000
$96,000
$79,000
$251,000
Direct Labor Hours
Required
Variable manufacturing
overhead rate
19
Ending Finished Goods Inventory Budget
Ending finished goods inventory budget details the budgeted
unit product cost, ending finished goods inventory in units (the
number of unsold units), and ending finished goods inventory in
dollars (the cost of unsold units)
Ending finished goods inventory needed for two reasons
To determine the cost of goods sold on the budgeted income
statement
To value ending inventories on the budgeted balance sheet
Production
Production budget
budget
Ending
Ending finished
finished goods
goods
inventory
inventory budget
budget
20
Ending finished goods inventory budget for Royal Company
Production costs per unit
Quantity
Cost
Total
Direct materials
5.00 lbs.
$0.4
$2.00
Direct labor
0.05 hrs.
$10.0
$0.50
Manufacturing overhead
0.05 hrs.
$49.7
$2.49
$4.99
Budgeted finished goods inventory
Ending inventory in units
Unit product cost
Ending finished goods inventory
$4.99
???
Total mfg. OH for quarter $251,000
Total labor hours required 5,050 = $49.70 per hour
21
Ending finished goods inventory budget for Royal Company
Production costs per unit
Quantity
Cost
Total
Direct materials
5.00 lbs.
$0.4
$2.00
Direct labor
0.05 hrs.
$10.0
$0.50
Manufacturing overhead
0.05 hrs.
$49.7
$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 Budget
22
Selling and Administrative Expense Budget
23
Selling and Administrative
Budget lists nonmanufacturing expenses
Sales
Sales budget
budget
Selling
Selling &
& Administrative
Administrative
Budget
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
Selling and Administrative Budget for Royal Company
From Sales
Budget
April
May
June
Quarter
20,000
50,000
30,000
100,000
Budgeted Variable S&A
rate
0.5
0.5
0.5
0.5
Budgeted Variable S&A
expenses
10,000
15,000
15,000
50,000
Budgeted Fixed S&A
expenses
70,000
70,000
70,000
210,000
Budgeted Total S&A
expenses
80,000
95,000
85,000
260,000
Budgeted sales
24
Consolidate for Financial Budgets
Operating budgets
Sales
Sales budget
budget
Ending
Ending
inventory
inventory
budget
budget
Direct
Direct materials
materials
budget
budget
Financial budgets
25
Production
Production budget
budget
Direct
Direct labor
labor
budget
budget
Budgeted
Budgeted
income
income
statement
statement
Selling
Selling and
and
administrative
administrative
budget
budget
Manufacturing
Manufacturing
overhead
overhead budget
budget
Cash
Cash budget
budget
Budgeted Income Statement
Budgeted income statement shows the companys
target revenues, expenses and profit.
It summarizes the financial results of operation budgets,
including sales, production, direct materials, direct labor,
manufacturing overhead, and selling and administrative
budgets
Budgeted income statement serves as a benchmark
against which subsequent actual performance can be
measured
Detect the problematic areas in a firm
Evaluate the performance of managers
26
Royal Company
Budgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10)
Less: Cost of goods sold (100,000 @
$1,000,000
$499,000
$4.99)
Gross margin
27
Sales Budget
Ending Finished
Goods Inventory
Budget
$501,000
Selling and administrative expenses
$260,000
Operating income
$241,000
Selling and
Administrative
Expense Budget
Cash Budget
Cash Budget details cash inflows and outflows
Revenues and costs on the income statement differ
from actual cash inflows and outflows
revenues are recorded when the product was sold, not when
the $$$ was actually received
product costs are expensed when the product was sold
(matching of costs to revenues), not when the cost was actually
incurred
depreciation is a non-cash cost item (not a cash outflow)
special items
Firms use cash budget to determine whether they
will have enough cash on hand to sustain operations
Cash shortage can be managed by accelerating revenues,
deferring payments, or borrowing
28
Format of the Cash Budget
29
The cash budget is divided into four sections:
Cash receipts section lists all cash inflows excluding cash
received from financing
Cash disbursements section consists of all cash payments
excluding repayments of principal and interest
Cash excess or deficiency section determines if the
company will need to borrow money or if it will be able to repay
funds previously borrowed; Cash inflow cash outflow
Financing section details the borrowings and repayments
projected to take place during the budget period
Cash Inflows from Operations
The main cash inflow is proceeds from sales
To estimate cash inflows, sales revenue needs to be adjusted
for the firms credit policy:
if you offer credit to customers, some of them will pay you weeks or
months after the sale
sales revenue is recognized on the income statement when the sale
took place, not when you actually received the $$$
30
Example: Cash receipts from Credit Sales
Many of your customers buy on credit (i.e., part of sales
revenue is collected several months after the sale).
On average, you collect 60% of revenue in the month of sale,
35% of revenue in the following month, and 5% of revenue 2
months later. What are your cash inflows in May?
Month
March
April
Sales
$150
$100
May
$130
Month
March
April
May
March
150x60%1
150x35% =
52.5
150x5% =
7.5
100x60%=
60
100x35% =
35
April
31
May
130x60% =
78
Cash
Collection
78+35 +7.5
= 120.5
Exercise: Cash receipts from credit sales
Wallmarts budgeted sales are as follows:
32
January
$150,000
February
$160,000
March
$172,000
The company expects to collect 75% of a months
sales in the month of sale and 25% in the following
month.
Question: What are the cash receipts for February?
Example: Royal Companys Cash Receipts
Royal Companys Sales Budget
Budgeted sales in units
Selling price
Budget sales revenue
April
May
June
Quarter
20,000
50,000
30,000
100,000
$10
$10
$10
$10
$200,000
$500,000
$300,000
$1,000,000
At Royal Company, all sales are on account.
Royals credit policy is
70% collected in the month of sale
25% collected in the month following sale
5% uncollectible
33
In April, the March 31st accounts receivable balance of $30,000 will
be collected in full.
Royal Companys expected cash receipts
April
Accounts receivable 3/31
May
June
Quarter
$30,000
$30,000
$140,000
$140,000
April Sales
70% * $200,000
25% * $200,000
$50,000
$50,000
$350,000
$350,000
May Sales
70%*$500,000
25%*$500,000
$125,000
$125,000
$210,000
$210,000
$335,000
$905,000
June Sales
70%*$300,000
Total cash collections
34
$170,000
$400,000
Cash Outflows from Operations
Cash outflows from operations: purchases of direct
materials, payment to direct labor, expenditures on
manufacturing overhead and SG&A costs
adjust for credit terms with suppliers
adjust for non-cash items (e.g., depreciation)
35
Example: Royal Companys Cash Disbursement
Royal Companys Direct Materials Budget
Materials to be purchased (lbs)
Materials price per pound
Cost of materials purchased
April
May
June
Quarter
140,000
221,500
142,000
503,500
$0.4
$0.4
$0.4
$0.4
$56,000
$88,600
$56,800
$201,400
Royal pays $0.4 per pound for its materials
Royal Companys cash payment policy
50% of a months purchase is paid for in the month of purchase;
50% is paid in the following month
The March 31 accounts payable balance is $12,000
36
Royal Companys expected cash disbursement for materials
April
Accounts payable 3/31
May
June
Quarter
$12,000
$12,000
$28,000
$28,000
April Purchases
50% * $56,000
50% * $56,000
$28,000
$28,000
$44,300
$44,300
May Purchases
50%*$88,600
50%*$88,600
$44,300
$44,300
$28,400
$28,400
$72,700
$185,000
June Purchases
50%*$56,800
37
Total cash disbursements
for materials
$40,000
$72,300
Royal Companys Cash Disbursement for labor, manufacturing
overhead, selling & administrative expenses
Royal Company - Non Cash Items
Fixed manufacturing overhead includes $20,000 of noncash costs
(primarily depreciation of plant assets)
Fixed selling and administrative expenses include $10,000 in costs
primarily depreciation that are not cash outflows of the current month
April
May
June
Quarter
Budgeted direct labor cost
$15,000
$23,000
$15,000
$53,000
Budgeted variable manufacturing
overhead
$26,000
$46,000
$29,000
$101,000
Budgeted fixed manufacturing
overhead
50,000-20,000
50,000-20,000
50,000-20,000
$90,000
=30,000
=30,000
Budgeted variable S&A expenses
10,000
15,000
15,000
$50,000
Budgeted fixed S&A expenses
70,000-10,000
70,000-10,000
70,000-10,000
=60,000
=60,000
=60,000
$180,000
Cash disbursement
38
=30,000
Special Items
Adjust for special items
Cash outflows: purchase of machines, payment of dividends, loan
payments
Cash inflows: sale of machines, sale of stock in capital market, loans
received
Special items in Royal Company
An April 1 cash balance of $40,000
Purchases $143,700 of equipment in May and $48,300 in June
(both purchases paid in cash)
Pays a cash dividend of $49,000 in April
Maintains a minimum cash balance of $30,000
Borrows on the first day of the month and repays loans one year
later
39
Royal Companys Cash Budget
April
May
June
Quarter
Beginning cash balance
$40,000
$30,000
$30,000
$40,000
Add: Cash collections
$170,000
$400,000
$335,000
$905,000
Total cash available
$210,000
$430,000
Materials
$40,000
$72,300
$72,700
$185,000
Direct labor
$15,000
$23,000
$15,000
$53,000
Manufacturing overhead
$56,000
$76,000
$59,000
$191,000
Selling and administrative
$70,000
$75,000
$75,000
$230,000
$143,700
$48,300
$192,000
$49,000
$49,000
Total disbursements
$230,000
$400,000
270,000
$900,000
Excess (deficiency)
$(20,000)
$30,000
95,000
$45,000
$50,000
$50,000
Total financing
$50,000
Ending cash balance
$30,000
$30,000
$95,000
Less: Cash disbursements
Equipment purchase
Dividend
Financing:
Borrowing
Repayments
40
$95,000
