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Cost II-Ch - 3 Master Budget
Cost II-Ch - 3 Master Budget
CHAPTER THREE
THE MASTER BUDGET
3.1. Overview of Budgeting
Developing a budget is the most important accounting tool to plan and control operations. A budget is the
quantitative expression of a proposed plan of action by management for a future time period. It is an aid to the
coordination and implementation of the plan. A budget can cover both financial and a non-financial aspect of
these plan and help management of the organization to follow in the upcoming period.
Budgets covering financial aspects quantify management’s expectations regarding future income, cash flows,
and financial position. Just as individual financial statements are prepared covering past periods, so they can be
prepared covering future periods – for example, a budgeted income statement of cash flows, and a budgeted
balance sheet. Underlying these financial budgets can be non-financial budgets, say, units manufactured or sold
and number of new products being introduced to the market.
A budget can also be described as a detailed plan outlining the acquisition and use of financial and other
resources over a specified time period.
3.2. Planning and Control
A good budgeting system should provide for both planning and control. Planning involves developing
objectives and preparing various budgets to achieve those objectives. Control involves the steps taken by
management to ensure that the objectives set down at the planning stage are attained and that all parts of the
organization work together towards those objectives. Thus, budgets can be used as a benchmark that allows
managers to compare actual performance with expected or desired performance.
3.3. Advantages of Budgeting
There are many advantages to budgeting, including:
Forces all levels of management to plan ahead.
Facilitate communication and coordination.
Provides definite objectives for controlling profit and operations.
Motivates personnel throughout the organization to meet planned objectives.
Evaluating performance and providing incentives.
3.4. Choosing a Budget Period
Budget periods vary in length. Some may be as short as a month, whereas others may cover many years. The
most common budgeting period, however, is a year. The annual budget is often subdivided by months for the
first quarter and by quarters for the remainder of the year. The budgeted data for a year are frequently revised as
the year unfolds. For example, at the end of the first quarter, the budget for the next three quarters is changed in
light of new information.
3.5. Types of budget
1. Master budget: a set of interrelated budgets covering all phases of an organization's operations for a
specific period of time.
2. Budgeted financial statements: show how a company's financial statements will appear at a specified
period of time. It includes budgeted income statement, budgeted balance sheet, and budgeted statement of
cash flows.
3. Capital budget: is a plan for the acquisition of capital assets like equipment.
4. Financial budget: is a plan that shows how a company will acquire its financial resources.
5. Rolling budget also known as revolving or continuous budget: is a budget that is always available for a
specific future period. It is one that covers a 12-month period but which adds a new month on the end as
the current month is completed.
3.6. The Master Budget: Overall Plan
The master budget consists of a number of separate, but interrelated budgets. The components of the master
budget for manufacturing firms are discussed in the following paragraphs.
The two major parts of a master budget are the operating budget and the financial budget. Operating budget
(profit plan) is a major part of a master budget that focuses on the income statement and its supporting
schedules.
Financial budget is the part of the master budget that focuses on the effects that the operating budget and other
plans (such as capital budgets and repayments of debt) will have on cash.
1. The Sales Budget - The sales or revenue budget is a detailed schedule showing the expected sales for the
coming period expressed in both birr and units of the product. It helps to determine how many units of a product
will have to be produced. The sales budget is usually accompanied by a schedule of expected cash receipts. The
schedule of expected cash collections should take in to account any delays that are anticipated in collecting
credited sales.
2. The Production Budget – lists the number of units that must be produced during the budgeted period to
meet the sales demand and to provide for desired ending inventory. The budgeted production for each period
can be determined by adding together the budgeted sales and the desired ending inventory and then subtracting
the beginning inventory. The desired ending inventory in units for each period is usually a predetermined
percentage of budgeted unit sales for the following period. The production budget is typically expressed in
terms of physical units rather than in dollars.
In a merchandising firm, a merchandise purchases budget would replace the production budget. The
merchandise purchases budget shows the amount of goods to be purchased from suppliers each period. This can
be determined by adding together the budgeted sales and the desired ending inventory and then subtracting the
beginning inventory. As in a manufacturing firm, the desired ending inventory in units is usually some
predetermined percentage of the unit sales for the following period.
3. The Direct Materials Budget - Once production needs have been determined, a direct materials budget
should be prepared. This budget details the materials that will be required to fulfill the production budget and to
ensure adequate inventory levels. Sufficient amounts of raw material must be acquired to meet both production
needs and to provide for desired ending inventories. Materials purchases can be determined by adding together
the materials required for production needs and the desired ending materials inventories and then subtracting the
beginning inventory. The desired ending inventory in units is usually a predetermined percentage of the number
of units that are expected to be used in production the following period. The direct materials budget is usually
accompanied by a schedule of expected cash disbursements for raw materials. This schedule should take in to
account any delays that are anticipated in paying for materials.
4. The Direct Labor Budget – is a quantitative estimate of the total direct labor hours required to complete the
expected production during the budget period.
5. The Manufacturing Overhead Budget - The manufacturing overhead budget lists all production costs other
than direct materials and direct labor. Manufacturing overhead costs should be broken down by cost behavior
for budgeting purposes. Typically, the variable portion of manufacturing overhead is assumed to be proportional
to budgeted activity and the fixed portion is assumed to be constant in total. Under the assumption that
depreciation is the only significant non-cash manufacturing overhead expense, the manufacturing overhead
expense can be converted to a cash flow basis by tacking out any depreciation charges.
6. Ending Finished Goods Inventory Budget - This budget details the amount and value of ending inventory
on the budgeted balance sheet. The unit product cost from this budget is also used to compute the cost of goods
sold for the budgeted income statement. The details of the computations will depend upon whether variable or
absorption costing is used. Managers often want budgets on an absorption-costing basis since that is the basis
that will ordinarily be used to report results to outsiders. Data for the computations in this schedule are found in
the direct materials, direct labor, and manufacturing overhead budgets.
7. The Selling and Administrative Expense Budget - The selling and administrative budget lists the
anticipated non-manufacturing expenses for the budget period. In practice this budget is usually made up of
many smaller individual budgets negotiated with various managers having sales and administrative
responsibilities. Setting appropriate budget limits for selling and administrative functions is one of the most
difficult problems in management accounting and is just beginning to be understood.
8. The Cash Budget - The cash budget should be broken down into time periods that are as short as feasible in
order to alert management to problems that may occur due to fluctuations in cash flows. As anyone with a
checking account knows, it is quite possible to have a positive overall cash flow during a period and yet be
overdrawn at some point during the period. The cash budget is composed of four major sections:
i. The receipts section.
ii. The disbursements section.
iii. Cash receipts, plus the beginning cash balance, less cash disbursements results in cash excess or
deficiency. If a deficiency exists, additional funds must be arranged for. If excess exists, previous
borrowing can be repaid or short-term investments made.
iv. The financing section of the cash budget provides a detailed account of the borrowing and repayments
projected to take place during the budget period. It also includes a detailing of interest payments.
9. Budgeted Financial Statements - The last components of the master budget consist of the budgeted income
statement and the budgeted balance sheet. The balance sheet is perhaps the most difficult of the statements to
construct in the examples we use. It requires pulling together data from a variety of schedules and sources.
Steps in preparing an operating budget for Manufacturing Companies
Step1. Revenue (sales) budget: it is the usual starting point for budgeting, because production and hence costs
and inventory level generally depend on the forecasted level of revenue.
Step 2. Production Budget (unit): after revenue is budgeted, the production budget can be prepared. The total
finished goods units to be produced depend on planned sales and expected changes in inventory level.
Budgeted Production (unit) = Budgeted sales + Target ending FG – Beginning FG+
Inventory (unit) Inventory (unit)
Step3. Direct Material Usage Budget & Direct Material Purchase Budget
The decision on the number of units to be produced is the key to computing the usage of direct material in
quantities and currency.
a) Direct Material Usage Budget in Units and Currency
Direct Material = Budgeted production X Quantity of material required per unit
Usage Budget (unit)
Direct Material Usage in Currency (birr) = Quantity of material used X rate per unit
b) Direct Material Purchase Budget
DMPB (unit) = Production Usage + Target End. inventory of Material in Unit – Beg. Inventory of RM in Units
Budgeted Labour Cost = Budgeted Labour Hours X Labour Cost per Unit
Step 5. Manufacturing overhead budget: The total of these costs depends on hours individual over head costs
vary with the assumed cost driver, direct manufacturing labour hours
2) Sales are collected in the following pattern; 70% of sales are collected in the quarters in which the sales
are made and the remaining 30% are collected in the following quarter. On January 1, 20x4, the
company’s balance sheet showed Br. 90,000 in account receivable, all of which will be collected in the
first quarter of the year. Bad debts are negligible and can be ignored.
3) The company maintains an ending inventory of finished units equal to 20% of the next quarter’s sales.
The requirement was met on December 31,20x3, in that the company had 2,000 units on hand to start
the new year.
4) Fifteen pounds of raw materials are needed to complete one unit of product. The company requires an
ending inventory of raw materials on hand at the end of each quarter equal to 10% of the following
quarter’s production needs of raw materials. This requirement was met on December 31,20x3 in that the
company had 21,000 pounds of raw materials to start the new year.
5) The raw material costs Br. 0.20 per pound. Raw materials purchased are paid for in the following
pattern: 50% paid in the quarter the purchases are made, and the remainder is paid in the following
quarter. On January 1, 20x4, the company’s balance sheet showed Br. 25,800 in accounts payable for
raw material purchases, all of which be paid for in the first quarter of the year.
6) Each unit of Great’s product requires 0.8 hours of labor time. Estimated direct labor cost per hour is Br.
7.50.
7) Variable overhead is allocated to production using labor hours as the allocation base as follows:
Indirect materials Br. 0.40
Indirect labor Br. 0.75
Fringe benefits Br. 0.25
Payroll taxes Br. 0.10
Utilities Br. 0.15
Maintenance Br. 0.35
Total Br. 2.00
Fixed overhead for each quarter was budgeted at Br. 60,000. Of the fixed overhead amount, Br. 15,000
of each quarter is depreciation. Overhead expenses are paid as incurred.
8) The company’s quarterly budgeted fixed selling and administrative expense are as follows:
Fixed Selling & adm. 20x4 Quarters
Expense 1 2 3 4 Total
Advertising Br. 20,000 Br. 20,000 Br. 20,000 Br. 20,000 Br. 80,000
Executive salaries Br. 55,000 Br. 55,000 Br. 55,000 Br. 55,000 Br. 220,000
Insurance - Br. 1,900 Br. 37,750 - Br. 39,650
Property taxes - - - Br. 18,150 Br. 18,150
Depreciation Br. 10,000 Br. 10,000 Br. 10,000 Br. 10,000 Br. 40,000
Total Br. 85,000 Br. 86,900 Br. 122,750 Br. 103,150 Br. 397,800
9) The only variable selling and administrative expense is sales commission and budgeted at Br. 1.80 per
unit of the budgeted sales. All selling and administrative expenses are paid during the quarter, in cash,
with exception of depreciation.
10) New equipment purchases will be made during each quarter of the budget year for Br. 50,000, Br.
40,000 and Br. 20,000 each for the last two quarters in cash, respectively.
11) The company declares and pays dividends of Br. 8,000 cash each quarter.
12) The company’s balance sheet as of December 31, 20x3 is presented below:
Great Company
Budgeted Balance Sheet
December 31, 20x4
Assets
Current Assets:
Cash 42,500
Accounts Receivable 90,000
Raw materials inventory (21,000 pounds) 4,200
Finished Goods inventory (2,000 units) 26,000
Total current assets 162,700
Plant and Equipment:
Land 80,000
Building and Equipment 700,000
Accumulated dep. (292,000)
Plant and Equipment, net 488,000
Total Assets 650,700
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable (Raw Materials 25,800
Stockholders’ Equity:
Common stock, no par 175,000
Retained earnings 449,900
Total Stockholders’ Equity 624,900
Total liabilities & Stockholders’ equity 650,700
Cost and Management Accounting II BY NIWAY A. 8
ECSU Department:-PFM & Accounting & finance
13) The company can borrow money from bank at 10% annual interest. All borrowings and all payments
are in multiple of Br. 1,000.
14) The company requires a minimum cash balance of Br. 40,000 at the end of each quarter. Interest is
computed and paid on the principal being repaid only at the time of repayment of principal. The
company wishes to use any excess cash to pay loans off as rapidly as possible.
Instruction:
Prepare a master budget for the four quarter period ending December 31, including the following budget
and schedules;
1. Operating budget of the company
a. A sales budget by quarter and in total.
b. A schedule of budgeted cash collections by quarter and in total.
c. A production budget
d. A direct material purchase budget.
e. A schedule of budgeted cash payments for purchases by quarter and in total.
f. A direct labor budget.
g. A manufacturing overhead budget.
h. Ending finished goods inventory budget.
i. A selling and administrative budget
j. A budgeted income statement for the four quarter ending December 31, 20x4.
2. Financial budget of the company
a. A cash budget by quarter and in total.
b. A budgeted balance sheet as of December 31, 20x4.
Solution:
1. A sales budget by quarter and in total.
Quarter
1 2 3 4 Total
Expected sales in units 10,000 30,000 40,000 20,000 100,000
Selling price per unit x 20 x 20 x 20 x 20 x 20
Total sales 200,000 600,000 800,000 400,000 2,000,000
2. A schedule of expected cash collections.
Quarter
1 2 3 4 Total
30% of the prev. Q sales 90,000 60,000 180,000 240,000 570,000
70% of the curr. Q sales 140,000 420,000 560,000 280,000 1,400,000
Total sales 230,000 480,000 740,000 520,000 1,970,000
3. A production budget
Quarter
1 2 3 4 Total
Expected sales in units 10,000 30,000 40,000 20,000 100,000
Add: Desired end. Inv. 6,000 8,000 4,000 3,000 3,000
Total needs 16,000 38,000 44,000 23,000 103,000
Less: Beg. Inv. Of FG 2,000 6,000 8,000 4,000 2,000
Units to be produced 14,000 32,000 36,000 19,000 101,000
4. A direct material purchase budget.
Quarter
1 2 3 4 Total
Units to be produced 14,000 32,000 36,000 19,000 101,000
RM needed per unit(pounds) x15 x15 x15 x15 x15
Production needs (pounds) 210,000 480,000 540,000 285,000 1,515,000
Add: desired end inv. RM 48,000 54,000 28,500 22,500 22,500
Total needs 258,000 534,000 568,500 307,500 1,537,500
Less: Beg. Inv. Of RM 21,000 48,000 54,000 28,500 21,000
RM to be purchased (pounds) 237,000 486,000 514,500 279,000 1,516,500
Raw Materials to be purchased (in birr)
Quarter
1 2 3 4 Total
RM to be purchased 237,000 486,000 514,500 279,000 1,516,500
RM costs per pound x 0.20 x 0.20 x 0.20 x 0.20 x 0.20
Total cost RM to be pur. Br. 47,400 Br. 97,200 Br.102,900 Br. 55,800 Br. 303,300
Quarter
1 2 3 4 Total
50% of the prev. Q purch. 25,800 23,700 48,600 51,450 149,550
50% of the curr. Q purch. 23,700 48,600 51,450 27,900 151,650
Total cash disbursement 49,500 72,300 101,050 79,350 301,200
6. A direct labor budget.
Quarter
1 2 3 4 Total
Units to be produced 14,000 32,000 36,000 19,000 101,000
DL hour per unit x0.8 x0.8 x0.8 x0.8 x0.8
Total DL hour needed 11,200 25,600 28,800 15,200 80,800
DL cost per hour x Br. 7.50 x Br. 7.50 x Br. 7.50 x Br. 7.50 x Br. 7.50
Total DL cost Br. 84,000 Br.192,000 Br.216,000 Br.114,000 Br. 606,000
7. A manufacturing overhead budget.
Quarter
1 2 3 4 Total
Total DL hour needed 11,200 25,600 28,800 15,200 80,800
Var. MOH rate x2 x2 x2 x2 x2
Variable MOH 22,400 51,200 57,600 30,400 161,600
Fixed MOH 60,600 60,600 60,600 60,600 242,400
Total MOH 83,000 111,800 118,200 91,000 404,000
Less: Depreciation 15,000 15,000 15,000 15,000 60,000
Cash disbur. For MOH 68,000 96,800 103,200 76,000 344,000
Quarter
1 2 3 4 Total
Expected sales in units 10,000 30,000 40,000 20,000 100,000
Var. sell exp. per unit x 1.80 x 1.80 x 1.80 x 1.80 x 1.80
Total var. sell expense 18,000 54,000 72,000 36,000 180,000
Fixed sell & adm expense
Advertising 20,000 20,000 20,000 20,000 80,000
Executive salaries 55,000 55,000 55,000 55,000 220,000
Insurance - 1,900 37,750 - 39,650
Property taxes - - - 18,150 18,150
Depreciation 10000 10,000 10,000 10,000 40,000
Total bud. Sell & adm. expense 103,000 140,900 194,750 139,150 577,800