Master Budgeting

Chapter 8

8-1
Learning Objective 1

Understand why organizations

budget and the processes
they use to create budgets.

8-2
 The Basic Framework of Budgeting

A budget is a detailed quantitative plan for

acquiring and using financial and other resources
over a specified forthcoming time period.
1. The act of preparing a budget is called
budgeting.
2. The use of budgets to control an
organization’s activities is known
as budgetary control.

8-3
 Planning and Control

Planning – Control –
involves developing involves the steps taken by
objectives and management to increase the
preparing various likelihood that the objectives
budgets to achieve are attained and that all parts
those objectives. of the organization are
working together toward that
goal.

8-4
 Advantages of Budgeting

Define goals
and objectives
Communicate Think about and
plans plan for the future

Coordinate
Advantages Means of allocating
activities resources

Uncover potential
bottlenecks

8-5
The Master Budget: An Overview
Sales budget

Selling and
Ending inventory administrative
Production budget
budget budget

Direct materials Direct labor Manufacturing

budget budget overhead budget

Cash budget

Budgeted
Budgeted
income
balance sheet
statement
8-6
Learning Objective 2

Prepare a sales budget,

including a schedule of
expected cash collections.

8-7
The Sales Budget
Sales is the most difficult aspect of budgeting.

Sales Staff
Market Research
Trend Analysis
Econometric Models
8-8
Budgeting Example
 Royal Company is preparing budgets for the
quarter ending June 30th.
 Budgeted sales for the next five months are:
 April 20,000 units
 May 50,000 units
 June 30,000 units
 July 25,000 units
 August 15,000 units
 The selling price is $10 per unit.

8-9
The Sales Budget
The individual months of April, May, and June are
summed to obtain the total budgeted sales in units
and dollars for the quarter ended June 30th

Expected Cash Collections Production Budget 8-10

 Expected Cash Collections

• All sales are on account.

• Royal’s collection pattern is:
70% collected in the month of sale,
30% collected in the month following sale.
• In April, the March 31st accounts receivable balance of
$30,000 will be collected in full.

8-11
Expected Cash Collections

8-12
Expected Cash Collections

30% 60,000 60,000

From the Sales Budget for April.

8-13
Expected Cash Collections

30% 60,000 60,000

30% 150,000 150,000

From the Sales Budget for May.
410,000 360,000

8-14
Quick Check 1

What will be the total cash collections for the

quarter? Cash collection for June
30 x 000 70 %
a. $700,000 ,
10 x

210 000
b. $220,000 =
,

+ 410000 170 000

+

150 000
c. $190,000 210
,

, 000
+
,

d. $940,000

8-15
Expected Cash Collections

March

April
30% 60,000 60,000

may
30% 150,000 150,000
June

410,000 360,000 940,000

8-16
Learning Objective 3

Prepare a production budget.

8-17
The Production Budget

Sales Production
Budget Budget
and
Expected
Cash
Collections

The production budget must be adequate to

meet budgeted sales and to provide for
the desired ending inventory.
8-18
 The Production Budget
• The management at Royal Company wants ending
inventory to be equal to 20% of the following month’s
budgeted sales in units.
beginning balance
• On March 31st, 4,000 units were on hand.

Let’s prepare the production budget.

8-19
The Production Budget

10 , 000

30 000 ,

4800
I

26 , 800

Sales Budget 8-20

The Production Budget

6808

↑ 56 000
,

10 000
,

46 , 000

Budgeted May sales 50,000

Desired ending inventory % 20%
March 31
Desired ending inventory 10,000
ending inventory.
8-21
Quick Check 2

What is the required production for May?

a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units

8-22
 164800 180000 102400447200

90000 51200
82400
The Production Budget 76080 82400 90000

20%

8-23
The Production Budget

Desired ending inventory:

July sales of 25,000 units × 20% = 5,000
Ending Finished Goods Inventory Budget 8-24
Learning Objective 4

Prepare a direct materials

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

8-25
The Direct Materials Budget

• At Royal Company, five pounds of material are

required per unit of product.
• Management wants materials on hand at the end of
each month equal to 10% of the following month’s
production.
• On March 31, 13,000 pounds of material are on hand.
Material cost is $0.40 per pound.

Let’s prepare the direct materials budget.

8-26
The Direct Materials Budget

From production budget.

8-27
The Direct Materials Budget

8-28
 The Direct Materials Budget

14500
244306
23000
March 31 inventory.
221 ,500

10% of following month’s Calculate the materials to

production needs. be purchased in May.
8-29
Quick Check 3

How much materials should be purchased in

May?
a. 221,500 pounds
b. 240,000 pounds
c. 230,000 pounds
d. 211,500 pounds

8-30
The Direct Materials Budget

8-31
The Direct Materials Budget

Assumed ending inventory.

8-32
Expected Cash Disbursement for Materials

• Royal pays $0.40 per pound for its materials.

• One-half of a month’s purchases is paid for in the
month of purchase; the other half is paid in the
following month.
• The March 31 accounts payable balance is $12,000.

Let’s calculate expected cash disbursements.

8-33
Expected Cash Disbursement for Materials

8-34
Expected Cash Disbursement for Materials

140,000 lbs. × $0.40/lb. = $56,000 8-35

 Quick Check 4

What are the total cash disbursements for the

quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400

8-36
Expected Cash Disbursement for Materials

221,500 lbs. × $0.40/lb. = $88,600 8-37

Learning Objective 5

Prepare a direct labor budget.

8-38
 The Direct Labor Budget
• At Royal, each unit of product requires 0.05 hours (3
minutes) of direct labor.
• The labor can be unskilled because the production
process is relatively simple and formal training is not
required.
• Royal pays its workers at the rate of $10 per hour.

Let’s prepare the direct labor budget.

8-39
The Direct Labor Budget

From production budget.

8-40
The Direct Labor Budget

8-41
The Direct Labor Budget

$ 13,000 $ 23,000 $ 14,500 $ 50,500

8-42
Quick Check 5
What would be the total direct labor cost for
the quarter if the company pays time and
one-half ($10 x 1.5 = $15) for all hours
worked by employees over 2,000 per
month? May : 2000x10
+
300x15

a. $51,700 =
24508
13000
b. $52,000
+

c. $53,250 08
d. $57,000

8-43
Learning Objective 6

Prepare a manufacturing
overhead budget.

8-44
 Manufacturing Overhead Budget
• At Royal, manufacturing overhead is applied to units of
product on the basis of direct labor-hours.
• The variable manufacturing overhead rate is $20 per
direct labor-hour.
• Fixed manufacturing overhead is $50,000 per month,
which includes $20,000 of noncash costs (primarily
depreciation of plant assets).

Let’s prepare the manufacturing overhead budget.

8-45
Manufacturing Overhead Budget

Direct Labor Budget.

8-46
Manufacturing Overhead Budget

Total mfg. OH for quarter $251,000

= $49.70 per hour
Total labor-hours required 5,050

Ending Finished Goods Inventory Budget 8-47

Manufacturing Overhead Budget

Depreciation is a noncash charge.

8-48
Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total

Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $ 10.00 0.50
Manufacturing overhead 0.05 hrs. $ 49.70 2.49
$ 4.99
Budgeted finished goods inventory
Ending inventory in units 5,000
Unit product cost $ 4.99
Ending finished goods inventory $ 24,950

Direct materials Direct labor budget.

budget and information.

8-49
Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total

Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $ 10.00 0.50
Manufacturing overhead 0.05 hrs. $ 49.70 2.49
$ 4.99

Total mfg. OH for quarter $251,000

= $49.70 per hour
Total labor-hours required 5,050

8-50
Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total

Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $ 10.00 0.50
Manufacturing overhead 0.05 hrs. $ 49.70 2.49
$ 4.99
Budgeted finished goods inventory
Ending inventory in units 5,000
Unit product cost $ 4.99
Ending finished goods inventory $ 24,950

Production Budget.

BudgetedIncome Statement 8-51

Learning Objective 7

Prepare a selling and

administrative expense
budget.

8-52
Selling and Administrative Expense Budget
• At Royal, the selling and administrative expense budget is divided into
variable and fixed components.
• The variable selling and administrative expenses are $0.50 per unit sold.
• Fixed selling and administrative expenses are $70,000 per month.
• The fixed selling and administrative expenses include $10,000 in costs –
primarily depreciation – that are not cash outflows of the current month.

Let’s prepare the company’s selling and administrative expense budget.

8-53
Selling and Administrative Expense Budget

Calculate the selling and administrative

cash expenses for the quarter. 8-54
Quick Check 6

What are the total cash disbursements for selling

and administrative expenses for the quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000

8-55
Selling and Administrative Expense Budget

BudgetedIncome Statement 8-56

 Learning Objective 8

Prepare a cash budget.

8-57
 Format of the Cash Budget

The cash budget is divided into four sections:

1. Cash receipts section lists all cash inflows excluding
cash received from financing;
2. Cash disbursements section consists of all cash
payments excluding repayments of principal and interest;
3. Cash excess or deficiency section determines if the
company will need to borrow money or if it will be able to
repay funds previously borrowed; and
4. Financing section details the borrowings and repayments
projected to take place during the budget period.

8-58
 Additional Cash Budget Information
Assume the following information for Royal:
Maintains a 16% open line of credit for $75,000.
Maintains a minimum cash balance of $30,000.
Borrows on the first day of the month and repays loans
on the last day of the month. ver -

Pays a cash dividend of $49,000 in April. ver

we
-

Purchases $143,700 of equipment in May and $48,300

in June (both purchases paid in cash).
Has an April 1 cash balance of $40,000.

8-59
 The Cash Budget – Computations for April
April May June Quarter
Beginning cash balance $ 40,000
Add: Cash collections 170,000 Schedule of Expected
Total cash available $ 210,000 Cash Collections
Less: Cash disbursements
Materials 40,000
Direct labor 13,000
Manufacturing overhead 56,000
Schedule of Expected
Selling and administrative 70,000
Cash Disbursements
Equipment purchase -
Dividend 49,000 Manufacturing
Total disbursements 228,000
Overhead Budget
Excess (deficiency) (18,000)
Financing:
Selling and Administrative
Borrowing 48,000
Repayment -
Expense Budget
Interest -
Total financing 48,000
Ending cash balance $ 30,000

8-60
 The Cash Budget – April Deficiency
April May June Quarter
Beginning cash balance $ 40,000
Add: Cash collections 170,000
Total cash available $ 210,000
Less: Cash disbursements
Materials 40,000
Direct labor 13,000
Manufacturing overhead 56,000
Because Royal maintains
Selling and administrative 70,000 a cash balance of $30,000,
Equipment purchase - the company must borrow
Dividend 49,000 $48,000 on its line-of-credit.
Total disbursements 228,000
Excess (deficiency) (18,000)
Financing:
Borrowing 48,000
Repayment -
Interest -
Total financing 48,000
Ending cash balance for April
Ending cash balance $ 30,000 is the beginning May balance.
8-61
The Cash Budget – Final Computations
April May June Quarter
Beginning cash balance $ 40,000 $ 30,000 $ 40,000 $ 40,000
Add: Cash collections 170,000 410,000 360,000 940,000
Total cash available $ 210,000 $ 440,000 $ 400,000 $ 980,000
Less: Cash disbursements
Materials 40,000 72,300 72,700 185,000
Direct labor 13,000 23,000 14,500 50,500
Manufacturing overhead 56,000 76,000 59,000 191,000
Selling and administrative 70,000 85,000 75,000 230,000
Equipment purchase - 143,700 48,300 192,000
Dividend 49,000 - - 49,000
Total disbursements 228,000 400,000 269,500 897,500
Excess (deficiency) (18,000) 40,000 130,500 82,500
Financing:
Borrowing 48,000 - 48,000
Repayment - - (48,000) (48,000)

$48,000 × 16% × 3/12 = $1,920

Interest - - (1,920) (1,920)

(Borrowings on April 1 and 48,000

Total financing - (49,920) (1,920)
Ending cash balance $ 30,000 $ 40,000 $ 80,580 $ 80,580
repayment on June 30)
8-62
 The Budgeted Income Statement

Cash Budgeted
Budget Income
Statement

With interest expense from the cash

budget, Royal can prepare the budgeted
income statement.
8-63
Learning Objective 9

Prepare a budgeted income

statement.

8-64
 The Budgeted Income Statement
Sales Budget.
Royal Company
Budgeted Income Statement
For the Three Months Ended June 30
E Ending Finished
Sales (100,000 units @ $10) $ 1,000,000
Goods Inventory
Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin 501,000 Budget.
Selling and administrative expenses 260,000
Operating income 241,000
Interest expense 1,920 Selling and
Net income $ 239,080 Administrative
Expense Budget.
Cash Budget

8-65
End of Chapter 8

8-66