Chapter 2

CHAPTER TWO Cost & Management Accounting - II
MASTER BUDGET AND RESPONSIBILITY ACCOUNTING

Master Budget
Budget is a formal business plan. A budget is a tool that helps managers in both their planning
and control functions. Interestingly, budget helps managers with their control function not only
by looking forward but also by looking backward. Budget deal with what managers’ are
planning for the future. Budget can be used as a benchmark that allows managers to
compare actual performance with estimated or desired performance.
The three major benefit of budgeting are as follows
1. Budgeting compels managers to think a head by formalizing their responsibility for
planning
2. Budgeting provide definite expectations that are the best framework for judging
subsequent performance
3. Budgeting aids managers in coordinating their effort, so that the plans of an
organizations sub unit meet the objective of the organization as a whole.
A master budget is a comprehensive expression of managements operating and financial
budget for future time period usually for a year. A master budget summarizes the planned
activities of all sub units of an organization – sales, production, distribution and finance.
Components of Master Budget:
As explained earlier, the master budget is the principal output of a budgeting system that shows a
comprehensive operating and financial plans of management. This budget ties together all
phases of an organization’s operations and is comprised of many separate budgets and schedules
that are inter-dependent. The terms used to describe assorted budget schedules vary from
organization to organization, though most master budgets have common elements. The usual
master budget for a non-manufacturing company, for instance, merchandising firm has the
following components:
1. Operating Budget
(a) Sales budget (and other cost-driver budgets as necessary)
(b) Purchases budget
(c) Cost of goods sold budget
(d) Operating expenses budget
(e) Budgeted income statement
2. Financial Budget
(a) Capital budget
(b) Cash budget
(c) Budgeted balance sheet
2.1. Operating Budget
The operating budget focuses on the income statement and its supporting schedules.
Although the operating budget is sometimes called the profit plan, an operating budget may
show a budgeted loss, or even be used to budget expenses in an organization or agency with no
sales revenue. The budgeting process normally begins with the preparation of the operating
Ephrem T. (MBA & Associate Msc) 1

budgets. An operating budget is prepared by individual sections within a company and becomes
part of the company’s master budget. The number of operating budgets depends on the nature of
the business entity. For instance, some operating budgets prepared for manufacturing
companies may not be required for merchandising concerns.
2.1.1. Sales Budget

The sales budget is the starting point for budgeting because the inventory levels, purchases, and
operating expenses are geared to the rate of sales activities and other cost drivers. A sales budget
is a detailed schedule showing the expected sales for the budget period. The sales budget
typically is expressed in both sales birr and units of product. An accurate sales budget is the
key to the entire budgeting process. All of the other parts of the master budget are dependent
on the sales budget in some way. Thus, if the sales budget is done sloppily or messily, then the
rest of the budgeting process is largely a waste of time. The sales budget for a hypothetical
company used in this Duty called ABC Company appears in table below shows the total
budgeted sales and the composition of cash and credit sales respectively.
ABC Company
Sales Budget
For the Quarter Ended March 31, 20XX
Months
Quarters
January February March
Budgeted cash sales Birr XX Birr XX Birr XX XXXX
Budgeted credit sales Birr XX Birr XX Birr XX Birr X
Total Budgeted sales Birr XXXX Birr XXXX Birr XXXX Birr XXXX
Notice that, to prepare the sales budget, budgeted cash sales and budgeted credit sales
information of the original data are used and that this information can be obtained from the
marketing department or any other sales forecast related units.
2.1.2. Cash Collection Budget

The schedule of expected cash collection is prepared at the same time of preparing the sales
budget. Thus, after the sales budget is prepared, the schedule of expected cash collections is
prepared to show how much cash is expected to be received from customers. The cash
collections include to current month’s cash sales plus the previous month’s credit sales
expected to be collected in the current month. In brief, the cash collections consist of collections
on sales made to customers in prior periods plus collections on sales made in the current budget
period. To prepare this schedule, you have to look at the sales budget prepared above and the
data given in the illustration on the mode of collecting credit sale. The schedule of expected cash
collections for ABC Company appears in table below, which will be later needed to prepare the
cash budget.

ABC Company
Cash Collection Budget
Months
Quarters
Accounts Receivable-beginning balance Birr XX - - Birr XX
January sales Birr XX Birr XX - Birr XX
February sales - Birr XX Birr XX Birr XX
March sales - - Birr XX Birr XX
Total expected cash collections Birr XXX Birr XXX Birr XXX Birr XXX
2.1.3. Purchases Budget

This budget is prepared to show the amount of goods to be purchased from suppliers during the
period. Merchandising firms would prepare an inventory purchases budget for each item carried
in stock. Some large retail organizations make such computations on a frequent basis to ensure
that adequate stocks are on hand to meet customer needs. In brief, after the sales budget is
prepared, the inventory purchases budget is prepared to show the amount of inventory that will
be needed to satisfy the amount of projected sales. Meeting the sales demand requires having
enough inventories to cover expected sales and future sales between reorder points. Accordingly,
the total amount of inventory needed for each month equals the amount needed to fulfill
budgeted sales demand plus the desired ending inventory. The total amount of inventory
needed can be obtained from two sources. These are the company can use existing stock, or
simply beginning inventory, and the company’s planned purchases. The schedule of inventory
purchases for ABC Company appears in table below.
ABC Company
Inventory Purchases Budget
Months
Quarters
Budgeted costs of goods sold Birr XX Birr XX Birr XX Birr XX
Add: Desired ending inventory Birr XX Birr XX Birr XX Birr XX
Total inventory needed Birr XX Birr XX Birr XX Birr XX
Less: Beginning inventory Birr XX Birr XX Birr XX Birr XX
Required purchases Birr XXXX Birr XXXX Birr XXXX Birr XXXX
2.1.4. Disbursement For Purchase Budget

This schedule is based on the purchases budget. This schedule is later needed to prepare the

overall cash budget. Disbursements for inventory purchases consist of payments for purchases
on account made in prior periods plus any payment for inventory purchases made in the
current budget period. The schedule of expected disbursements for purchases for ABC
Company appears in table below.
ABC Company
Expected Cash Disbursements for Purchases Budget
Months
Quarters
Accounts payable-beginning balance Birr XX - - Birr XX
January purchases Birr XX Birr XX - Birr XX
February purchases - Birr XX Birr XX Birr XX
March purchases - - Birr XX Birr XX
Total disbursements for purchases Br XXXX Br XXXX Br XXXX Br XXXX
2.1.5. Operating Expenses Budget
This budget lists the budgeted operating expenses for the budget period. All budgeted selling
and administrative expenses would be compiled and listed down. In large organizations, this
budget would be a compilation of many smaller, individual budgets submitted by department
heads and other persons responsible for selling and administrative expenses. For example, the
marketing manager in a large organization would submit a budget detailing the advertising
expenses for each budget period.
The budgeting of operating expenses depends on various factors. Month-to-month fluctuations
in sales volume and other cost-driver activities directly influence many operating expenses.
Examples of expenses driven by sales volume include sales commissions and many delivery
expenses. Other expenses are not influenced by sales or other cost-driver activity, and such
expenses include rent, insurance, depreciation, and salaries within appropriate relevant
ranges and are regarded as fixed. The operating expenses budget does not contain a
provision for interest expense, because the amount of interest expense cannot be determined
until the amount of expected borrowing has been established through the preparation of the cash
budget. Accordingly, the interest component will be determined at a later point in the budgeting
process. The operating expense budget, in any case, will be later needed to prepare the budgeted
income statement. The schedule of operating expense budget for ABC Company appears in table
below.

ABC Company
Operating Expense Budget
Months
Quarters
Salaries and wages Birr XX Birr XX Birr XX Birr XX
Advertising Birr XX Birr XX Birr XX Birr XX
Shipping Birr XX Birr XX Birr XX Birr XX
Depreciation Birr XX Birr XX Birr XX Birr XX
Other expenses Birr XX Birr XX Birr XX Birr XX
Total budgeted operating expenses Birr XXXX Birr XXXX Birr XXXX Birr XXXX
2.1.6. Disbursements For Operating Expenses Budget
This schedule is based on the operating expenses budget. For example, if the information
available states that cash expenses are paid as incurred it means that all cash expenses incurred in
first month will be paid in that month, and so on. In practice, differences between expense
recognition and cash flow are present because of several conditions. Thus, expenses recognized
in one period may not affect the cash flow of that period if they will be paid in later periods.
Notice that depreciation expense is not included in the cash disbursements for operating
expenses, because depreciation is a non-cash expense. Cash outflow for investments in plant
assets is shown as an investing activity at the time cash is paid to purchase plant assets. At this
time, the investing activity will be shown on a separate line on the cash budget. At later times,
depreciation is recognized as an expense by rationally and systematically allocating the cost of
plant assets over their useful life. Such an allocation, however, does not represent an expense that
calls for the payment of cash. The schedule of expected cash disbursements for operating
expenses for ABC Company appears in table below.
ABC Company
Cash Disbursements for Operating Expense Budget
Months
Quarters
Salaries and wages Birr XX Birr XX Birr XX Birr XX
Advertising Birr XX Birr XX Birr XX Birr XX
Shipping Birr XX Birr XX Birr XX Birr XX
Other expenses Birr XX Birr XX Birr XX Birr XX
Disbursements for operating Birr Birr Birr Birr
expenses XXXX XXXX XXXX XXXX

Notice from the operating expense disbursement schedule that depreciation expense is excluded
for reasons explained earlier. This schedule will later be needed when the cash budget is
prepared.
2.1.6. Budgeted Income Statement

The budgeted income statement from operations can be prepared from the data developed in all
tables shown above. The budgeted income statement is one of the key schedules in the budget
process. It shows the company’s planned profit for the upcoming budget period, and it stands as
a benchmark against which subsequent company performance can be measured. The income
statement will be completed after addition of the interest expense, which is computed after the
cash budget, has been prepared.
If expected profitability is unsatisfactory, management may take actions, including abandoning
the project for which the budget is prepared or altering planned activity. Management perhaps
may convince employees to accept lower pay or take actions to reduce the number of employees,
which is of course is not a corrective action. Likewise, the pricing strategy could be scrutinized
or examined for possible changes. Indeed, budgets are usually prepared on spreadsheets or
computerized mathematical models that enable managers to easily perform “what-if” analysis.
Managers change some variables on the spreadsheet, and the software instantly presents revised
set of budgets. Although computer technology can provide instant access to a wide array of
budgeted data, the manager remains responsible for data analysis and decision-making. The
proper interpretation of budgeted data requires an understanding of the origins and limitations of
the budget amounts. For this reason, you are advised to retrace the data in the budgeted income
statement, and other Performa financial statements for that matter, back to the source data.
The budgeted income statement for ABC Company appears in table below, which is referenced
by the source data for its preparation. Notice that income taxes are ignored in this illustration.
ABC Company
Budgeted Income Statement
Sales Birr XX
Less cost of goods sold Birr XX
Gross margin Birr XX
Less operating expenses:
Salaries and wages Birr XX
Advertising Birr XX
Shipping Birr XX
Depreciation Birr XX
Other expenses Birr XX
Total operating expenses Birr XX
Net operating income Birr XX
Less interest expense Birr XX

Net income Birr XX
The interest expense will be computed later when the cash budget is prepared. The main reason
why the budgeted income statement is prepared before the cash budget is to show that the
ultimate output of the operating budgets is Performa or budgeted income statement.
Steps in preparing an operating budget for Manufacturing Companies
Step1. Revenue budget:
It is the usual starting point for budgeting, because production and hence costs and inventory
level generally depend on the forecasted level of revenue.
Budgeted Revenue = Budgeted quantity x unit selling price
Step2. Production Budget (unit):
After revenue is budgeted, the production budget can be prepared. The total finished goods units
to be produced depend on planned sales and expected changes in inventory level.
Budgeted Production (unit) = Budgeted sales + Target ending FG – Beginning FG
Inventory (unit) Inventory (unit)
Step3. Direct Material Purchase& Usage Budget
The decision on the number of units to be produced is the key to computing the usage of direct
material in quantities and currency.
3.1 Direct Material Usage Budget in Units and Currency
Direct Material = Budgeted production X Quantity of material required per unit
Usage Budget (unit)
Direct Material Usage in Currency = quantity of material used X rate per unit
3.2 Direct Material Purchase Budget
DMPB (unit) = Production Usage + Target EI of Material in Unit – Beginning Inventory
of RM in Units
DMPB in Currency= purchase quantity X rate per unit
Step4. Direct Manufacturing Labour Budget
These costs depends on wage rates, production methods and hiring plans
 Budgeted Labour Hours = budgeted Production X Time Required per Unit
 Budgeted Labour Cost = Budgeted Labour Hours X Labour Cost per Unit
Step5. Manufacturing overhead budget:
The total of these costs depends on hours individual over head costs vary with the assumed cost
driver, direct manufacturing labour hours
Step6. Ending inventory budget
RM ending Budget = Unit cost of RM X Quantity of Ending Inventory
FG good Ending inventory = Unit Cost of Production X Quantity of Ending Inventory

Step7. Cost of good sold budget

Beginning FG inventory XXX
Beginning work in process XX
Direct Material used XX
Direct Manufacturing Labour XX
Total Work in Process Inventory XX
Less: Ending Work in Process XX
Cost of goods manufactured XX
Cost of Goods Available for Sale XXX
Less: Ending Finished Good Inventory XX
Cost of Good Sold XXX
Step8. Budgeted Income Statement
Revenue XXX
Less: Cost of Goods Sold (XX)
Gross Margin XXX
Less: Operating Costs
Research & Development Costs XX
Marketing Costs XX
Distribution Costs XX
Customer service Cost XX
Administrative Costs XX XX
Operating Income XXX
Illustration example
RAM Engineering is a machine shop that uses skilled labour and Metal alloy to manufacture two
types of air craft replacement parts Regular & Heavy duty. After carefully examining relevant
factors, the executive of RAM Engineering forecasts the following figures for 2006. You are
now expected to prepare the budgeted income statement for RAM engineering. Assume that
work in process inventory is zero, units costs of direct material purchased & finished goods
sold is remain unchanged though out the budgeted year and variable production costs are
variable with respect to direct manufacturing labour hours.
Direct Material
Material 111 alloy $7perKG
Material 112alloy $10perKg
Direct manufacturing labour $20perKg
Product
Content of each product unit Regular Heavy duty
Direct material 111alloy 12kgs 12kgs
Direct material 112 alloy 6kgs 8 kgs
Direct manufacturing labour 4hours 6hours

All direct manufacturing costs are variable with respect to the unit of out produced, additional
information regarding the year 2006 is as follows:
Product
Regular Heavy duty
Expected sales in units 5000 1000
Selling price per unit $600 $800
Target ending inventory in 1,100 50
unit
Beg. Inventory in units 100 50
Beg. Inventory in dollars $38,400 $26,200
Direct Material
111 alloy 112alloy
Beg. Inventory in kgs 7,000 6000
Target ending inventory in Kg 8000 2000
Budgeted Manufacturing Overhead Cost

Variable Cost $780,000
Fixed Cost $420,000
Total Manufacturing Cost $1,200,000
Other (Non- Manufacturing) Cost
Variable Cost $475,000
Fixed Cost $395,000
Total $870,000
2.2. Financial Budget
The second major part of the master budget is the financial budget, which consists of the capital
budget, cash budget, budgeted balance sheet, & budgeted statement of cash flows. The
capital expenditure budget or capital budget is a very important budget as it throws light on a
firm’s outlay and expansion and diversification program. This budget may not be restricted to a
single year and may be prepared to cover a long period of years. While preparing this budget,
factors such as sales potential for the increased production, possibility of price reduction, and
increased selling and administrative costs are to be considered. The capital expenditure budget
enables a firm to establish a system of priorities, and serves as a tool for controlling
expenditure. It also facilitates cost reduction program particularly when modernization and
renovation is covered by this budget. However, the capital expenditure budget will not be
discussed in this section. This section, therefore, focuses on the cash budget, budgeted balance
sheet, and budgeted statement of cash flows. The financial budget focuses on the effects that the
operating budget and other plans (such as capital budgeting and repayment of debt) will have
on cash. The financial budget consists of the capital budget, cash budget, budgeted balance
sheet, and budgeted statement of cash flows.

2.2.1. Capital Budget

The capital budget is prepared for additions to property and equipment. This budget is used to
describe a company’s long-term plans regarding investment in facilities, equipment, new
products, store outlets, and lines of business.
2.2.2. Cash Budget
The cash budget is used, as you shall see later in this section, to ensure that cash will be
available throughout the budget year. Once the operating budgets have been established, the cash
budget and other financial budgets can be prepared. A cash budget is a detailed plan showing
how cash resources will be acquired and used over some specified time period. All of the
operating budgets have an impact on the cash budget. In the case of the sales budget, the
impact comes from planned cash receipts to be collected from sales to customers. In the case of
the other budgets, the impact comes from the planned cash expenditures within the budgets
themselves.
The cash budget is a statement of planned cash receipts and disbursements and pulls together
much of the data developed in the preceding steps. Most of the raw data needed to prepare the
cash budget are included in the cash receipts and disbursements schedules that were discussed
earlier. However, further refinements of these data are sometimes necessary. The cash budget is
composed of four major sections listed below:
1. The Receipts Section. This section consists of a listing of all of the cash inflows, except for
financing, expected during the budget period. Generally, the major source of receipts will be
from sales.
2. The Disbursements Section. This section consists of all cash payments that are planned for
the budget period. These payments will include raw materials purchases, direct labor
payments, manufacturing overhead costs, operating expenses, and so on, as contained in their
respective budgets. In addition, other cash disbursements such as equipment purchases,
dividends, and other cash withdrawals by owners are listed. This is additional information
that does not appear on any of the earlier schedules.
3. The Cash Excess or Deficiency Section. The cash excess or deficiency is computed as follows:
Cash Balance, Beginning Birr XX
Add Cash Received Birr XX
Total cash available before financing Birr XX
Less disbursement Birr XX
Excess (deficiency) of cash Birr XX
If there is a cash deficiency during any budget period, the company will need to borrow funds.
If there is cash excess during any budget period, funds borrowed in previous periods can be
repair or the idle funds can be placed in short-term or other investments.
4. The Financing Section. This section provides a detailed account of the borrowings and
repayments projected to take place during the budget period. It also includes a detail of
interest payments that will be due on money borrowed.
The following points are worth mentioning about the cash budget shown for ABC Company in
table below:
(a) Cash balance, beginning. It is taken from the original information given or available, that
is, a cash balance on December 31, 20XX in the case of ABC Company. Thus,
remember that the ending cash balance of December becomes the beginning cash
balance of January. Moreover, the beginning cash balance for the quarter means the
same as the beginning cash balance for January. This is so because the quarter begins
on January 1.
(b) Collections from customers. The collections from customers are brought from the
schedule of expected cash collections.
(c) Purchases of inventory. The figures for purchases of inventory are taken from the
schedule of expected cash disbursements for purchases.
(d) Operating expenses. The figures for operating expenses are taken from the schedule of
expected cash disbursements for operating expenses.
(e) Purchases of equipment and cash dividends. While the figures for purchases of
equipment are taken from information given or available and the figure for cash
dividends.
(f) Financing.
ABC Company
Cash Budget
Months
Quarters
Cash balance, beginning Birr XX - - Birr XX
Add Cash Received
Collection from customers Birr XX Birr XX Birr XX Birr XX
Total cash available [a] Birr XX Birr XX Birr XX Birr XX
Less disbursements:
Purchases of inventory Birr XX Birr XX Birr XX Birr XX
Operating expenses Birr XX Birr XX Birr XX Birr XX
Purchases of equipment - Birr XX Birr XX Birr XX
Cash dividends Birr XX - - Birr XX
Total disbursements [b] Birr XX Birr XX Birr XX Birr XX
Excess (deficiency) of cash [c] = [a] Birr XX Birr XX Birr XX Birr XX
+ [b]
Financing:
Borrowings (at beginning) Birr XX - - Birr XX
Repayments (at ending) - - Birr XX Birr XX
Interest - - Birr XX Birr XX
Total financing [d] Birr XX - Birr XX Birr XX
Birr Birr Birr
Cash balance, ending [e] = [c] + [d] Birr XXXX
XXXX XXXX XXXX
2.2.3. Budgeted Balance Sheet

Financial budgets are concerned with the inflows and outflow of cash, which may be detailed in
cash budget and showing expected financial position at the end of the budget period in a
proforma or budgeted balance sheet. The preparation of the operating budget should precede
the preparation of the financial budget because many of the financing activities are not known
until the operating budgets are known.
The budgeted or proforma balance sheet projects each balance sheet item in accordance with the
business plan as expressed in the previous schedules. To construct the budgeted balance sheet,
we start with the general ledger account balances as of December 31,20XX given or available
data in the case of ABC Company and adjust each balance sheet account balance for the changes
expected to take place during 20XX. The budgeted balance sheet for ABC Company is shown in
table below.
ABC Company
Budgeted Balance Sheet
March 31, 20XX
Assets
Current assets:
Cash Birr XX
Accounts receivable Birr XX
Inventory Birr XX
Total current assets Birr XX
Plant assets:
Building and equipment (net) Birr XX
Total Assets Birr XX
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable Birr XX
Stockholders’ equity:
Capital stock Birr XX

Retained earnings Birr XX

Total stockholders’ equity Birr XX
TTotal Liabilities and Stockholder’s ‘Equity Birr XXX
Carefully observe the following explanations about the figures contained in the budgeted balance
sheet shown in table above.
(a) Cash: The figure for cash is brought from the cash budget prepared before and shows
the ending cash balance for the month of March or for the quarter in general.
(b) Accounts Receivable: The figure for accounts receivable represents the credit sales
expected to be made in March. You are encouraged to look back at the explanation given
below the schedule of expected cash collections that appears in schedule.
(c) Inventory: The figure for inventory is brought from the inventory purchases budget in
schedule 1(c) and shows the desired ending inventory for the month of March or for the
quarter in general.
(d) Plant assets (net): The figure for plant assets (net) is computed from the acquisition cost
of the plant assets and its accumulated depreciation.
(e) Accounts payable: The figure for accounts payable represents the amount of the
inventory purchases and other items acquired on account in March. You are encouraged
to look back at the explanation given below the schedule of expected cash disbursements
for inventory purchases.
(f) Capital stock: The figure for capital stock is taken as it is directly from information
given on the general ledger account balances as of the date of incorporation and any
other paid in capital in excess of par value.
(g) Retained earnings: The figure for retained earnings is computed projected retained
earnings and adding it to the net income projected and deducting the dividends to paid.
Example 1:
To illustrate the budget process for merchandising firms, a hypothetical office supplies specialty
store in Addis Ababa called ANC Company will be considered. The company prepares its master
budget on a quarterly basis. The following data have been assembled to assist in the preparation
of the master budget for the first quarter of 2005:
(a) As of December 31, 2004, the company’s general ledger showed the following account balances:
Debit Credit
Cash Birr 48,000
Accounts receivable 224,000
Inventory 60,000
Building and equipment (net) 370,000
Accounts payable Birr 93,000
Capital stock 500,000
Retained earnings 109,000
Total Birr 702,000 Birr 702,000

(b) Actual sales for December 2004 and budgeted sales for the next four months of 2005 are as follows:
December (actual) Birr 280,000
Budgeted sales of 2005:
January 400,000
February 600,000
March 300,000
April 200,000
(c) Sales are 20% for cash and 80% on credit. All payments on credit sales are collected in the
month following sale. The accounts receivable at December 31, 2004 are a result of
December credit sales.
(d) The company’s gross profit rate is 40% of sales.
(e) Monthly expenses are budgeted as follows:
Salaries and wages Birr 27,000 per month
Advertising Birr 70,000 per month
Shipping 5% of sales
Depreciation Birr 14,000 per month
Other expenses 3% of sales
Note that cash expenses are paid as incurred.
(f) At the end of each month, inventory is to be on hand (minimum required or desired inventory
level) equal to 25% of the following month’s sales needs, stated at cost.
(g) One-half of a month’s inventory purchases are paid for in the month of purchase, the other
half is paid for in the following month.
(h) During February, the company will purchase a new copy machine for Birr 1,700 cash.
During March, other equipment will be purchased for cash at a cost of Birr 84,500.
(i) During January, the company will declare and pay Birr 45,000 in cash dividends.
(j) The company must maintain a minimum cash balance of Birr 30,000 each month. An open
line of credit is available at a local bank for any borrowing that may be needed during the
quarter. All borrowing is done at the beginning of a month, and all repayments are made at
the end of a month. Borrowings and repayments of principal must be in multiples of Birr
1,000. Interest is paid only at the time of payment of principal. The annual interest rate is
12%.
Example 2
The treasurer of XYZ Company needs to prepare a cash budget for June, July and August. He
has the following information
1. Cash balance for may 31 $15,000, minimum cash balance required is $5,000
2. Net sales:
Actual Forecasted
January $ 28,000 June $76,800
February $31,500 July $100,000
March $49,500 August $125,000
April $64,000
May $72,000
3. All sales are on credit. The credit manager collects 80% accounts receivable in the month
following the sales, 10% in the second month, 8% in the third month and 2% is uncollectible.
4. Cost of goods sold: 75% of Nets sales each month, material purchase are 25% of CGS. The
firm pays for purchases as follows
75%- the first month
25% - The second month following purchase
Direct labour expenses are 58%of CGS, factory overhead is 25% of CGS. The firms pay
both of these expenses in the month it incurs them
5. The forecast for selling and administrative expense is 19,000 per month from May through
December.
6. In June the company is expected to incur a liability of $120,000 for anew machine to make
coiled spring. Equal payment on the machine will start in July and continue for the next three
month.
Responsibility Accounting
Responsibility accountingis a system that measures the plans, budgets, actions, and actual
results of each responsibility center. A responsibility center is a part, segment, or subunit of an
organization whose manager is accountable for a specified set of activities.
There are four types of responsibility centers:

1. Revenue centerthe manager is accountable for revenues only.
2. Cost centerthe manager is accountable for costs only.
3. Profit centerthe manager is accountable for revenues and costs.
4. Investment centerthe manager is accountable for investments, revenues, and costs.
This functional approach allows responsibility to be assigned to the segment managers that have
the greatest amount of influence over the key elements to be managed. These elements include
revenue for a revenue center (a segment that mainly generates revenue with relatively little
costs), costs for a cost center (a segment that generates costs, but no revenue), a measure of

profitability for a profit center (a segment that generates both revenue and costs) and return on
investment (ROI) for an investment center (a segment such as a division of a company where the
manager controls the acquisition and utilization of assets, as well as revenue and costs).
Advantages and Disadvantages
Responsibility accounting has been an accepted part of traditional accounting control systems for
many years because it provides an organization with a number of advantages. Perhaps the most
compelling argument for the responsibility accounting approach is that it provides a way to
manage an organization that would otherwise be unmanageable. In addition, assigning
responsibility to lower level managers allows higher level managers to pursue other
activities such as long term planning and policy making. It also provides a way to motivate
lower level managers and workers. Managers and workers in an individualistic system tend to
be motivated by measurements that emphasize their individual performances. However, this
emphasis on the performance of individuals and individual segments creates what some critics
refer to as the "stovepipe organization." Others have used the term "functional silos" to
describe the same idea.
Summary and Controversial Question

An implicit assumption of responsibility accounting is that separating a company into
responsibility centers that are controlled in a top down manner is the way to optimize the
system. However, this separation inevitably fails to consider many of the interdependencies
within the organization. Ignoring the interdependencies prevents teamwork and creates the need
for buffers such as additional inventory, workers, managers and capacity. Of course, a system
that prevents teamwork and creates excess is inconsistent with the lean enterprise concepts of
just-in-time and the theory of constraints. For this reason, critics of traditional accounting control
systems advocate managing the system as a whole to eliminate the need for buffers and
excess. They also argue that companies need to develop process oriented learning support
systems, not financial results, fear oriented control systems. The information system needs to
reveal the company's problems and constraints in a timely manner and at a disaggregated level so
that empowered users can identify how to correct problems, remove constraints and improve the
process. According to these critics, accounting control information does not qualify in any of
these categories because it is not timely, disaggregated, or user friendly.
This harsh criticism of accounting control information leads us to a very important controversial
question. Can a company successfully implement just-in-time and other continuous
improvement concepts while retaining a traditional responsibility accounting control
system? Although the jury is still out on this question, a number of field research studies indicate
that accounting based controls are playing a decreasing role in companies that adopt the lean
enterprise concepts.

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CHAPTER TWO Cost & Management Accounting - II

MASTER BUDGET AND RESPONSIBILITY ACCOUNTING

Ephrem T. (MBA & Associate Msc) 1

2.1.1. Sales Budget

2.1.2. Cash Collection Budget

Ephrem T. (MBA & Associate Msc) 2

2.1.3. Purchases Budget

2.1.4. Disbursement For Purchase Budget

Ephrem T. (MBA & Associate Msc) 3

Ephrem T. (MBA & Associate Msc) 4

Ephrem T. (MBA & Associate Msc) 5

2.1.6. Budgeted Income Statement

Ephrem T. (MBA & Associate Msc) 6

Net income Birr XX

Ephrem T. (MBA & Associate Msc) 7

Step7. Cost of good sold budget

Ephrem T. (MBA & Associate Msc) 8

Budgeted Manufacturing Overhead Cost

Ephrem T. (MBA & Associate Msc) 9

2.2.1. Capital Budget

2.2.3. Budgeted Balance Sheet

Ephrem T. (MBA & Associate Msc) 12

Retained earnings Birr XX

Ephrem T. (MBA & Associate Msc) 13

There are four types of responsibility centers:

3. Profit centerthe manager is accountable for revenues and costs.

4. Investment centerthe manager is accountable for investments, revenues, and costs.

Ephrem T. (MBA & Associate Msc) 15

Advantages and Disadvantages

Summary and Controversial Question

Ephrem T. (MBA & Associate Msc) 17

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