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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?