Chapter 8

The Master Budget

Cost AccountingFoundations and Evolutions

Kinney, Prather, Raiborn

Learning Objectives (1 of 2)

• Explain why budgeting is important• Describe how strategic planning is related

to budgeting• Identify the starting point of a master

budget and explain why it is the starting point

• Prepare various master budget schedules and explain how they relate to one another

Learning Objectives (2 of 2)

• Explain why the cash budget is important in the master budgeting process

• List the benefits provided by a budget

• (Appendix) Explain how a budget manual facilitates the budgeting process

Management

Planning is the cornerstone of effective management

Terms

• Budgeting - Formalizes plans and translates qualitative narratives into a documented, quantitative format

• Budget - Expresses a commitment to planned activities and resource acquisition and use

The Planning Process

Strategic

Planning

Tactical

Planning

Budget

Strategic Planning

• Long-term (5 to 10 years)

• Top-level management

• Long-range goals, strategies, and policies

• Foundation for short-term planning

• Identify and gather information on key variables, both internal and external

Strategic

Planning

Strategic Planning

Effective strategic planning requires that managers build

plans and budgets that integrate external

considerations and influences with internal factors

Strategic

Planning

External Key Variables• Competitor actions• U.S. market conditions• U.S. political/regulatory climate• Emerging technology issues• Consumer trends and attitudes• International market conditions• Demographics• International political/regulatory climate

Strategic

Planning

Tactical Plans

• Short-term (1 to 18 months)

• Top and middle management

• Specific objectives and means to achieve strategic plans

• Basis against which results can be measured

Tactical

Planning

Budgets• Communicate objectives, constraints, and

expectations• Provide financial predictions • Provide nonfinancial performance goals and

objectives• Identify potential difficulties• Determine resource allocation and constraints• Permit control through budget-to-actual

comparisons

Budget

Budgeting

• Short-term• Top, middle, and operational management

involvement• Usable guidelines to implement strategic

and tactical plans• Allocates resources• Standard against which performance can be

measured

Budget

Planning Relationships

Strategic

Planning

Tactical

Planning

Budget

Top Management

Top and Middle

Management

Top, Middle, and

OperationalManagement

The Control Phase

• Actual-to-budget comparisons

• Determining and investigating variances

• Corrective action

• Feedback to operating managers

Budget

The Master Budget

• A comprehensive set of budgets, budgetary schedules, and pro forma organizational financial statements

• For a specific period of time

• Static – based on a single level of output demand

• Interactive – departments generate and consume information

The Master Budget

Operating Budgets Financial BudgetsSales BudgetProduction BudgetPurchases BudgetDirect Labor BudgetOverhead Budget

Selling & Administrative Budget

Cash BudgetCapital Expenditures

BudgetBalance SheetIncome Statement

Statement of Cash Flows

Statement of Retained Earnings

Budget

The Operating Budget

Sales Budget

Sales Forecast

• Ask sales personnel

• Extrapolate past trends

• Use market research

• Employ statistical models and simulation

SalesForecast

Sales Budget

Units to be sold

* Selling price per unit

= Dollars of sales

The Operating Budget

Sales Budget

Production Budget

Production Budget

• Production manager combines– Sales estimates– Beginning inventory targets– Ending inventory targets

• Determines the types, quantities, and timing of products to be manufactured

Ending Inventory Policy

• Percentage of next period’s projected sales

• Constant amount

• Increasing amount

• Near-zero in just-in-time systems

Cost of holding inventory includes storage, insurance, obsolescence, shrinkage, damage

Production Budget Finished Good Units

Units to be sold (from sales budget)

+ Desired ending inventory

= Total units needed during period

- Units in beginning inventory

= Units to be produced

The Operating Budget

Sales Budget

Production Budget

Purchases Budget

Purchases Budget

Units to be produced (from production budget)+ Desired ending inventory= Total needed- Beginning inventory= Units for which purchases are required* Quantity required per unit= Quantity to purchase* Price per pound= Total cost of purchases

The Operating Budget

Sales Budget

Production Budget

Direct Labor Budget

Purchases Budget

Direct Labor Budget

• Total number of people• Specific types of workers • Production hours needed• Costs

– Union contracts– Minimum wage laws– Fringe benefit costs– Payroll taxes

Direct Labor Budget

Units to be produced (or DM components)

* Standard time allowed per unit

= Standard labor time allowed

* Per hour direct labor cost

= Total direct labor cost

The Operating Budget

Sales Budget

Production Budget

Overhead Budget

Direct Labor Budget

Purchases Budget

Overhead Budget

• Identify activity base

• Estimate overhead costs

• Separate costs as fixed or variable

• Show total costs for operating budgets

• Show costs without depreciation for cash budgets

Overhead Budget

Predicted activity base

* Variable overhead rate per unit of activity

= Total variable overhead cost

+ Fixed overhead cost

= Total overhead cost

= Total cost without depreciation

The Operating Budget

Sales Budget

Production Budget

Overhead Budget

Direct Labor Budget

Purchases Budget

Selling and Admin Budget

Selling and Administrative Budget

Predicted sales dollars (or other measure)

* Variable S&A rate per dollar

= Total variable overhead cost

+ Fixed S&A cost

= Total S&A cost

= Total cost without depreciation

The Financial Budget

Operating Budget

The Financial Budget

Operating Budget

Cash Budget

Cash Budget• Highlights importance of cash for

organization’s continued existence• Translates accrual-based information into

cash flows• Indicates effectiveness of credit practices• Allows for planned cash borrowing or

investing• Used to prepare pro forma Cash Flow

Statement

Cash BudgetBeginning cash balance

+ Cash receipts (collections)

= Cash available for disbursements

- Cash disbursements

= Cash excess or deficiency

- Minimum desired cash balance

= Cash needed/available for investment or loan repayment

+/- Various financing measures

= Ending cash balance

Cash Collections/Disbursements

• Collections– Sales

• Cash

• Accounts Receivable

• Disbursements– Purchases

• Cash

• Accounts Payable

Receipts/Disbursements

From Jan Feb Mar Total

Nov

Dec

Jan

Feb

Mar

Total

Cash Collections/Disbursements

Reduced by discounts and

estimated uncollectible

accounts

Percentage of cash

received/paid during the

month

How to Improve Cash Flow

• Establish sound credit practices

• Expedite fulfillment and shipping

• Bill promptly and accurately

• Offer discounts for prompt payments

• Aggressively follow up on past due accounts

• Deposit payments promptly

• Seek better payment terms from suppliers/banks

• Keep tight control of inventory

• Review and reduce expenses

• Pay bills on time but never before they are due

NY State Society CPAs

The Financial Budget

Operating Budget

Cash Budget

Capital Budget

Capital Budget

• Long-term fixed asset needs– Plant– Equipment

• Payment points

The Financial Budget

Operating Budget

Cash Budget

Capital BudgetIncome

Statement/COGMfg

The Financial Budget

Operating Budget

Cash Budget

Capital BudgetIncome

Statement/COGMfg

Statement of Retained Earnings

The Financial Budget

Operating Budget

Cash Budget

Capital BudgetIncome

Statement/COGMfg

Statement of Retained Earnings Balance Sheet

The Financial Budget

Operating Budget

Cash Budget

Capital BudgetIncome

Statement/COGMfg

Statement of Retained Earnings Balance Sheet

Statement of Cash Flows

Budgets Provide

• Guide to align activities and resources with organizational goals

• Vehicle to promote employee participation, cooperation, and departmental coordination

• Tool to enhance planning, controlling, problem solving, and evaluating

Budget

Budgeting Provides

• Basis to sharpen responsiveness to internal and external factors

• Model to view future performance and consider alternative measures

• Benchmark to judge organizational effectiveness and efficiency

Budget

Budgeting Terms

• Continuous budgeting

– 12-month rolling budget

Budgeting Terms

• Continuous budgeting

• Budget slack– intentional underestimation of revenue– intentional overestimation of expenses

Budgeting Terms

• Continuous budgeting

• Budget slack

• Participatory budget– developed by top management and operating

personnel

Budgeting Terms

• Continuous budgeting

• Budget slack

• Participatory budget

• Imposed budgets– developed by top management– imposed on operating personnel

Activity Budget

• Connect line items in budget to list of activities

• Raise awareness of non-value-added activities

• Question and reduce non-value-added costs

Budget

Budget Manual

• Statements of budgetary purpose and its desired results

• Listing of specific budgetary activities to be performed

• Calendar of scheduled budgetary activities

• Sample of budgetary forms

• Original, revised, and approved budgets

Questions

• How are strategic and tactical planning related to budgeting?

• In what order are the master budget schedules prepared?

• Why is the cash budget important in the master budgeting process?