CHAPTER TWO

MASTER BUDGET

Dr. Ch. Venkata Krishna Reddy

 Chapter Two
Master Budget
• A budget is
I. The quantitative expression of a proposed
plan of action by management.
II. An aid to coordinate what needs to be done
to implement that plan.
III. A systematic plan for the utilization of
manpower and material resources.
IV. It represents an estimate of future costs and
revenues.
 The main characteristics of a budget

• It is prepared in advance and is derived from a

long-term strategy of the organization.
• It relates to future period for which objectives
or goals have already been laid down.
• It is expressed in quantitative form, physical
or monetary units, or both.
 Advantages of budget
• It brings efficiency and improvement in the work of the
organization.
• It is a way of communicating the plans to various units of the
organization.
• It serves as a benchmark for controlling on-going operation.
• is a way of motivating managers to achieve the goals set for the
units.
• It helps in developing a team sprit where participation in
budgeting is encountered.
• It helps in reducing wastages and losses by revealing them in
time for corrective action.
• It serves as a basis for evaluating the performance of managers.
• It helps in developing a team sprit where participation in
budgeting is encountered.
 Budgetary control

• The exercise of control in the organization

with the help of budgets is known as
budgetary control.
• The process of budgetary control includes:
1. Preparation of various budgets/ Schedules,
2. Continues comparison of actual performance
with budgetary performance, and
3. Revision of budgets in the light of changed
circumstances.
 Principal budget factor or key factor
termed as
budget limiting factor
as constraint
• that factor the extent of whose influence must first be
assessed in order to prepare the functional budget.
• A typical list of some of the key factors is given below.

Sales Material Plant Labor Management

•Sales: Consumer demand, shortage of sales staff, inadequate advertising

•Material: Availability of supply, restrictions on import
•Labor: Shortage of labor
•Plant: Availability of capacity, bottlenecks in key processes
•Management: Lack of capital, pricing policy, shortage of efficient executives, lack
of know- how, faulty design of the product etc.
 Cont….

• For example,
• A company has production capacity to
produce 30,000 tones per annum but if the
sales forecast tells that the market can absorb
only 20,000 units, there is no point in
producing 30,000 units.
• Thus the sale is the key factor in this case
 Cont…
• If the company has capacity to produce
30,000 units and the market has the capacity
to absorb the entire production which means
that sales is not the key factor,
• But if raw material is available in limited
quantity so that only 25,000 units can be
produced, the raw material will become the
key factor.
 CLASSIFICATION OF BUDGET

• Budget can be classified into different categories

on the basis of time, function, capacity
utilization /or flexibility.
• So, budgets can be classified as per the following
basis.
• On the basis of Area of Operation /or activity
1. Functional /operational Budgets
 budgets that reflect day-to-day activities or
operations of an organization.
 it includes purchases, labor cost, production
and overhead, sales, purchases etc.,
 Cont…

2. Financial budget
 Relates to financing of assets and generally
indicates cash inflow and outflow.
 cash budget
 Cash collection budget
 Cash payment budget
 Budgeted balance sheet
 On the basis of Capacity Utilization

• Fixed Budget
– It is prepared at single level of capacity
– Can not be modified for actual capacity
– The fixed budget doesn’t change as per the
fluctuations of business.
• Flexible Budgets
– It is prepared at various level of capacity
– Can be modified for actual capacity
– Flexible budget changes as per the
fluctuations of business;
 Cont…

Classification of Budgets According to Time

• Short Term Budget:
• Any budget that is prepared for a period up to one
year
• Medium Term Budget:
• Budget prepared for a period 1-3 years is Medium
Term Budget.
• Long Term Budgets:
• Any budget exceeding 3 years is known as Long Term
Budgets.
 What is master budget?

• Is the set of budgeted financial statements

and supporting schedules for the entire
organization
 Step 1: Prepare the Revenues Budget:

EXAMPLE
• Slopes, Incorporation manufactures and sells
snowboards. A slope manufactures a single
model, the Pipex.
• In the summer of 2017, Slopes’ management
accountant gathered the following data to
prepare the sales budget for 2018:
• Slopes’ CEO expects to sell 1,000 snowboards
during 2018 at an estimated retail price of $450
per board.
 Cont….

The $450,000 is the amount of revenues in the budgeted income statement. The
revenues budget is often the result of elaborate information gathering and discussions
among sales managers and sales representatives who have a detailed understanding
of customer needs, market potential, and competitors’ products. This information is
often gathered through a customer response management (CRM) or sales
management system. Statistical approaches such as regression and trend analysis can
also help in sales forecasting. These techniques use indicators of economic activity
and past sales data to forecast future sales.
 Step 2: Prepare the Production Budget (in units):
The production budget is prepared after the sales budget. The production budget lists the
number of units that must be produced to satisfy sales needs and to provide for the desired
ending inventory. The total finished goods units to be produced depend on budgeted unit
sales and expected changes in units of inventory levels: The following formula will help us to
determine the amount of unit that must be produced:

ASSUME
• Slopes’ CEO further expects 2018 beginning
inventory of 100 snowboards and would like to
end 2018 with 200 snowboards in stock.
Cont…
 Step 3: Prepare the Direct Material Usage
Budget and Direct Material Purchases Budget
The direct material quantities used depend on the efficiency with which materials are
consumed to produce a snowboard. In determining budgets, managers are constantly
anticipating ways to make process improvements that increase quality and reduce
waste, thereby reducing direct material usage and costs.
• For example, the bill of materials would indicate that
 5 board feet of wood and
 6 yards of fiberglass are needed to produce each
Snowboard.
 Assume also that Slopes uses a FIFO inventory method for
both direct materials and finished goods.
Cont…
The purchasing manager prepares the budget for direct material purchases based on
the budgeted direct materials to be used in production, the beginning inventory of direct
materials, and the target ending inventory of direct materials.
 Step 4: Prepare the Direct Manufacturing Labor
Costs Budget:
In this step, manufacturing managers use labor standards, the time allowed per unit of
output, to calculate the direct manufacturing labor costs budget. These costs depend on wage
rates, production methods, process and efficiency improvements and hiring plans.
• For the illustration purpose, consider the following data gathered
by the management accountant of slopes Incorporation in the
summer of 2017 to prepare DLCs budget for the coming year:
Labor requirements ………………………… 5 labor hours per snowboard
2018 unit price…………………………….… $25.00 per hour
 Step 5: Prepare the Manufacturing Overhead
Costs Budget:
The total of these costs depends on how individual overhead costs vary with respect to the
cost driver, which is a variable, such as level of activity or volume that casually affects costs
over a given time span.

• Budgeted Manufacturing Overhead Costs = Budgeted Fixed Overhead Costs +

Budgeted Variable Overheads
ASSUME:
• Variable manufacturing overhead is $7 per direct
manufacturing labor-hour.
• There are also $66,000 in fixed manufacturing overhead
costs budgeted for 2018.
 Step 6: Prepare the Ending Inventories Budget
The dollar amount for the ending inventory of finished goods is needed below to
determine the budgeted amount of cost of goods sold. The dollar amounts for ending
direct materials and finished goods are also needed for the preparation of the budgeted
balance sheet.
• Budgeted Cost of Ending Direct Materials inventory = Target
Ending DMs in units x Budgeted Price
• Budgeted cost of Ending Finished Goods Inventory (FGI) = Desired
Ending FGIs in units x Budgeted Product Cost per Output Unit.

As stated earlier, Slopes Incorporation uses direct manufacturing labor hours to allocate
manufacturing overhead costs to finished goods inventory. As a result, manufacturing
overhead costs are allocated to finished goods inventory at the budgeted rate of $19 per
direct manufacturing labor-hour (total budgeted manufacturing overhead, $104,500 ÷ 5,500
budgeted direct manufacturing labor-hours). Schedule 6A shows the computation of the unit
cost of Snowboards started and completed in 2018.
 Cont…
Slopes Incorporation

Schedule 6A: Unit Costs of Ending Finished Goods Inventory

December 31, 2018
Cost per unit of Input per unit of Tot
Input Output al
Direct Material Wood $30 5 b.f. $150
Inventories
Fiberglass 5 6 yards 30

Direct manufacturing labor 25 5 hrs 125

Manufacturing overhead 19 5 hrs 95
Total $400
N.B. Under FIFO method, this unit cost is used to calculate the cost of target
ending inventories of finished goods in Schedule 6B:
 Cont…

Slopes Incorporation

Schedule 6B: Ending Inventory Budget

December 31, 2018

Quantity Cost per Unit Total

Direct Materials

Wood 1,500 $30 $45,000

Fiberglass 2,000 5 10,000 $55,000

Finished Goods

Snowboards 200 400 80,000 80,000

Total ending inventory $135,000

N.B: This is based on 2018 Costs of manufacturing finished goods because under the FIFO costing method,
the units in finished goods ending inventory consists of units that are produced during 2018.
Step 7: Prepare the Cost of Goods Sold Budget:
Step 8: Prepare the Nonmanufacturing Costs Budget
Step 9: Prepare the Budgeted Income Statement
 Financial budget

• The Cash Budget

• The cash budget is composed of four major
sections:
1. The receipts section
2. The disbursements section
3. The cash excess or deficiency section
4. The financing section.
Cont….
 Cont…

• All sales are made on credit. 40% are collected in the month of
sale, 58% in the month following the sale, and the remaining 2% are
uncollectible.
• Merchandise purchases are paid in full the month following the
month of purchase.
• The selling and administrative expenses above include $8,000 of
depreciation on display fixtures and warehouse equipment.
• All other selling and administrative expenses are paid as incurred.
McCracken wants to maintain a minimum cash balance of $15,000.
• Any amount below this can be borrowed from a local bank as
needed in increments of $1,000.
• All borrowings are made at month end.
 Cont…

Required: Prepare McCracken’s cash budget for the month of May. McCracken expects to have $24,000 of cash on hand at the beginning
of May.
Based on the above relevant data the cash budget of McCracken Plumbing Supply Company will be developed as follows:

McCracken Plumbing Supply Cash Budget

For the Month of May

Cash Balance, beginning $ 24,000

Add receipts:
Collections from customers ($130,000 × 40%) + ($110,000 × 58%) 115,800

Total cash available before current financing (1) $139,800

Deduct disbursements:
Merchandise purchases……………………………………………... Selling and administrative 85,000
($50,000 - $8,000) …………………….. _42,000

Total disbursement (2) $127,000

Minimum cash balance desired (3) _15,000
Total cash needed (4) = (2+3) $142,000
Cash excess (deficiency) (5) = (1 – 4) (2,200)
Financing:
Borrowing 3,000
Principal Repayment 0
Interest payment 0
Total effects of financing $3,000
Cash balance, ending $800
 Sales Forecasting

• What is Sales Forecasting?

A Sales forecast is a projection of the expected
customer demand for products or services at a
specific company, for a specific time horizon, and
with certain underlying assumptions.
Essential tool used for business planning, marketing,
and general management decision making.
Sales forecasting can help you achieve sales goals.
Sales forecasting can hep drive sales revenue,
improve efficiency, increase customer retention and
reduce costs.
 Factors affecting Sales Forecasting

• External Factors • Internal Factors

 Relative State of the  Labour problems
Economy  Inventory shortages
 Direct and indirect
 Working capital shortage
competition
 Price changes
 Styles or fashions
 Consumer earnings
 Changes in distribution
 Population changes Method
 Weather
 Sales Forecasting Methods

• Qualitative
 Executive opinion method
 Delphi method
 Sales force composite method
 Survey of Buyer’s intentions

• Quantitative
 Time Series Analysis
 Market Test Method
 Regression Analysis
 Benefits of Sales Forecasting

• Better control of Inventory

• Staffing
• Customer Information
• Use for Sales People
• Obtaining Financing
Difficulties of Sales Forecasting
• Seller Subjectivity
• Lack of predictive data
• Limitations in Technology
• Lack of sales management rigor in the process
• Part hard fact, part guesswork
• Forecast may be wrong
• Time may change
CHAPTER END