Master Budgeting: - Part I

7-1
Master Budgeting
Chapter 8 – Part I
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
7-2
Learning Objective 1
Understand why
organizations budget and
the processes they use to
create budgets.
7-3
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.
7-4
Difference Between 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 set down while planning are
those objectives. attained and that all parts of
the organization are working
together toward that goal.
7-5
Advantages of Budgeting
Define goals
and objectives
Communicate
Think about and
plans
plan for the future
Advantages
Coordinate Means of allocating

activities resources
Have benchmarks
for evaluating
performance
7-6
Responsibility Accounting
Managers should be held responsible for those

items - and only those items - that they can
actually control to a significant extent.
Responsibility accounting enables
organizations to react quickly to deviations
from their plans and to learn from feedback.
Managers can understand the sources of
significant favorable or unfavorable
discrepancies (not penalize individuals for not
achieving targets).
7-7
Choosing the Budget Period
Operating Budget
2016 2017 2018 2019

Operating budgets
ordinarily A continuous (perpetual) budget is a
cover a one-year period 12-month budget that rolls
corresponding to a forward one month (or quarter)
company’s fiscal year. as the current month (or quarter)
Many companies divide is completed.
their annual budget
into four quarters.
7-8
Self-Imposed Budgets
Top Management
Middle Middle
Management Management
Supervisor Supervisor Supervisor Supervisor

A self-imposed budget or participative budget is a budget that
is prepared with the full cooperation and participation of
managers at all levels.
7-9
Advantages of Self-Imposed Budgets

1. Individuals at all levels of the organization are viewed as
members of the team whose judgments are valued by
top management.
2. Budget estimates prepared by front-line managers are
often more accurate than estimates prepared by top
managers.
3. Motivation is generally higher when individuals
participate in setting their own goals than when the
goals are imposed from above.
4. A manager who is not able to meet a budget imposed
from above can claim that it was unrealistic. Self-
imposed budgets eliminate this excuse.
7-10
Disadvantages of Self-Imposed Budgets

1. Lower-level managers may make suboptimal budgeting
recommendations if they lack the broad strategic
perspective.
2. Self-imposed budgeting may allow lower-level managers
to create ‘budgetary slacks’, because the managers who
create budgets are held accountable for actual results
that deviate from the budget.
7-11
Self-Imposed Budgets –
Management Review
Self-imposed budgets should be reviewed
by higher levels of management to
prevent “budgetary slack.”
Most companies issue broad guidelines in
terms of overall profits or sales. Lower
level managers are directed to prepare
budgets that meet those targets.
7-12
Human Factors in Budgeting

The success of a budget program depends on three
important factors:
1. Top management must be enthusiastic and
committed to the budget process.
2. Top management must not use the budget to
pressure employees or blame them when
something goes wrong.
3. Highly achievable budget targets are usually
preferred when managers are rewarded based
on meeting budget targets.
7-13
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
7-14
Seeing the Big Picture – Part 1
To help you see the “big picture” keep in mind

that the 10 schedules in the master budget are
designed to answer the 10 questions shown on the
next screen.
7-15
Seeing the Big Picture

1. How much sales revenue will we earn?
2. How much cash will we collect from customers?
3. How much raw material will we need to purchase?
4. How much manufacturing costs will we incur?
5. How much cash will we pay to our suppliers and our direct laborers,
and how much cash will we pay for manufacturing overhead resources?
6. What is the total cost that will be transferred from finished goods
inventory to cost of good sold?
7. How much selling and administrative expense will we incur and how
much cash will be pay related to those expenses?
8. How much money will we borrow from or repay to lenders – including
interest?
9. How much operating income will we earn?
10.What will our balance sheet look like at the end of the budget period?
7-16
The Master Budget: Based on

Estimates and Assumptions
A master budget is based on various estimates

and assumptions. For example, the sales budget
requires three estimates/assumptions as follows:
1. What are the budgeted unit sales?
2. What is the budgeted selling price per unit?
3. What percentage of accounts receivable will
be collected in the current and subsequent
periods?
7-17
Prepare a sales budget,

including a schedule of
expected cash
collections.
7-18
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.
7-19
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
April May June Quarter

Budgeted sales in units 20,000 50,000 30,000 100,000
Selling price per unit $ 10 $ 10 $ 10 $ 10
Total budgeted sales $ 200,000 $ 500,000 $ 300,000 $ 1,000,000
7-20
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.
Expected Cash Collections
7-21
Calculations for April

Accounts Receivable 3/31 $ 30,000 $ 30,000
Accounts Receivable 6/30 = 30% x $300,000 = $90,000
7-22
Expected Cash Collections –

Calculations for May
April Sales
70% × $200,000 140,000 140,000
30% × $200,000 60,000 60,000
From the Sales Budget for April: Accounts Receivable

6/30 = 30% x $300,000 = $90,000
Expected Cash Collections –
7-23
Calculations for June

April Sales
70% × $200,000 140,000 140,000
30% × $200,000 60,000 60,000
May Sales
70% × $500,000 350,000 350,000
30% × $500,000 150,000 150,000
June Sales
70% × $300,000 210,000 210,000
$ 170,000 $ 410,000 $ 360,000 $ 940,000
From the Sales Budget for May: Accounts Receivable

6/30 = 30% × 300,000 = $90,000
7-24
Concept Check 1
What will be the total cash collections for the

quarter?
a. $700,000
b. $220,000
c. $190,000
d. $940,000
7-25
Concept Check 1a
What will be the total cash collections for the

quarter?
a. $700,000
b. $220,000
c. $190,000
d. $940,000
7-26
Prepare a production
budget.
7-27
The Production Budget

Sales
Budget
and Production
Expected Budget
Cash
Collections
The production budget must be adequate to

meet budgeted sales and to provide for
the desired ending inventory.
7-28
The Production Budget - Details

The management at Royal Company wants ending
inventory to be equal to 20% of the following month’s
budgeted sales in units.
On March 31st, 4,000 units were on hand.
Let’s prepare the production budget.
If Royal was a merchandising company it would prepare

a merchandise purchase budget instead of a production
budget.
7-29
The Production Budget –

Budgeted Sales
Budgeted Sales 20,000 50,000 30,000 100,000
Add: Desired ending inventory
Total needs
Less Beginning inventory
Required production
7-30

Budgeted Sales 20,000 50,000 30,000 100,000
Add: Desired ending inventory 10,000
Total needs 30,000
Less Beginning inventory 4,000
Required production 26,000
March 31 Budgeted May sales 50,000

ending inventory Desired ending inventory % 20%
Desired ending inventory 10,000
7-31
Concept 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
7-32
Concept Check 2a
What is the required production for May?
a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units
7-33

Budgeted Sales 20,000 50,000 30,000 100,000
Add: Desired ending inventory 10,000 6,000
Total needs 30,000 56,000
Less Beginning inventory 4,000 10,000
Required production 26,000 46,000
7-34

Budgeted Sales 20,000 50,000 30,000 100,000
Add: Desired ending inventory 10,000 6,000 5,000 5,000
Total needs 30,000 56,000 35,000 105,000
Less Beginning inventory 4,000 10,000 6,000 4,000
Required production 26,000 46,000 29,000 101,000
Add: Desired ending inventory:

July sales of 25,000 units × 20% = 5,000
7-35
Prepare a direct
materials budget,
including a schedule of
expected cash
disbursements for
purchases of materials.
7-36
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.
7-37
The Direct Materials Budget -

Production
Production 26,000 46,000 29,000 101,000
Materials per unit (pounds)
Production needs
Add: Desired ending inventory
Total needed
Less: Beginning inventory
Materials to be purchased
From the production budget

7-38
The Direct Materials Budget –

Production Needs
Production 26,000 46,000 29,000 101,000
Materials per unit (pounds) 5 5 5 5
Production needs 130,000 230,000 145,000 505,000
Add: Desired ending
inventory
Total needed
Less: Beginning inventory
Materials to be purchased
7-39

Production 26,000 46,000 29,000 101,000

Add: Desired ending inventory 23,000
Total needed 153,000

Less: Beginning inventory 13,000 March 31 inventory
Materials to be purchased 140,000
10% of following month’s

production needs Now, why don’t you calculate
the materials to be purchased
In May
7-40
Concept 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
7-41
Concept Check 3a
How much materials should be purchased in May?

a. 221,500 pounds
b. 240,000 pounds
c. 230,000 pounds
d. 211,500 pounds
7-42

Production 26,000 46,000 29,000 101,000
Add: Desired ending inventory 23,000 14,500
Total needed 153,000 244,500
Less: Beginning inventory 13,000 23,000
Materials to be purchased 140,000 221,500
7-43

Production 26,000 46,000 29,000 101,000
Add: Desired ending 23,000 14,500 11,500 11,500
inventory
Total needed 153,000 244,500 156,500 516,500
Less: Beginning inventory 13,000 23,000 14,500 13,000
Materials to be purchased 140,000 221,500 142,000 503,500
Beginning inventory from April: 13,000
7-44
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.
7-45

Materials – Part 2

Accounts payable 3/31 $ 12,000 $ 12,000
7-46

Materials - Calculations
April purchases
50% x $56,000 28,000 28,000
50% x $56,000 28,000 28,000
May purchases
50% x $88,600 44,300 44,300
50% x $88,600 44,300 44,300
June purchases
50% x $56,800 28,400 28,400
Total cash disbursements $ 40,000 $ 72,300 $ 72,700 $ 185,000
140,000 lbs. × $0.40/lb. = $56,000
Compute the expected cash disbursements for materials for the

quarter.
7-47
Quick Check 4
What are the total cash disbursements for

the quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400
7-48
Quick Check 4a
What are the total cash disbursements for

the quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400
See the spreadsheet on the next slide.

7-49
Materials – Ending Accounts Payable

Balance
April purchases
50% × $56,000 28,000 28,000
50% × $56,000 28,000 28,000
May purchases
50% × $88,600 44,300 44,300
50% × $88,600 44,300 44,300
June purchases
50% × $56,800 28,400 28,400
Total cash disbursements $ 40,000 $ 72,300 $ 72,700 $ 185,000
Accounts payable at July 30 = $56,800 × 50% = $28,400
7-50
Prepare a direct labor

budget.
7-51
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.
7-52
The Direct Labor Budget – Units of

Production

Units of production 26,000 46,000 29,000 101,000
Direct labor time per unit
Labor hours required
Hourly wage rate
Total direct labor costs
From the production budget
7-53
The Direct Labor Budget –

Labor Hours Required
Direct labor time per unit 0.05 0.05 0.05 0.05
Labor hours required 1,300 2,300 1,450 5,050
Hourly wage rate
Total direct labor costs
7-54
The Direct Labor Budget –

Direct Labor Costs
Direct labor time per unit 0.05 0.05 0.05 0.05
Labor hours required 1,300 2,300 1,450 5,050
Hourly wage rate $ 10 $ 10 $ 10 $ 10

Total direct labor costs $ 13,000 $ 23,000 $ 14,000 $ 50,500

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7-1

The Basic Framework of Budgeting

A budget is a detailed quantitative plan for

Difference Between Planning and

Coordinate Means of allocating

Managers should be held responsible for those

Choosing the Budget Period

2016 2017 2018 2019

Supervisor Supervisor Supervisor Supervisor

Advantages of Self-Imposed Budgets

Disadvantages of Self-Imposed Budgets

Human Factors in Budgeting

The Master Budget – An Overview

Direct materials Direct labor Manufacturing

Seeing the Big Picture – Part 1

To help you see the “big picture” keep in mind

Seeing the Big Picture

The Master Budget: Based on

A master budget is based on various estimates

Prepare a sales budget,

The Sales Budget

April May June Quarter

Expected Cash Collections

Calculations for April

April May June Quarter

Accounts Receivable 6/30 = 30% x $300,000 = $90,000

Expected Cash Collections –

From the Sales Budget for April: Accounts Receivable

Calculations for June

From the Sales Budget for May: Accounts Receivable

What will be the total cash collections for the

What will be the total cash collections for the

The Production Budget

The production budget must be adequate to

The Production Budget - Details

On March 31st, 4,000 units were on hand.

Let’s prepare the production budget.

If Royal was a merchandising company it would prepare

The Production Budget –

April May June Quarter

Budgeted Sales 20,000 50,000 30,000 100,000

Add: Desired ending inventory

Less Beginning inventory

The Production Budget –

March 31 Budgeted May sales 50,000

The Production Budget –

Budgeted Sales 20,000 50,000 30,000 100,000

Add: Desired ending inventory 10,000 6,000

Total needs 30,000 56,000

Less Beginning inventory 4,000 10,000

Required production 26,000 46,000

The Production Budget –

Add: Desired ending inventory:

The Direct Materials Budget

Let’s prepare the direct materials budget.

The Direct Materials Budget -

From the production budget

The Direct Materials Budget –

The Direct Materials Budget –