master budgeting

strategic cost management lesson 5

The Basic Framework of Budgeting  A 12-month budget that rolls forward

one month (or quarter) as the current
 A budget is a detailed quantitative plan for
month (or quarter) is completed
acquiring and using financial and other  One month/quarter is added at the end
resources over a specified forthcoming time
of the budget as each month/quarter
period
comes to a close
1. The act of preparing a budget is called
 Gives the managers focus on at least
budgeting.
one year ahead so they do not become
2. The use of budgets to control an
too narrowly focused on short-term
organization’s activities is known
results
as budgetary control.
Understanding the Key Components of Master
Advantages of Budgeting
Budget in Manufacturing, Merchandising, and
1. Communicate plans Service Industries
2. Think about and plan for the future
 First step: budget the revenue, whether it is
3. Means of allocating resources
a sales budget for providing goods or
4. Uncover potential bottlenecks
services or a funding budget
5. Coordinate activities of the entire
 Although operational budgets are adapted
organization by integrating the plans of its
according to the industries, they are very
various parts
similar and typically comprise of budgets for:
6. Ensures that everyone in the organization is
 Income Statement
pulling in the same direction
 Cash
7. Define goals and objectives that serve as
 Balance sheet
benchmarks for evaluating subsequent
 Major differences of different industries
performance
include:
Choosing the Budget Period 1. Manufacturing – production budget is
involved
1. Operating Budget 2. Merchandising – no production budget;
 Ordinarily cover a one-year period only purchase budget of merchandise
corresponding to a company’s fiscal 3. Service industries – budget for revenue
year. Many companies divide their and cost of providing services
annual budget into four quarters. 4. Not-for-profit – expected funding
 The first quarter is subdivided into available and plan usage of funding
months and monthly budgets are
developed The Master Budget: An Overview
 The last 3 quarters may be carried into
budget as quarterly totals only
 As the year progresses, the 2 nd quarter
figures are broken down into months
and the 3rd quarter figures are also
broken down, and so forth
 Has the advantage of requiring periodic
review and reappraisal of budgets
throughout the year

2. Continuous/Perpetual Budget
  Sales Budget – includes selling and  August 4,000,000 – 25% of 2,000,000 from
administrative budget and production July + 70% of 5,000,000
budget  September 3,350,000 – 25% of 5,000,000
 Production/Purchases Budget – production from August + 70% of 3,000,000
for manufacturing and purchases for
merchandising The Production Budget
 Production Budget – dictates DM, DL,  The production budget must be adequate to
MOH budget meet budgeted sales and to provide for the
 Cash Budget – DM, DL, MOH, selling and desired ending inventory
administrative budget  Prepared after the completion of the Sales
 Budgeted Income Statement and Budget
Budgeted Balance Sheet – cash budget
Preparing the Production Budget
Preparing a Sales Budget

 Budgeted Sales xx
 The individual months of July, August, and Add: Desired Ending Inventory xx
September are summed to obtain the total Total Needs xx
budgeted sales in units and dollars for the Less: Beginning Inventory (xx)
quarter ended September 30th Required Production xx

Expected Cash Collections

 Presented in units
 The desired ending inventory of the
previous month is the beginning inventory
of the following month

 The total column represents the end of the

quarter
 Total Ending Inventory is the ending
inventory of September
 Whatever the ending inventory is at the
 The figures are computed based on the Sales last month of the quarter, that is the
Budget presented earlier total ending inventory for the quarter
 Ending AR for June will be collected in full in  Total Beginning Inventory is the beginning
July, which is why it is part of July inventory of July
 July 1,400,000 – 70% of 2,000,000
  The beginning inventory of the first Preparing the Expected Cash Disbursement for
month of the quarter is forwarded to Materials
the total column

Preparing the Direct Materials Budget

 Anchored to the production budget

 Required production xx
Multiplied by materials/unit xx
Total material needs for production xx  Calculated based on the total materials to be
Add: Desired RM, end xx purchased computed in the DM Budget
Total material needs for the period xx  Example: July disbursements are computed
Less: Beginning RM (xx) as follows:
Total materials to be purchased xx  1,400,000 total materials to be
purchased (per DM Budget) X $0.40 =
$560,000
 One-half is payable during the month,
so recognize only $280,000 + $120,000
full payment of the June AP = $400,000
 Example: August disbursements are
computed as follows:
 2,215,000 total materials to be
purchased X $0.40 = $886,000
 Desired RM, end is 10% of the total
 $443,000 (half of $886,000) +
materials needs for production of the
$280,000 balance from July = $723,000
following month
 It is as if you are paying for 2 months
 Beginning raw materials is the desired RM,
end of the previous month Preparing the Direct Labor Budget

 Total Desired RM, end is the ending

inventory of September
 Whatever the ending inventory is at the
last month of the quarter, that is the
total ending inventory for the quarter
 Total Beginning RM is the beginning
inventory of July
  Units of production (per Prod. Budg.) xx  Always deduct noncash costs as they do not
Multiplied by DL/unit xx represent actual disbursement
Labor hours required xx
VS Guaranteed labor hours xx Preparing the Ending Finished Goods Inventory
Budgeted DLH xx Budget
Multiplied by hourly wage rate xx
Direct labor cost xx  Production cost per unit:
 DM needed per unit x cost
 DL hours/unit x cost
 MOH rate x cost

 Units of production is from the Production

Budget’s Required production
 No layoff policy – use the guaranteed labor
hours; however if there is no such policy,
then we use the labor hours required
 If the labor hours required exceeds the  Ending inventory (units) is based on the data
guaranteed labor hours, use the labor hours from the Production Budget
required
Preparing the Selling and Administrative Expense
Preparing the Manufacturing Overhead Budget Budget

 From the $700,000, only $600,000

 Budgeted DLH xx
represent actual outflow for the month as
Multiplied by Variable MOH rate xx
the $100,000 represent non-cash outflows
Variable MOH cost xx
 Budgeted sales (units) xx
Fixed MOH cost xx
Total MOH cost xx Multiplied by Variable S&A rate xx
Less: Non-cash Costs (xx) Variable S&A expenses xx
Cash disb. for manuf. cost xx Fixed S&A expenses xx
Total S&A expenses xx
Less: Noncash expenses (xx)
Cash S&A expenses xx

 Use the labor hours required and not the

guaranteed labor hours
Preparing the Cash Budget

 Divided into four sections:

1. Cash Receipts – lists all cash inflows
excluding cash received from financing
2. Cash Disbursements – all cash
payments excluding prepayments of
principal and interest
3. Cash excess or deficiency – determines
if the company will need to borrow
money or if it will be able to repay funds
previously borrowed
4. Financing – details the borrowings and
repayments projected to take place
during the budget period
 Cash in excess – will not only determine
whether you can repay funds you have
previously borrowed but will also determine
if you have enough cash you can set aside
for either a short-term or long-term
investment

 The ending cash balance must be able to

satisfy the minimum cash balance, which is
why the borrowing amounted to $500,000
 Open line of credit – for borrowing purposes to compensate for the deficit and to satisfy
 Beginning cash balance xx the minimum cash balance requirement
Add: Cash collections xx
Total cash available xx
Less: Cash disbursements
Materials xx
Direct labor xx
Manuf. Overhead xx
Selling and admin exp. xx
Equipment purchase xx
Dividend xx
Total disbursements (xx)
Excess (deficiency) xx
Financing:
Borrowing xx
Interests xx
Repayments xx
Total financing (xx)
Ending cash balance xx
 All information is based on the preceding
budgets prepared
 If your cash excess is equal to the minimum
cash balance (in this case, $300,000), then
you cannot set aside that excess for the
 payment of interest. However, if you have Preparing the Budgeted Balance Sheet
more than your desired ending cash balance,
then you can pay some of the interest
accrued
 If the problem is silent, the general
assumption is that the payment of the
principal is done at a lump sum, meaning you
cannot pay a portion of it. It is paid in a one-
time amount
 You can pay the interest monthly but
the payment of the principal is done at
one time.
 We can only pay via installment for the
principal if it is explicitly stated in the
problem
 We pay off the interest first. No lender will
allow you to pay the principal without paying
the interest first
 To get the $20,000 interest payment on
September: $500,000 x 16% x 3/12
(start counting from July 1 up to
September 31)
 The treatment of the excess cash against the
minimum cash balance requirement will
depend on the policy of the company,
whether they will invest it in a short-term
investment or long-term investment
 At the end of the quarter, the ending cash
balance of the total column should be equal
to the ending cash balance of September as
this is the last month of the quarter
 The beginning cash balance is the beginning
cash balance of July (start of the quarter)

Preparing the Budgeted Income Statement

 With the interest expense from the cash

budget, we can prepare the budgeted
income statement

 The unit cost used in computing the COGS is

based on the Ending Finished Goods
Inventory Budget  RMI – multiply the number of units/pound
 Included in the selling and administrative by the cost per pound
expense are the noncash disbursements (i.e.
depreciation)