CHAPTER THREE

MASTER BUDGET
 1.Master Budget
 A budget: quantitative expression of a proposed plan of action by management for a
specified period & an aid to coordinate what needs to be done to implement that plan.
 A budget includes both financial and nonfinancial aspects of plan.
 It serves as a blueprint for company to follow in upcoming period.
 A financial budget quantifies management’s expectations regarding income, cash flows, &
financial position.
 Just as financial statements are prepared for past periods, financial statements can be
prepared for future periods like:
 A budgeted income statement
 A budgeted statement of cash flows
 A budgeted balance sheet.
 Master Budget:
 Expresses management’s operating & financial plans for specified period
(usually a fiscal year)
 It includes a set of budgeted financial statements.
 It is initial plan of what company intends to accomplish in budget period.
 Evolves from both operating and financing decisions made by managers.
 Operating decisions deal with how to best use limited resources of
organization.
 Financing decisions deal with how to obtain funds to acquire those
resources.
 Advantageous of budget
 Budgets are an integral part of management control systems.

 When administered thoughtfully by managers, budgets do the following:

 Promote coordination & communication among subunits within company

 Provide a framework for judging performance and facilitating learning

 Motivate managers and other employees

 Means of allocation resources and create cost awareness.

 Components of Master Budget
 Master budget is principal output of a budgeting system that shows

a comprehensive operating and financial plans of management.

 The usual master budget for non-manufacturing company, for

instance, merchandising firm has the following components:

1.Operating Budget
A. Sales budget
B. Purchases budget
C. Cost of goods sold budget
D. Operating expenses budget
E. Budgeted income statement

2. Financial Budget
F. Capital budget
G. Cash budget
H. Budgeted balance sheet
I. Budgeted cash flow statement
 1. Operating Budget (Profit Plan)
 Focuses on income statement & its supporting schedules & used to budget
expenses in organization or agency with no sales revenue.
 Budgeting process normally begins with preparation of operating budgets.

 Operating budget is prepared by individual sections within a company &

becomes part of company’s master budget.
 Number of operating budgets depends on nature of business entity.

 For instance, some operating budgets prepared for manufacturing

companies may not be required for merchandising concerns.
 A. Sales Budget
 It is starting point for budgeting b/c inventory levels, purchases &
operating expenses are geared to rate of sales activities & other cost
drivers.

It detailed schedule showing expected sales for budget period.

Expressed in both sales birr & units of product & accurate sales
budget is key to entire budgeting process.
All of other parts of master budget are dependent on sales
budget.
 Sales budget is done sloppily or messily, then rest of budgeting
process is largely a waste of time.

 To prepare sales budget, budgeted cash sales & budgeted credit

sales information of original data are used & that this information
can be obtained from marketing department or any other sales
forecast related units.

Total Budgeted sales= Budgeted cash sales + Budgeted credit sales

 B. Cash Collection Budget
 Cash collection is prepared at same time of preparing sales budget.

 After sales budget is prepared, cash collections is prepared to show

how much cash is expected to be received from customers.

 It include to current month’s cash sales plus previous month’s credit

sales to be collected in current month.

 Cash collection budget = previous period credit sales that collected

in current period + Current period cash sales

 C. Purchases Budget
 It is prepared to show amount of goods to be purchased from suppliers

during period.

 After sales budget is prepared, inventory purchases budget is prepared to

show amount of inventory that will be needed to satisfy amount of projected

sales.
 Meeting sales demand requires having enough inventories to cover expected
sales & future sales between reorder points.
 Total amount of inventory needed for each month equals amount needed to
 January February March Quarterly
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
 D. Disbursement For Purchase Budget
 It is based on purchases budget and needed to prepare 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 current budget period.

 Total disbursements for purchases = Accounts payable-beginning balance + current period

purchases

E. Operating Expenses Budget

 It lists budgeted operating expenses for budget period.

 All budgeted selling and administrative expenses would be compiled and listed down.

 For example, marketing manager in large organization would submit budget detailing
advertising expenses for each budget period.
 Budgeting of operating expenses depends on various factors.

 Month-to-month fluctuations in sales volume & other cost-driver activities

directly influence many operating expenses.

 Other expenses are not influenced by sales or other cost-driver activity, & such
expenses include rent, insurance, depreciation, & salaries within appropriate
relevant ranges & are regarded as fixed.

 Operating expenses budget does not contain a provision for interest expense,
because amount of interest expense cannot be determined until amount of
expected borrowing has been established through preparation of the cash budget.

 Operating expense budget, needed to prepare the budgeted income statement.

 ABC Company
Operating Expense Budget
For the Quarter Ended December 31, 20XX
Months
Quarters
January February March

Salaries & 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

Birr XXXX Birr XXXX Birr XXXX Birr XXXX

Total budgeted operating expenses
 E. Disbursements For Operating Expenses Budget
 It is based on operating expenses budget.
 For e.g. if 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

 Depreciation expense is not included in 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, investing activity will be shown on a separate line on cash budget.

 Depreciation is recognized as expense by rationally & systematically allocating cost of

plant assets over their useful life.

 Such an allocation, however, does not represent expense that calls for payment of cash.
 ABC Company
Cash Disbursements for Operating Expense Budget
For the Quarter Ended December 31, 20XX
Months
January February March 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 Birr XXXX Birr XXXX Birr XXXX Birr XXXX
operating expenses
 G. Budgeted Income Statement

 It is one of key schedules in budget process.

 It shows company’s planned profit for upcoming budget period &

it stands as benchmark against which subsequent company
performance can be measured.

 Income statement will be complete after addition of interest

expense, which is computed after the cash budget, has been
prepared.
 Budgeted income statement
ABC Company
Budgeted Income Statement
For the Quarter Ended December 31, 20XX
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

 Interest expense will be computed later when cash budget is prepared. Main reason why budgeted income
statement is prepared before the cash budget is to show that ultimate output of operating budgets is Performa or
 Steps in preparing operating budget for Manufacturing Companies
 Step1. Revenue budget: it is usual starting point for budgeting, because
production & costs & inventory level generally depend on forecasted level of
revenue.

Budgeted Revenue = Budgeted quantity x unit selling price

 Step2. Production Budget (unit): after revenue is budgeted, production
budget can be prepared.
Budgeted Production (unit) = Budgeted sales + Target ending FG I (in unit) – Beginning FGI(in
unit)
 Step 3. Direct Material Usage Budget & Direct Material Purchase Budget
 Decision on number of units to be produced is key to computing usage of
direct material in quantities and currency.
 Direct Material Usage Budget in Units and Currency
 DM Usage Budget(unit) = Budgeted production X Quantity of material required per
unit
 DM Usage in Currency = Quantity of material used X rate per unit
 Direct Material Purchase Budget
 DMPB (unit) = Production Usage + Target Ending inventory of Material
in Unit – Beginning Inventory of RM in Units
 Step4. Direct Manufacturing Labor Budget: depends on wage rates, production methods
& hiring plans
 Budgeted Labor Hours = Budgeted Production X Time Required per Unit
 Budgeted Labor Cost = Budgeted Labor Hours X Labor Cost per Unit

 Step5. Manufacturing overhead budget: total of these costs depends on hours individual
over head costs vary with assumed cost driver, direct manufacturing labor hours

 Step6. Ending inventory budget

 RM ending Budget = Unit cost of RM X Quantity of Ending Inventory

 FG Ending inventory = Unit Cost of Production X Quantity of Ending

Inventory
 Step 7. Cost of good sold budget
Beginning FG inventory XXX
Beginning work in process XX
Direct Material used XX
Direct Manufacturing Labor 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
 2. Financial Budget
 It consists capital budget, cash budget, budgeted balance sheet, & budgeted
statement of cash flows.

 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.
Capital expenditure budget enables 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.

The financial budget focuses on effects that operating budget and

other plans (such as capital budgeting and repayment of debt) will
have on cash.
A.Capital Budget
 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.

B. Cash Budget
 Prepared to ensure that cash will be available throughout the budget year.

 Once operating budgets have been established, cash budget & 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 operating budgets have impact on cash budget.

In case of sales budget, impact comes from planned cash receipts to be collected from sales
to customers.
In case of other budgets, impact comes from planned cash expenditures within budgets
themselves.
Cash budget is statement of planned cash receipts and disbursements and pulls together
much of data developed in the preceding steps.
Most of the raw data needed to prepare 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. Receipts Section: Consists of listing of all of cash inflows, except for financing, expected
during budget period.
 Generally, major source of receipts will be from sales.
2. Disbursements Section: Consists of all cash payments that are planned for 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. 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 repaid or idle funds can be placed in short-term or other investments.

4. Financing Section.
 This section provides a detailed account of borrowings and repayments projected to take
place during the budget period.
 The following points are worth mentioning about the cash budget

A. Cash balance, beginning. It is taken from original information given or available

 Ending cash balance of December becomes beginning cash balance of January. Moreover, beginning cash
balance for the quarter means the same as beginning cash balance for January. This is so because the quarter
begins on January 1.

B. Collections from customers.: Collections from customers are brought from schedule of expected cash collections.

C. Purchases of inventory: Figures for purchases of inventory are taken from schedule of expected cash
disbursements for purchases.

D. Operating expenses. Figures for operating expenses are taken from schedule of expected cash disbursements for
operating expenses.

E. Purchases of equipment and cash dividends. Figures for purchases of equipment are taken from information
given or available and the figure for cash dividends.

F. Financing.
 ABC Company
Cash Budget
For the Quarter Ended December 31, 20XX
Months
Quarters
January February March
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] + [b] Birr XX Birr XX Birr XX Birr XX
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
C. 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 end of budget period
in budgeted balance sheet.

 Preparation of operating budget should precede preparation of financial budget because

many of financing activities are not known until the operating budgets are known.

 The budgeted balance sheet projects each balance sheet item in accordance with business
plan as expressed in the previous schedules.

 To construct budgeted balance sheet, start with general ledger account balances as of
December and adjust each balance sheet account balance for changes expected to take
place during period
 ABC Company
Budgeted Balance Sheet
December 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
Total Liabilities and Stockholders’ Equity Birr XXX
Carefully observe the following explanations about figures contained in the budgeted
balance sheet.

A. Cash: Figure for cash is brought from cash budget prepared before and shows ending
cash balance for month of March or for quarter in general

B. Accounts Receivable: Figure for accounts receivable represents credit sales expected to
be made in March.

C. Inventory: Figure for inventory is brought from inventory purchases budget schedule
and shows desired ending inventory for month of March or for the quarter in general.

D. Plant assets (net): Figure for plant assets (net) is computed from acquisition cost of plant
assets and its accumulated depreciation.
E. Accounts payable: Figure for accounts payable represents amount of
inventory purchases and other items acquired on account in March.

F. Capital stock: 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: Figure for retained earnings is computed projected

retained earnings and adding it to net income projected and deducting

dividends to paid.
Next Lesson Illustration

Have a nice Time

 Illustration example
• RAMA Engineering is a machine shop that uses skilled labor and Metal alloy to manufacture
two types of air craft replacement parts Regular & Heavy duty. After carefully examining
relevant factors, the executive of RAMA Engineering forecasts the following figures for 2006.
You are now expected to prepare the budgeted income statement for RAMA engineering.
Assume that work in process inventory is zero, units costs of direct material purchased &
finished goods sold is remain unchanged throughout the budgeted year and variable
production costs are variable with respect to direct manufacturing labor hours.

• Direct Material

• Material 111 alloy $7perKG

• Material 112alloy $10perKg

Product

All direct manufacturing costs are variable with respect to the unit of produced,
additional information regarding the year 2006 is as follows:
Direct Material
Required: Prepare;
1. Budgeted Revenue

2. Production budget

3. Direct Material Budget In Kgs and in Birr

4. Direct Manufacturing Labor Budget

5. Manufacturing Overhead Budgets

6. Ending Inventory Budget

7. Cost of Goods Sold Budget

8. Budgeted income statement

Example : 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 2007:

(a)As of December 31, 2006, the company’s general ledger showed the following account
balances:
B. Actual sales for December 2006 and budgeted sales for the next four

months of 2007 are as follows:

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, 2006 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:

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.

H. During January, the company will declare and pay Birr 45,000 in cash
dividends.
I. 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%.
 Required: Prepare;
A. Operating Budget

1. Sales Budget

2. Cash Collection Budget

3. Inventory Purchase Budget

4. Cash disbursement of inventory purchase budget

5. Operating Expense Budget

6. Disbursements For Operating Expenses Budget

7. Budgeted Income Statement

B. Financial Budget

8. Cash Budget