Flexible Budgets & Variance Analysis I

Chapter 1: Introduction

Overview of Master Budget and Responsibility Accounting

• Importance of understanding the master budget process for effective financial planning and control.

• Key components of the master budget include:

  • Sales Budget: The initial budget that dictates production needs based on sales forecasts.

  • Production Budget: Determines the production quantity required based on sales projections and inventory levels.

  • Direct Manufacturing Labor Budget: Calculates labor costs needed for planned production.

  • Cost of Goods Sold: Calculates the direct costs attributable to the production of goods sold.

  • Non-manufacturing budgets: Budgets that account for other operational costs not directly tied to production.

  • Operating Income: The profit realized from normal business operations.

  • Capital and Cash Flow Budgets: Budgets designed to project cash needs and investments.

  • Pro forma Financial Statements: Forecasted financial statements that project future financial performance.

Sales Budget

• The sales budget is the first budget prepared and defines how much of each product needs to be produced based on sales forecasts.

• Production Process: Calculating how many units need to be produced involves these steps:

  1. Total Available Inventory = Opening Inventory + Production

  2. Sales (Usage) = Total Available - Ending Inventory

  3. Production Formula: Production = Sales + Ending Inventory - Opening Inventory

Production Budget Example

• Opening Inventory: 16,000 (as of Dec 31)

• Ending Inventory Calculation:

  • January: (Feb Sales 12,000) + (0.5 * March Sales 8,000) = 16,000

  • February: (0.5 * March Sales 9,000) + 8,000 = 12,500

  • March: (9,000) + (0.5 * May Sales 9,000) = 13,500

Inventory Movement

• Production Needs Formula: Total Requirement = Sales + Ending Inventory; then, Production Needs = Total Requirement - Opening Inventory.

Direct Manufacturing Labor Budget

• Calculate Labor Costs: This budget estimates labor costs based on budgeted production, accounting for varying labor hours required each month.

• Labor costs typically increase from January to March as production ramps up.

Problem-Solving Example

To solve a problem related to determining production requirements, follow these steps:

1. Identify Sales Forecasts: Examine the sales budget to gather projected sales figures for each month.

2. Calculate Ending Inventory: Use sales forecasts to determine required ending inventory levels leveraging future sales expectations (e.g., 50% of the next month's sales).

3. Apply Production Formula: With opening inventory, calculate the total production required:

   • Use the formula: Production = Sales + Ending Inventory - Opening Inventory.

4. Adjust for Inventory Movement: Ensure to calculate inventory movement accurately based on the obtained figures to avoid shortages or overproduction.

5. Review Labor and Costs: After determining production needs, adjust labor budgets accordingly to ensure sufficient labor is available.