Group 4

Master Budgeting
A budget is a detailed quantitative plan for acquiring
and using financial and other resources over a
specified forthcoming time period.
1. The act of preparing a budget is called
budgeting.
2. The use of budgets to control an
organization’s activities is known as
budgetary control.
Planning – Control –
involves involves the steps taken by
developing management to increase
the likelihood that the
objectives and objectives set down while
preparing various planning are attained and
budgets to that all parts of the
achieve those organization are working
objectives. together toward that goal.
The master budget consists of a number of
separate but interdependent budgets that
formally lay out the company’s sales,
production, and financial goals.
 Sales budget

Selling and
Ending inventory administrative
Production budget
budget budget

Direct materials Direct labor Manufacturing

budget budget overhead budget

Cash Budget

Budgeted
Budgeted
income
balance sheet
statement
A master budget is based on various estimates and
assumptions. For example, the sales budget
requires three estimates/assumptions as follows:
1. What are the budgeted unit sales?
2. What is the budgeted selling price per unit?
3. What percentage of accounts receivable will be
collected in the current and subsequent periods.
 Expected Income
Since a budget is a plan for spending money,
there must first be money to spend. When you
create a personal budget, the income from your
job provides the source of funds to pay your bills.
If you have a job already, it is reasonable to
assume you will continue receiving the same
paycheck over a period of time. When you're
creating a budget for a business, the income
assumptions might be created based on
projected sales levels of a specific product or
service.
 Expected Expenses
The expenses you expect to pay from your
budget are also assumptions. Even if each
expenditure expectation is based on previous
expenditures, it is still an assumption that the
expense will not change. For personal
budgeting, expense assumptions are often
the non-fixed expenses you have, such as
groceries and transportation costs. On a
business budget, expense assumptions might
include the cost of raw materials needed to
create products.
 Potential Problems

When creating either a personal or a business

budget, using budget assumptions is normal -
- particularly when you're creating the budget
for the first time, or with unknown elements
in the plan. Budget assumptions must be
reasonable, however, otherwise you could be
setting yourself up for failure. A reasonable
budget assumption is based on research or
existing data.
 Changes

The best research and supporting data for

budget assumptions cannot guarantee the
success of the budget. Sometimes local or world
events arise unexpectedly that change
everything, and require the budget to be
completely re-created from scratch. A personal
budget may have to be completely changed if
you're laid off from work for example, and a
business budget may need to change if a major
supplier goes out of business.
 Sales budget is the first and basic component
of master budget and it shows the expected
number of sales units of a period and the
expected price per unit. It also shows total
sales which are simply the product of
expected sales units and expected price per
unit.
 Company ABC Company
Sales Budget
For the Year Ended December 31, 20XX
Quarter 1 Quarter 2 Quarter 3 Quarter 4

Forecasted unit sales 5,500 6,000 7,000 8,000

x Price per unit $10 $10 $11 $11

Total gross sales $55,000 $60,000 $77,000 $88,000

- Sales discounts & allowances $1,100 $1,200 $1,540 $1,760

= Total net sales $53,900 $58,800 $75,460 $86,240

 The production budget calculates the number of
units of products that must be manufactured,
and is derived from a combination of the sales
forecast and the planned amount of finished
goods inventory to have on hand (usually as
safety stock to cover for unexpected increases in
demand). The production budget is typically
prepared for a "push" manufacturing system, as
is used in a material requirements planning
environment.
 + Forecasted unit sales
 + Planned finished goods ending
inventory balance
 = Total production required

 - Beginning finished goods inventory

 = Products to be manufactured
 It can be very difficult to create a
comprehensive production budget that
incorporates a forecast for every variation on
a product that a company sells, so it is
customary to aggregate the forecast
information into broad categories of
products that have similar characteristics.
 The planned amount of ending finished goods
inventory can be subject to a considerable amount of
debate, since having too much may lead to obsolete
inventory that must be disposed of at a loss, while
having too little inventory can result in lost sales
when customers want immediate delivery. Unless a
company is planning to draw down its inventory
quantities and terminate a product, there is generally
a need for some ending finished goods inventory.
 As an example of a production budget,
ABC Company plans to produce an array of
plastic pails during the upcoming budget
year, all of which fall into the general
Product A category. Its production needs
are outlined as follows:
 ABC Company
 Production Budget
 For the Year Ended December 31, 20XX
 The production budget deals entirely with
unit volumes. Unlike most other parts of
the corporate budget, the production
budget does not translate its production
requirements into dollars. Instead, the
unit requirements of the production
budget are shifted into other parts of the
budget, such as the direct labor budget
and the direct materials budget, which
are then translated into dollars.
 A case can be made that this budget is not
needed in a "pull" production environment,
where goods are produced only on an as-
needed basis. Under this concept, it is not
necessary to estimate unit quantities to be
produced, since the production environment
merely reacts to actual demand.
 How much inventory did a business purchase within an accounting
period? The information is useful for estimating the amount of
cash needed to fund ongoing working capital requirements. You
can calculate this amount with the following information:
 -Total valuation of beginning inventory. This information appears
on the balance sheet of the immediately preceding accounting
period.
 -Total valuation of ending inventory. This information appears on
the balance sheet of the accounting period for which purchases
are being measured.
 -Cost of goods sold. This information appears on the income
statement of the accounting period for which purchases are being
measured.
 (Ending inventory - Beginning inventory) + Cost of
goods sold = Inventory purchases

 Thus, the steps needed to derive the amount of

inventory purchases are:

 -Obtain the total valuation of beginning inventory,

ending inventory, and the cost of goods sold.
 -Subtract beginning inventory from ending
inventory.
 -Add the cost of goods sold to the difference
between the ending and beginning inventories.
 This calculation does not work well for the
manufacturing sector, since the cost of goods sold can
be comprised of items other than merchandise, such
as direct labor. These other components of the cost of
goods make it more difficult to discern the amount of
inventory purchases.

 An additional problem with the calculation is that it

assumes an accurate inventory count at the end of
each reporting period. If there was no physical count,
or if the record keeping for a perpetual inventory
system is not accurate, then the inputs used for the
calculation of inventory purchases are not necessarily
correct.
 ABC International has beginning inventory of $500,000,
ending inventory of $350,000, and cost of goods sold of
$600,000. Therefore, the amount of its inventory purchases
during the period is calculated as:

 ($350,000 Ending inventory - $500,000 Beginning inventory) +

$600,000 Cost of goods sold
 = $450,000 Inventory purchases

 The amount of purchases is less than the cost of goods sold,

since there was a net drawdown in inventory levels during the
period.
 The direct materials budget calculates the
materials that must be purchased, by time period,
in order to fulfill the requirements of the
production budget. It is typically presented in
either a monthly or quarterly format in the annual
budget. In a business that sells products, this
budget may contain a majority of all costs
incurred by the company, and so should be
compiled with considerable care. Otherwise, the
result may erroneously indicate excessively high
or low cash requirements to fund materials
 + Raw materials required for
production
 + Planned ending inventory balance
 = Total raw materials required

 - Beginning raw materials inventory

 = Raw materials to be purchased
 It is impossible to calculate the direct materials budget for
every component in inventory, since the calculation would be
massive. Instead, it is customary to either calculate the
approximate amount of inventory required, expressed as a
grand total for the entire inventory, or else at a somewhat
more detailed level by commodity type. It is possible to create
a reasonably accurate direct materials budget by either means,
if you have a material requirements planning software
package that has a planning module. By entering the
production budget into the planning module, the software can
generate the expected direct materials budget for future
periods. Otherwise, you will have to calculate the budget
manually.
 A lesser alternative is to calculate the direct
materials budget based on the historical
percentage of direct materials experienced in
recent reporting periods; doing so assumes that the
same ratio of direct material costs to revenues will
continue, which can be a dangerous assumption.
Realistically, the mix of products sold will change
over time, so the historical percentage of direct
materials to revenues may not match actual results
in future periods.
 ABC Company plans to produce a variety
of plastic goods, and 98 percent of its raw
materials involve plastic resin. Thus, there
is only one key commodity to be
concerned with. Its production needs are
outlined as follows:
 ABC Company
 Direct Materials Budget
 For the Year Ended December 31, 20XX
 The preparation of the direct materials budget can be so
detailed that the preparer becomes lost in the details and does
not determine whether the entire result is reasonable.
Accordingly, be sure to review the completed budget based on
historical percentages, and consult with the purchasing staff to
see if cost assumptions are reasonable.
 If product life cycles are quite short and margins vary
substantially by product, this budget may become highly
inaccurate if the forecast period is for a full year. In this case, it
may make more sense to budget over a shorter period.
 It is not customary to include a cash requirements calculation
as part of the direct materials budget. Instead, the cash
requirements are calculated for all of the revenues and
expenditures of a business as a whole, and are then
summarized on a separate page of the budget.
 used to calculate the number of labor hours
that will be needed to produce the units
itemized in the production budget.

 useful for anticipating the number of

employees who will be needed to staff the
manufacturing area throughout the
manufacturing period.
 Direct Labor Cost

Number of
Units to be
produced x Labor Hours
per Unit x Rate per
Hour

 The basic calculation used by the budget is to

import the number of units of production
from the production budget and to multiply
this by the standard number of labor hours
for each unit.
 Hampton Freeze, Inc.

 Which manufactures Popsicles with different

varieties of flavors.

 Hampton Freeze, Inc. each cases of Popsicles

requires 0.4 of direct labor hour.

 Workers agree with a wage rate of $ 15 per hour.

 contains all the costs, other than raw materials and
labor, that will be incurred by a manufacturing
company or department during a fiscal year.

 These ongoing costs are a valid part of

manufacturing expenses you incur and should be
calculated as part of your manufacturing budget.
 At Hampton Freeze, Inc, manufacturing overhead is
applied to units of product on the basis of direct
labor hours.

 The variable manufacturing overhead rate is $ 4 per

direct labor hour.

 Fixed manufacturing overhead is $ 60,600 per

quarter.
 Total
Direct
Labor
hours
x Variable
RATE = Variable Manufacturing
Overhead

FIXED TOTAL
Variable
Manufacturing
Overhead
+ Manufacturing
Overhead
= Manufacturing
Overhead
 A business finished goods inventory includes
products that are complete and ready for sale
but have not been sold.

 A budget for these goods can be developed

after the direct materials, direct labor, and
overhead budgets are developed.
 The ending finished goods inventory budget is
important because it assigns a value to every unit
produced based on raw materials, direct labor, and
overhead.

 This information is used to complete the cost of

goods sold budget, and both budgets are needed to
complete a balance sheet.
 This type of budget is necessary to establish prices
for goods being sold. In order to cover all costs and
make a profit, it obviously is important to know how
much money it costs to produce each item in a
business's inventory.
involves costs related to the operational
activities.
The costs include production cost,
overhead cost, manufacturing cost, labor
cost, administrative cost, working capital,
etc.
This budget includes the sales of the
business
 a financial budget prepared to calculate the
budgeted cash inflows and outflows during a
period and the budgeted cash balance at the
end of the period.

 The fundamental concept of a cash budget is

estimating all future cash receipts and cash
expenditures that will take place during the
time period.
 Financial budget is the budget for balance
sheet elements. It deals with the expected
assets, liabilities, and stockholders' equity.

 A financial budget presents a company's

strategy for managing its assets, cash flow,
income, and expenses.
 Top Down  Bottom Up
Budget Budget
- is a budget that is set - a system
without allowing the of budgeting in
ultimate budget holder which budget holders
to have the opportunity have the opportunity to
to participate in participate in setting
the budgeting process. their own budgets
Thank you for listening!