203 CH8: Master Budgeting

LO:

1 Understand why organizations budget and the processes they use to create budgets.

2 Prepare a sales budget, including a schedule of expected cash collections.

3 Prepare a production budget.

4 Prepare a direct materials budget, including a schedule of expected cash disbursements for purchases of materials.

5 Prepare a direct labor budget.

6 Prepare a manufacturing overhead budget.

7 Prepare a selling and administrative expense budget.

8 Prepare a cash budget.

9 Prepare a budgeted income statement.

10 Prepare a budgeted balance sheet.

Concept Checks

  1. D

Introduction

  • Budget : detailed plan for the future that is usually expressed in formal quantitative terms

    • For companies, budget ordinarily covers a one-year period corresponding to its fiscal year; often broken down into quarterly and monthly budgets

    • Perpetual budget : 12 month budget that continuously rolls forward one month (or quarter) at a time as the current month (or quarter) is completed

    • Keeps managers continually focused one year ahead

      • For two purposes :

        • Planning : involves developing goals and preparing various budgets to achieve goals

        • Control : involves gathering feedback to ensure that the plan is being properly executed or modified as circumstances change

    • To be effective, good budgeting system must provide for both planning and control

Why and How Do Organizations Create Budgets?

  • Why Do Organizations Create Budgets?

    • Planning standpoint

      • Encourage managers to think/plan for future

      • Communicate financial goals throughout the organization

      • Allocate resources within organization where they can be used most effectively

      • Coordinate the plans and activities of departmental managers

      • Uncover potential bottlenecks before they occur

    • Control standpoint, organizations compare budget to actual results to

      • Improve efficiency and effectiveness of operations

      • Evaluate and reward employees

  • How Do Organizations Create Budgets?

    • Self-imposed budget/participative budget : budget that is prepared with full cooperation and participation of managers at all levels

    • Top-down approach, top-level managers initiate the budgeting process by issuing profit targets

      • Lower-level managers are directed to prepare budgets that meet those targets

      • Often demoralizes LLMs because ignores their knowledge and opinions

      • TLM may possess strategic vision but lacks operational knowledge, leads to unrealistically high/low targets

    • Companies involve LLM in budgeting process because

      • Shows respect for their opinions

      • Leverages their knowledge to provide more accurate estimates than those imposed by TLM who has less intimate knowledge of day-to-day operations

      • Increases motivation to achieve their own self-imposed goals

      • empowers them to take ownership of the budget and to be accountable for deviations from it

    • Limitations of self-imposed budgets

      1. LLM may make suboptimal budgeting estimates if they lack the broad strategic perspective possess by TLM

      2. if budget is used to reward employees, LLM may create too much budgetary slack

        • Budgetary slack : underestimating revenues or overestimating expenses

The Master Budget: An Overview

  • Master budget : a number of separate but interdependent budgets that formally lay out the company’s sales, productions, and financial goals that culminates in a cash budget, budgeted income statement and budgeted balance sheet

  • Sales budget : detailed schedule showing expected sales for the budget period

    • Accuracy is key; all other parts of master budgets depends on this

  • Production budget : used to determine DM DL and MOH budgets

    • Once determined, ending FGI budget can be determined

  • Cash budget : shows how cash resources will be acquired and used

  • Budgeted income statement : provides estimate of NI for budget period; relies on info from sales/fgi/selling and administrated/cash budget

  • Balance sheet : estimates company’s assets, liabilities and SE at end of budget period

  • Seeing the Big Picture

    • 10 key questions

      1. How much sales will we earn

      2. How much cash will we collect from customers

      3. How much RM will we need to purchase

      4. How much manufacturing cost (DM DL MOH) will be incurred

      5. How much cash will be paid to suppliers and direct laborers and how much will be paid for MOH resources

      6. What is total cost that will be transferred from FGI to COGS

      7. How much S&A expenses will be incurred and how much ccash will be paid related to those expenses

      8. How much money will be borrowed from or repay to lenders— including interest

      9. How much net operating income will be earned

      10. What will balance sheet look like at the end of the budget period

Preparing the Master Budget

  • The Beginning Balance Sheets

  • The Budgeting Assumptions

  • The Sales Budget

    • What are the budgeted unit sales

    • What is the budgeted selling price per unit

    • What percentage of AR will be collected in the current and subsequent periods

  • The Production Budget

    • What percentage of next period’s unit sales needs to be maintained in ending FGI

  • Inventory Purchases—Merchandising Company

  • The Direct Materials Budget

    • How many units of RM are needed to make one unit of FG

    • What is the budgeted cost for one unit of RM

    • What percentage of next period’s production needs should be maintained in ending RM inventory

    • What percentage of RM purchases will be paid in the current and subsequent periods

  • The Direct Labor Budget

    • How many direct labor-hours are required per unit of finished goods

    • What is the budgeted direct labor wage rate per hour

  • The Manufacturing Overhead Budget

    • What is the budgeted variable overhead cost per unit of the allocation base

    • What is the total budgeted fixed overhead cost per period

    • What is the budgeted depreciation expense on factory assets per period

  • The Ending Finished Goods Inventory Budget

  • The Selling and Administrative Expense Budget

    • What is the budgeted variable S&A expense per unit sold

    • What is the total budgeted fixed S&A expense per period

    • What is the budgeted depreciation expense on non-factory assets per period

  • The Cash Budget

    • What is the budgeted minimum cash balance

    • What is the estimated expenditures for non-current asset purchases and dividends

    • What is the estimated interest rate on borrowed funds

  • The Budgeted Income Statement

  • The Budgeted Balance Sheet