8 (a) - Master Budget

The master budget is the aggregation of all lower-level budgets produced by a

company's various functional areas, and also includes budgeted financial
statements, a cash forecast, and a financing plan. The master budget is typically
presented in either a monthly or quarterly format, or usually covers a company's
entire fiscal year. An explanatory text may be included with the master budget,
which explains the company's strategic direction, how the master budget will
assist in accomplishing specific goals, and the management actions needed to
achieve the budget. There may also be a discussion of the headcount changes
that are required to achieve the budget.
A master budget is the central planning tool that a management team uses to
direct the activities of a corporation, as well as to judge the performance of its
various responsibility centres. It is customary for the senior management team
to review a number of iterations of the master budget and incorporate
modifications until it arrives at a budget that allocates funds to achieve the
desired results. Hopefully, a company uses participative budgeting to arrive at
this final budget, but it may also be imposed on the organization by senior
management, with little input from other employees.
The budgets that roll up into the master budget include:

Direct labour budget

Direct materials budget

Ending finished goods budget

Manufacturing overhead budget

Production budget

Sales budget

Selling and administrative expense budget

Cash Budget
The cash budget contains an itemization of the projected sources and uses of
cash in a future period. This budget is used to ascertain whether company
operations and other activities will provide a sufficient amount of cash to meet
projected cash requirements. If not, management must find additional funding
sources.
The inputs to the cash budget come from several other budgets. The results of
the cash budget are used in the financing budget, which itemizes investments,
debt, and both interest income and interest expense.
The cash budget is comprised of two main areas, which are Sources of Cash and
Uses of Cash. The Sources of Cash section contains the beginning cash balance,
as well as cash receipts from cash sales, accounts receivable collections, and the
sale of assets. The Uses of Cash section contains all planned cash expenditures,
which
comes
from
the Direct
Materials
Budget, Direct
Labour

Budget, Manufacturing Overhead Budget, and Selling and Administrative

Expense budget. It may also contain line items for fixed asset purchases and
dividends to shareholders.
If there are any unusually large cash balances indicated in the cash budget,
these balances are dealt with in the financing budget, where suitable
investments are indicated for them. Similarly, if there are any negative balances
in the cash budget, the financing budget indicates the timing and amount of any
debt or equity needed to offset these balances.
8 (b) - An inventory valuation allows a company to provide a monetary
value for items that make up their inventory. Inventories are usually the largest
current asset of a business, and proper measurement of them is necessary to
assure
accurate financial
statements.
If
inventory
is
not
properly
measured, expenses and revenues cannot be properly matched and a company
could make poor business decisions.
Inventory valuation methods are used to calculate the cost of goods sold and
cost of ending inventory. Following are the most widely used inventory valuation
methods:
First-In, First-Out Method
Last-In, First-Out Method
Average Cost Method
First-in-First-Out Method (FIFO)
According to FIFO, it is assumed that items from the inventory are sold in the
order in which they are purchased or produced. This means that cost of older
inventory is charged to cost of goods sold first and the ending inventory consists
of those goods which are purchased or produced later. This is the most widely
used method for inventory valuation. FIFO method is closer to actual physical
flow of goods because companies normally sell goods in order in which they are
purchased or produced.
Last-in-First-Out Method (LIFO)
This method of inventory valuation is exactly opposite to first-in-first-out method.
Here it is assumed that newer inventory is sold first and older remains in
inventory. When prices of goods increase, cost of goods sold in LIFO method is
relatively higher and ending inventory balance is relatively lower. This is because
the cost goods sold mostly consists of newer higher priced goods and ending
inventory cost consists of older low priced items.
Average Cost Method (AVCO)
Under average cost method, weighted average cost per unit is calculated for the
entire inventory on hand which is used to record cost of goods sold. Weighted
average cost per unit is calculated as follows:

Total Cost of Goods in

Weighted Average Cost Per Inventory
Unit=
Total Units in Inventory
The weighted average cost as calculated above is multiplied by number of units
sold to get cost of goods sold and with number of units in ending inventory to
obtain cost of ending inventory.

which means the goods that are unsold are the ones that were most recently
added to the inventory. Conversely, LIFO is Last In, First Out, which means
goods most recently added to the inventory are sold first so the unsold
goods are ones that were added to the inventory the earliest. LIFO
accounting is not permitted by the IFRS standards so it is less popular. It
does, however, allow the inventory valuation to be lower in inflationary
times.

Comparison chart
Stands
for
Unsold
inventory
Restrictio
ns
Effect of
Inflation

Effect of
Deflation

Record
keeping

FIFO

LIFO

First in, first out

Last in, first out

Unsold inventory comprises goods

acquired most recently.
There are no GAAP or IFRS
restrictions for using FIFO; both
allow this accounting method to be
used.
If costs are increasing, the items
acquired first were cheaper. This
decreases the cost of goods sold
(COGS) under FIFO and increases
profit. The income tax is larger.
Value of unsold inventory is also
higher.
Converse to the inflation scenario,
accounting profit (and therefore
tax) is lower using FIFO in a
deflationary period. Value of
unsold inventory, is lower.
Since oldest items are sold first,
the number of records to be
maintained decreases.

Unsold inventory comprises the

earliest acquired goods.
IFRS does not allow using LIFO for
accounting.

Fluctuati Only the newest items remain in

If costs are increasing, then recently

acquired items are more expensive.
This increases the cost of goods sold
(COGS) under LIFO and decreases
the net profit. The income tax is
smaller. Value of unsold inventory is
lower.
Using LIFO for a deflationary period
results in both accounting profit and
value of unsold inventory being
higher.
Since newest items are sold first, the
oldest items may remain in the
inventory for many years. This
increases the number of records to
be maintained.
Goods from number of years ago

ons the inventory and the cost is more

recent. Hence, there is no unusual
increase or decrease in cost of
goods sold.

may remain in the inventory. Selling

them may result in reporting unusual
increase or decrease in cost of
goods.

Effect of Inflation-- If costs are increasing, the items acquired first were
cheaper. This decreases the cost of goods sold (COGS) under FIFO and increases
profit. The income tax is larger. Value of unsold inventory is also higher. If costs
are increasing, then recently acquired items are more expensive. This increases
the cost of goods sold (COGS) under LIFO and decreases the net profit. The
income tax is smaller. Value of unsold inventory is lower.
During a period of steady or rising prices, inventory value will be same under
cost or lower of cost or market method. When there is a fall in prices, a cost
based inventory will be higher than that valued at a lower of cost or market
method. A taxpayer gains a larger profit during valuation on the basis of cost for
the accounting year. Generally, over a period of two years or more, the total
profit or loss under cost or lower of cost or market method will be the same.
However, the total tax will be different.
Inventory rules are not considered uniform. The best accounting practice
prevalent in the industry should be given effect[iii]. When a taxpayer has used
one inventory valuation for more than one accounting year the consistency in
the practice should be given more weight than application of a new inventory
valuation method. However, the prior used method should be in accordance with
the regulations. The IRS has the right to question a method of valuation of
inventory [iv]. If the method a taxpayer is using for valuing inventory does not
reflect income, the taxpayer can be asked to change it[v]. When a taxpayer has
more than one trade or business, the IRS can require consistency in the
inventory valuation method. The method used in one trade or business should
be followed in another business as well. However, the same method of valuation
can be applied only when the method clearly reflects income.
Accounting Standard (AS) 2 Valuation of Inventories requires valuation of
stocks on the basis of absorption costing method. This means that the value of
closing stock would include all variable and a fair proportion of fixed
manufacturing overheads attributable to the stock. Please note that except
where specific references are made, the article is based on the personal opinion
of the author. There may be alternatives which may be better than that indicated
in this article.
Scope :
This article illustrates how the provisions of Accounting Standard can be put into
practice. The article does not go into detail of all the provisions of the Standard.
For definitions of the terms, one may refer to the Standard. It also deals with
issues arising due to difference in AS 2 and Sec.145A of the Income Tax Act, 1961
and documentation to be maintained in order to justify that the audit was
performed in accordance with the applicable audit standards.
Overview :
This article discusses the following points:
1. Basis of Valuation of Inventories

Raw Materials

Work-in-Process

Finished Goods

Normal Production Capacity

Fixed Manufacturing Overheads


Over / Under absorption
2. Implications of FIFO Method
3. Application in case of multi-product lines
4. Deferred Tax
5. Concept of Materiality
6. Documentation
Basis of Valuation:
Accounting Standard (AS) 2 require valuation of stocks at the lower of cost or net
realizable value. Cost includes those costs/expenses incurred in bringing the
inventories to their present location and condition. The valuation may be done on
the following basis:
Raw Materials: Price as shown in invoice including duties and taxes (other
than those subsequently recoverable by the enterprise from the taxing
authorities such as CENVAT, Sales-tax set-off), freight inwards and other
expenses directly attributable to the acquisition. Trade discounts, rebates, duty
drawbacks and other similar items are deducted in determining the costs of
purchase.
Work-in-process: Cost of purchase as calculated above and all variable
manufacturing overheads and a fair proportion of fixed manufacturing overheads
as estimated on the basis of Normal Production Capacity applicable to the
percentage of completion of production of Finished Goods.
Example showing Apportionment of Fixed Manufacturing overheads:
Normal Production Capacity: 10,000 units
Total Annual Fixed Manufacturing Overheads: Rs.1,00,000/Fixed Manufacturing Overhead Absorption Rate = Rs.1,00,000 / 10,000 units =
Rs.10 per unit
Total goods in process at the end of the year : 100 units
Percentage of completion: 75%
Therefore, fixed manufacturing overheads attributable to the stock in process will
be: Rs.10 * 100 units * 75% = Rs.750