cost accounting chapter 5

master budgets

What is a budget?

A written financial plan managers use to coordinate a business’s activities with its goals and strategies.

What are the objectives of budgeting?

1. Planning

2. goal setting

3. coordination

4. communication

5. benchmarking

6. motivation

7. performance evaluation

How does budgeting benefit planning?

It turns long-term strategic plans (3–10 years) and medium/short-term operational plans into concrete actions.

What is the purpose of coordination and communication in budgeting?

To help everyone in the organization work toward the same goals.

How does benchmarking work in budgeting?

Compares actual results with budgeted results to motivate employees and evaluate managers.

What is a positive vs. negative variance in budgeting?

• Positive: Actual results are better than budgeted

• Negative: Actual results are worse than budgeted

How do budgeting procedures differ between small and large companies?

• Small: Simple, informal

• Large: Complex, formal with a budget committee including upper, middle, and lower management

How does human behaviour affect budgeting?

Managers must support and communicate the budget to foster acceptance and participation.

What is a participatory budget?

A budget developed with input from the people directly affected by it.

What is budgetary slack?

Managers intentionally understate revenues or overstate expenses to make targets easier to meet.

What is the ‘spend it or lose it’ problem in budgeting?

Departments may spend leftover budget to avoid future cuts, even if spending is unnecessary.

What is a strategic budget?

A long-term (3–10 years) financial plan to coordinate activities needed to achieve long-term goals

What is an operational budget?

A short-term plan (weekly, monthly, quarterly, or yearly) to coordinate activities to achieve short-term goals.

What is a static budget?

A budget prepared for only one level of sales volume.

What is a flexible budget?

A budget prepared for various sales levels — used for ‘what-if’ analysis.

What is a master budget?

The complete set of budgeted financial statements and supporting schedules for the whole organisation.

What are the main parts of a master budget?

operating budget + financial budget + capital expenditures budget

What does the operating budget include?

• Sales budget

• production budget

• direct materials budget

• direct labour budget

• MOH budget

• COGS budget

• selling & administrative expenses budget

What does the capital expenditures budget cover?

The company’s plan for purchasing long-term assets like property, plant, and equipment.

What does the financial budget include?

• Cash budget

• budgeted income statement

• budgeted balance sheet

What is the first component of the operating budget?

The sales budget — it drives the rest of the budget.

How do you prepare a sales budget?

Expected unit sales × Selling price per unit for each period, then sum up.

How do you prepare a production budget?

Budgeted sales (units)

• Desired ending inventory - beginning inventory = required production

How do you prepare a direct materials budget?

Units to produce × Materials needed/unit = Needed for production

• Desired ending inventory - beginning inventory = materials to purchase × cost per unit = total cost of purchases

How do you prepare a direct labour budget?

Units to produce × Hours/unit = Total direct labour hours
× Hourly wage = Total direct labour cost

How do you prepare a MOH (Manufacturing Overhead) budget?

Variable OH Rate × Direct Labour Hours + Fixed OH Costs = Total MOH

How do you prepare a selling & administrative expenses budget?

Budget non-manufacturing costs (sales commissions, salaries, rent, depreciation, advertising, supplies) — split into variable and fixed costs.

How do you prepare a COGS budget?

Direct materials cost/unit + Direct labour cost/unit + MOH cost/unit = Total manufacturing cost per unit.

three types of budgets in the master budget

1. operating budget

2. capital expenditure budget

3. financial budget

operating budget

• A detailed plan that projects sales revenue, production costs (like direct materials, direct labour, and manufacturing overhead), cost of goods sold (COGS), and selling & administrative expenses.

• purpose: To plan day-to-day operations for a specific period (usually 1 year).

• It provides the basis for the income statement and helps coordinate activities like sales, production, and expenses.

• includes

  • Sales Budget (first and most crucial)

  • Production Budget

  • Direct Materials, Direct Labour, and MOH Budgets

  • COGS Budget

  • Selling & Administrative Expenses Budget

capital expenditures budget

• A plan for the company’s investments in long-term assets, like new equipment, machinery, buildings, or technology.

• purpose: To budget for major purchases that support production and growth strategies over the long term.

• key point: Tied closely to strategic goals. Management must carefully consider timing, financing, and expected return on investment.

financial budget

• a plan that focuses on the company’s cash position and overall financial health

• purpose: to ensure the company has enough cash to fund operations and investments, and to project overall financial results

• combines the outcomes of the operating and capital budgets

• includes

  • cash budget (details expected cash inflows and outflows, financing needs)

  • budgeted income statement

  • budgeted balance sheet