Summary of Master Budget

Master budget is a combination of interdependent budgets in an organization. It is used as a

tool for planning and decision making. The process starts with a sales forecast and a sales
budget, and then production budget is prepared. Production budget helps to prepare material
budget, labor and overhead budget for the factory. Outside the factory a company prepares
selling and administrative expense budget, cash budget, budgeted income statement and
budgeted balance sheet.

We have learnt how to prepare some very important budgets like sales budget (with expected
cash collection schedule), production budget, material purchase budget (with expected cash
payment schedule) and cash budget.

Static Budget Vs Flexible Budget:

On the basis of flexibility we can classify budgets into two groups:

Static budget (sometimes called fixed budget) is based on one level of activity. It ignores the
possibility of changes in the level of activity in future. For example; if we make a sales budget
assuming 1000 units of sales in first quarter of next year. This is a static budget. There may be
change in customers’ demand, market environment, internal problem in the company’s
factory; the sales units may be changed. It may become 800 units or 1200 units. If our
organization doesn’t make budget for the 800 units and 1200 units, and if we are
preparing budgets only for one level of activity, for example; 1000 units’ sales; then we
are making static budget.

Flexible budget allows budgets for different level of activity within the relevant range of
operation for a particular period of operation. If our organization makes budget for the 800
units, 1000 units and 1200 units sales; then we are making flexible budget.

Overall master budget is prepared by using the static budget model.

Flexible budget is a good performance evaluation device. Flexible budget performance

report is prepared to compare actual performance and budgeted performance at different level
of activity. It can be used to control costs of different departments of an organization.

Originally, the flexible budget idea was applied to control factory overhead costs. But, at
present many companies are using flexible budge for the entire budget operations.

Sometimes, flexible budgets may be used along with a static budget. For example, a firm
with a steady production capacity but uncertain sales demand may adopt static budge for
production and flexible budget for sales.
Capacity Levels:
The term ‘capacity’ refers the amount of resources; (machineries, building and human
resources) with whom a company expects to conduct the business.

To understand how organizations prepare flexible budgets, we need to know the following
capacity levels:

a. Theoretical capacity: It means the capacity of an organization or a department to

operate with its full or 100% capacity of resources without any disturb or any problem.
b. Practical capacity: It refers the capacity to be used by an organization or a department
after considering the unavoidable disturbs such as; time lost for repairs or machine
breakdown, delay in delivery of raw materials, weekly holidays, etc.
Practical capacity normally stands at 15% to 25% below the theoretical capacity; that
ranges from 75% to 85%.
c. Normal Capacity: It refers the average capacity of an organization or a department. It
is determined by considering the use of capacity at the average level of sales or
demands over a long period of time.
d. Idle Capacity: It results from a temporary idleness of normal capacity due to
temporary slowdown of demands.
e. Excess Capacity: It results from excessive capacity of resources than normal capacity
that a company never hopes to use.

Illustration on flexible budget

A manufacturing company is currently producing 1200 units (at 60% capacity) per month.
The following particulars relating to cost structure are available:

Particulars Tk.
Direct Materials 5 per unit (p.u.)
Direct Labor 2 p.u.
Manufacturing Overhead (variable) 5 p.u.
Manufacturing Overhead (Fixed) 1000 per month
Selling and Administrative Overhead (All variable) 3 p.u.
Selling Price 20
Requirements: Total capacity of the firm is 2000 units per month. Prepare a flexible budget
for 60%, 80% and 100% levels.
Solution:

Workings: Calculation of Units at Different Capacity:

2000 units X 60% =1200 units

2000 units X 80% = 1600 units

2000 units X 100% = 2000 units

FLEXIBLE BUDGETS

Sl.No. Particulars Capacity levels

60% 80% 100%
(1200 (1600 (2000
units) units) units)
a Sales (Tk.20 per unit)
20 X 1200 units Tk.24000
20 X 1600 units 32000
20 X 2000 units 40000

b Direct Materials (Tk. 5 per unit)

5 X 1200 units 6000
5X 1600 units 8000
5 X 2000 units
10000
c Direct Labor (Tk. 2 per unit)
2 X 1200 units 2400
2X 1600 units 3200
2 X 2000 units
4000
d Manufacturing Overhead (variable) (Tk. 5 per unit)
5 X 1200 units 6000
5X 1600 units 8000
5 X 2000 units
10000
e Manufacturing Overhead (Fixed) (Tk.1000 per month) 1000 1000 1000
f Selling and Administrative Overhead (Tk. 3 per unit)
3 X 1200 units 3600
3X 1600 units 4800
3 X 2000 units
6000
g Total Expenses (b + c + d + e + f) 13600 25000 31000
Net Income (a - g) 10400 7000 9000
Comment: The company is earning its highest level of profit at present (the level 60%),
as the net income is the highest at this level.
Illustration 2: PQR Company is currently producing 1200 units (at 60% capacity) per month.
The following particulars relating to cost structure are available:

Particulars Tk.
Direct Materials 5 per unit (p.u.)
Direct Labor 2 p.u.
Manufacturing Overhead (variable) 5 p.u.
Manufacturing Overhead (Fixed) 1000 per month
Selling and Administrative Overhead (All variable) 3 p.u.
Selling Price 20
Total capacity of the firm is 2000 units per month. Taking into account the following further
information:

i. If activity exceeds 60% level, a 5% quantity discount on raw materials on account of

increase in the total quantity will be received.

ii. The present fixed cost structure will remain constant up to 90% capacity, beyond which a
20% increase in cost is expected.

iii. The present unit selling price will remain constant up to 75% activity level beyond which a
2.5% reduction on original price for increase in activity by every 5%.

Required: Prepare a flexible budget for 60%, 80% and 100% levels for the next year.
Recommend the most profitable level.

Solution:

Workings:

i. Direct Material Cost at above 60% level:

Tk.5 – (Tk.5 X .05) = Tk.4.75
ii. Fixed cost (Manufacturing Overhead) at above 90% level:
Tk.1000 + (Tk.1000 X .20) = Tk.1200
iii. Selling price at above 75% level:

At 80% level: Tk.20 – (Tk.20 X .025) = Tk.19.50

At 85% level: Tk.20 – (Tk.20 X .05) = Tk. 19
At 90% level: Tk.20 – (Tk.20 X .075) =Tk. 18.50
At 95% level: Tk.20 – (Tk.20 X .10) =Tk. 18
At 100% level: Tk.20 – (Tk.20 X .125) =Tk. 17.50
 PQR Company
Flexible Budget
for the next year

Sl.No. Particulars Capacity levels

60% 80% 100%
(1200 (1600 (2000
units) units) units)
a Sales (Tk.20 per unit)
Tk. 20 X 1200 units Tk.24000
Tk. 19.50 X 1600 units 31200
Tk. 17.5 X 2000 units 35000

b Direct Materials (Tk. 5 per unit)

Tk. 5 X 1200 units 6000
Tk. 4.75X 1600 units 7600
Tk. 4.75 X 2000 units
9500
c Direct Labor (Tk. 2 per unit)
Tk. 2 X 1200 units 2400
Tk. 2X 1600 units 3200
Tk. 2 X 2000 units
4000
d Manufacturing Overhead (variable) (Tk. 5 per unit)
Tk.5 X 1200 units 6000
Tk.5X 1600 units 8000
Tk.5 X 2000 units
10000
e Manufacturing Overhead (Fixed) (Tk.1000 per month up 1000 1000 1200
to 90% level)
f Selling and Administrative Overhead (Tk. 3 per unit)
Tk. 3 X 1200 units 3600
Tk. 3X 1600 units 4800
Tk. 3 X 2000 units
6000
g Total Expenses (b + c + d + e + f) 19000 24600 30700
Net Income (a - g) 5000 6600 4300

The company will earn highest profit at 80% level

Illustration 3:

60 %= 1200 unit
1%= 1200/60
80%=(1200/60)X80