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Chapter 8 Master Budgeting
Chapter 8 Master Budgeting
Master Budgeting
Learning objectives
• 1. Understand why organizations budget
• 2. Prepare operating budgets
Sales budget
Production budget
Direct materials budget
Direct labor budget
Manufacturing overhead budget
Ending finished goods inventory budget
Selling and administrative budget
• 3. Prepare financial budgets
Budgeted income statement
Cash budget
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Budget
• A budget is a plan for using limited resources:
The goals we’re trying to achieve in a specific
period
How we plan to achieve these goals
The act of preparing a budget is called
budgeting
The use of budgets to control an organization’s
activities is known as budgetary control
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Choosing a Budget Period
• Annual operating budget covers a one-year period
corresponding to a company’s fiscal year
Many companies divide their annual budget into four quarters
Operating Budget
Ending Selling
Selling and
and
Ending Production
inventory Production budget
budget administrative
administrative
inventory
budget budget
budget
budget
Direct
Direct materials
materials Direct
Direct labor
labor Manufacturing
Manufacturing
budget
budget budget
budget overhead
overhead budget
budget
Cash
Cash Budget
Budget
Not required
Budgeted
Budgeted Budgeted
Budgeted
income
income balance
balance sheet
sheet
statement
statement
Financial budgets
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Sales Budget
• Starting point for master budget
How much sales revenue will we earning in the following year?
• Based on:
The budgeted price you expect to charge
Expected future unit sales (estimates from Marketing)
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Example: Royal Company
• 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 budgeted selling price is $10 per unit.
• The sales budget for the second quarter is
Production Budget
• How many units do we need to produce?
• Budgeted production depends on:
expected sales in units (from the sales budget)
firm’s inventory policy for finished goods
Sales
Sales budget
budget
Production
Production budget
budget
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Production Budget
Example: The management at Royal Company wants ending inventory
to be equal to 20% of the following month’s budgeted sales in units
Beginning Inventory in April = Ending Inventory in March = 20,000*20%=4,000
Budgeted sales in July is 25,000 units
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Budgets for Inputs (DL, DM and Overhead)
• Direct Materials Budget
• Based on estimates of materials per unit of product, and
prices of materials
• Direct Labor Budget
• Based on estimates of DL hours per unit of product, and
wage per hour
• Manufacturing Overhead
• Based on estimates of fixed overhead and variable
overhead per unit of product
Production
Production budget
budget
Direct
Direct materials
materials Direct
Direct labor
labor Manufacturing
Manufacturing
budget
budget budget
budget overhead
overhead budget
budget
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Direct Materials Budget for Royal Company
April May June Quarter
Units to be produced 26,000 46,000 29,000 101,000
Materials per unit (lbs) 5 5 5 5
Production needs (26000*5) = 230,000 145,000 505,000
130,000
Add: Desired ending 230,000*10% 145,000*10% 11,500 11,500
Inventory =23,000 =14,500 (assumed)
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Direct Labor Budget for Royal Company
April May June Quarter
Units to be produced 26,000 46,000 29,000 101,000
Direct Labor per unit (hrs) 0.05 0.05 0.05 0.05
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Manufacturing Overhead Budget for Royal Company
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Production
Production budget
budget
Ending
Ending finished
finished goods
goods
inventory budget
inventory budget
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Ending finished goods inventory budget for Royal Company
Production costs per unit Quantity Cost Total
Direct materials 5.00 lbs. $0.4 $2.00
Direct labor 0.05 hrs. $10.0 $0.50
Manufacturing overhead 0.05 hrs. $49.7 $2.49
$4.99
Budgeted finished goods inventory
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Production Budget
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Selling and Administrative Expense Budget
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From Sales
Budget
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Consolidate for Financial Budgets
Operating budgets
Sales
Sales budget
budget
Selling
Selling and
and
Ending
Ending administrative
Production
Production budget
budget administrative
inventory
inventory budget
budget
budget
budget
Direct
Direct materials
materials Direct
Direct labor
labor Manufacturing
Manufacturing
budget
budget budget
budget overhead
overhead budget
budget
Budgeted
Budgeted
Financial budgets income
income Cash
Cash budget
budget
statement
statement
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Royal Company
Budgeted Income Statement
For the Three Months Ended June 30
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Cash Budget
• Cash Budget details cash inflows and outflows
• Revenues and costs on the income statement differ
from actual cash inflows and outflows
revenues are recorded when the product was sold, not when
the $$$ was actually received
product costs are expensed when the product was sold
(matching of costs to revenues), not when the cost was actually
incurred
depreciation is a non-cash cost item (not a cash outflow)
special items
• Firms use cash budget to determine whether they
will have enough cash on hand to sustain operations
Cash shortage can be managed by accelerating revenues,
deferring payments, or borrowing
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Format of the Cash Budget
• The cash budget is divided into four sections:
Cash receipts section lists all cash inflows excluding cash
received from financing
Cash disbursements section consists of all cash payments
excluding repayments of principal and interest
Cash excess or deficiency section determines if the
company will need to borrow money or if it will be able to repay
funds previously borrowed; Cash inflow – cash outflow
Financing section details the borrowings and repayments
projected to take place during the budget period
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Example: Cash receipts from Credit Sales
• Many of your customers buy on credit (i.e., part of sales
revenue is collected several months after the sale).
On average, you collect 60% of revenue in the month of sale,
35% of revenue in the following month, and 5% of revenue 2
months later. What are your cash inflows in May?
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Example: Royal Company’s Cash Receipts
Royal Company’s Sales Budget
April May June Quarter
Budgeted sales in units 20,000 50,000 30,000 100,000
Selling price $10 $10 $10 $10
Budget sales revenue $200,000 $500,000 $300,000 $1,000,000
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April Sales
May Sales
June Sales
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Royal Company’s expected cash disbursement for materials
April Purchases
May Purchases
June Purchases
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Special Items
• Adjust for special items
Cash outflows: purchase of machines, payment of dividends, loan
payments
Cash inflows: sale of machines, sale of stock in capital market, loans
received
•Special items in Royal Company
An April 1 cash balance of $40,000
Purchases $143,700 of equipment in May and $48,300 in June
(both purchases paid in cash)
Pays a cash dividend of $49,000 in April
Maintains a minimum cash balance of $30,000
Borrows on the first day of the month and repays loans one year
later
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