Preparing the Master Budget

1. A sales budget, including a schedule of expected cash collections.

2. A production budget (a merchandise purchases budget would be used in a merchandising
company).
3. A direct materials budget, including a schedule of expected cash disbursements for purchases of
materials.
4. A direct labor budget.
5. A manufacturing overhead budget.
6. An ending finished goods inventory budget.
7. A selling and administrative expense budget.
8. A cash budget.
9. A budgeted income statement.
10. A budgeted balance sheet.

Review Problem: Budget Schedules

Mynor Corporation manufactures and sells a seasonal product that has peak sales in the third quarter.
The following information concerns operations for Year 2the coming yearand for the first two
quarters of Year 3:

a. The companys single product sells for $8 per unit. Budgeted sales in units for the next six
quarters are as follows (all sales are on credit):

Year 2 Quarter Year 3 Quarter

1 2 3 4 1 2
Budgeted unit sales 40,000 60,000 100,000 50,000 70,000 80,000

b. Sales are collected in the following pattern: 75% in the quarter the sales are made, and the
remaining 25% in the following quarter. On January 1, Year 2, the companys balance sheet
showed $65,000 in accounts receivable, all of which will be collected in the first quarter of the
year. Bad debts are negligible and can be ignored.
c. The company desires an ending finished goods inventory at the end of each quarter equal to
30% of the budgeted unit sales for the next quarter. On December 31, Year 1, the company had
12,000 units on hand.
d. Five pounds of raw materials are required to complete one unit of product. The company requires
ending raw materials inventory at the end of each quarter equal to 10% of the following
quarters production needs. On December 31, Year 1, the company had 23,000 pounds of raw
materials on hand.
e. The raw material costs $0.80 per pound. Raw material purchases are paid for in the following
pattern: 60% paid in the quarter the purchases are made, and the remaining 40% paid in the
following quarter. On January 1, Year 2, the companys balance sheet showed $81,500 in
accounts payable for raw material purchases, all of which will be paid for in the first quarter of
the year.

Required:
Prepare the following budgets and schedules for the year, showing both quarterly and total figures:

1. A sales budget and a schedule of expected cash collections.

2. A production budget.
3. A direct materials budget and a schedule of expected cash payments for purchases of
materials.
Solution to Review Problem

1. The sales budget is prepared as follows:

Year 2 Quarter
1 2 3 4 Year
Budgeted unit sales 40,000 60,000 100,000 50,000 250,000
Selling price per unit 8 8 8 8 8
Total sales 320,000 480,000 800,000 400,000 2,000,000

Based on the budgeted sales above, the schedule of expected cash collections is prepared as follows:

Year 2 Quarter
1 2 3 4 Year
Accounts receivable, beginning balance $ 65,000 $ 65,000
First-quarter sales ($320,000 * 75%, 25%) 240,000 $80,000 320,000
Second-quarter sales ($480,000 * 75%, 25%) 360,000 $120,000 480,000
Third-quarter sales ($800,000 * 75%, 25%) 600,000 $200,000 800,000
Fourth-quarter sales ($400,000 * 75%) 300,000 300,000
Total cash collections $ 305,000 $ 440,000 $ 720,000 $ 500,000 $ 1,965,000

2. Based on the sales budget in units, the production budget is prepared as follows:

*30% of the following quarters budgeted sales in units.

30% of the budgeted Year 3 first-quarter sales.

3. Based on the production budget, raw materials will need to be purchased during the year as
follows:

*10% of the following quarters production needs in pounds.

10% of the Year 3 first-quarter production needs in pounds.

Based on the raw material purchases above, expected cash payments are computed as follows:
 Year 2 Quarter
1 2 3 4 Year 2
Cost of raw materials to be purchased at $0.80 per
$194,400 $293,200 $328,400 $230,800 $1,046,800
pound

Accounts payable, beginning balance $81,500 $81,500

First-quarter purchases ($194,400 * 60%, 40%) 116,640 $77,760 194,400
Second-quarter purchases ($293,200 * 60%, 40%) 175,920 $117,280 293,200
Third-quarter purchases ($328,400 * 60%, 40%) 197,040 $131,360 328,400
Fourth-quarter purchases ($230,800 * 60%) 138,480 138,480
Total cash disbursements $198,140 $253,680 $314,320 $269,840 $1,035,980
Questions

Q1: What is a budget? What is budgetary control?

A budget is a detailed plan outlining the acquisition and use of financial and other resources over a given
time period. As such, it represents a plan for the future expressed in formal quantitative terms. Budgetary
control involves the use of budgets to control the actual activities of a firm.

Q2: Discuss some of the major benefits to be gained from budgeting.

Budgets provide a means of communicating managements plans throughout the organization.

Budgets force managers to think about and plan for the future.
The budgeting process provides a means of allocating resources to those parts of the
organization where they can be used most effectively.
The budgeting process can uncover potential bottlenecks before they occur.
Budgets coordinate the activities of the entire organization. Budgeting helps to ensure that
everyone in the organization is pulling in the same direction.
Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent
performance.

Q3: What is meant by the term responsibility accounting?

Responsibility accounting is a system in which a manager is held responsible for those items of revenues
and costsand only those itemsthat the manager can control to a significant extent. Each line item in
the budget is made the responsibility of a manager who is then held responsible for differences between
budgeted and actual results.

Q4: What is a master budget? Briefly describe its contents.

A master budget represents a summary of all of managements plans and goals for the future, and
outlines the way in which these plans are to be accomplished. The master budget is composed of a
number of smaller, specific budgets encompassing sales, production, raw materials, direct labor,
manufacturing overhead, selling and administrative expenses, and inventories. The master budget
generally also contains a budgeted income statement, budgeted balance sheet, and cash budget.

Q5: Why is the sales forecast the starting point in budgeting?

The level of sales impacts virtually every other aspect of the firms activities. It determines the production
budgets, cash collections, cash disbursements, and selling and administrative budgets that in turn
determine the cash budget and budgeted income statement and balance sheet.

Q6: As a practical matter, planning and control mean exactly the same thing. Do you agree? Explain.

No. Planning and control are different, although related, concepts. Planning involves developing
objectives and formulating steps to achieve those objectives. Control, by contrast, involves the means by
which management ensures that the objectives set down at the planning stage are attained.

Q7: Describe the flow of budget data in an organization. Who are the participants in the budgeting
process, and how do they participate?

The flow of information moves in two directionsupward and downward. The initial flow should be from
the bottom of the organization upward. Each person having responsibility over revenues or costs should
prepare the budget data against which his or her subsequent performance will be measured. As the
budget data are communicated upward, higher-level managers should review the budgets for consistency
with the overall goals of the organization and the plans of other units in the organization. Any issues
should be resolved in discussions between the individuals who prepared the budgets and their managers.

All levels of an organization should participate in the budgeting processnot just top management or the
accounting department. Generally, the lower levels will be more familiar with detailed, day-to-day
operating data, and for this reason will have primary responsibility for developing the specifics in the
budget. Top levels of management will have a better perspective concerning the companys strategy.

Q8: What is a self-imposed budget? What are the major advantages of self-imposed budgets? What
caution must be exercised in their use?

A self-imposed budget is one in which persons with responsibility over cost control prepare their own
budgets, i.e., the budget is not imposed from above.

The major advantages are: (1) the views and judgments of persons from all levels of an organization are
represented in the final budget document; (2) budget estimates generally are more accurate and reliable,
since they are prepared by those who are closest to the problems; (3) managers generally are more
motivated to meet budgets which they have participated in setting; (4) self-imposed budgets reduce the
amount of upward blaming resulting from inability to meet budget goals.

One caution must be exercised in the use of self-imposed budgets. The budgets prepared by lower-level
managers should be carefully reviewed to prevent too much slack.

Q9: How can budgeting assist a company in planning its workforce staffing levels?

Budgeting can assist a firm in its employment policies by providing information on probable future
staffing needs. Budgeting can also assist in stabilizing a companys work force. By careful planning
through the budget process, a company can often smooth out its activities and avoid erratic hiring and
laying off employees.

Q10: The principal purpose of the cash budget is to see how much cash the company will have in the
bank at the end of the year. Do you agree? Explain.

No, although this is clearly one of the purposes of the cash budget. The principal purpose is to provide
information on probable cash needs during the budget period, so that bank loans and other sources of
financing can be anticipated and arranged well in advance.
Cash Budget with Supporting Schedules

Garden Sales, Inc., sells garden supplies. Management is planning its cash needs for the second quarter.
The company usually has to borrow money during this quarter to support peak sales of lawn care
equipment, which occur during May. The following information has been assembled to assist in preparing
a cash budget for the quarter:

a. Budgeted monthly absorption costing income statements for AprilJuly are:

April May June July

Sales $600,000 $900,000 $500,000 $400,000

Cost of goods sold 420,000 630,000 350,000 280,000
Gross margin 180,000 270,000 150,000 120,000
Selling and administrative expenses:
Selling expense 79,000 120,000 62,000 51,000
Administrative expense* 45,000 52,000 41,000 38,000
Total selling and administrative expenses 124,000 172,000 103,000 89,000
Net operating income $56,000 $98,000 $47,000 $31,000

*Includes $20,000 of depreciation each month.

b. Sales are 20% for cash and 80% on account.

c. Sales on account are collected over a three-month period with 10% collected in the month of
sale;
d. 70% collected in the first month following the month of sale; and the remaining 20% collected in
the second month following the month of sale. Februarys sales totaled $200,000, and Marchs
sales totaled $300,000.
e. Inventory purchases are paid for within 15 days. Therefore, 50% of a months inventory
purchases are paid for in the month of purchase. The remaining 50% is paid in the following
month. Accounts payable at March 31 for inventory purchases during March total $126,000.
f. Each months ending inventory must equal 20% of the cost of the merchandise to be sold in the
following month. The merchandise inventory at March 31 is $84,000.
g. Dividends of $49,000 will be declared and paid in April.
h. Land costing $16,000 will be purchased for cash in May.
i. The cash balance at March 31 is $52,000; the company must maintain a cash balance of at least
$40,000 at the end of each month.
j. The company has an agreement with a local bank that allows the company to borrow in
increments of $1,000 at the beginning of each month, up to a total loan balance of $200,000.
The interest rate on these loans is 1% per month and for simplicity we will assume that interest
is not compounded. The company would, as far as it is able, repay the loan plus accumulated
interest at the end of the quarter.

Required:
1. Prepare a schedule of expected cash collections for April, May, and June, and for the quarter in total.
2. Prepare the following for merchandise inventory:
a. A merchandise purchases budget for April, May, and June.
b. A schedule of expected cash disbursements for merchandise purchases for April, May, and
June, and for the quarter in total.
3. Prepare a cash budget for April, May, and June as well as in total for the quarter.
Schedule of Expected Cash Collections; Cash Budget

Herbal Care Corp., a distributor of herb-based sunscreens, is ready to begin its third quarter, in which
peak sales occur. The company has requested a $40,000, 90-day loan from its bank to help meet cash
requirements during the quarter. Because Herbal Care has experienced difficulty in paying off its loans in
the past, the loan officer at the bank has asked the company to prepare a cash budget for the quarter. In
response to this request, the following data have been assembled:

a. On July 1, the beginning of the third quarter, the company will have a cash balance of $44,500.
b. Actual sales for the last two months and budgeted sales for the third quarter follow (all sales are
on account):

May (actual) ................................................. $250,000

June (actual) ................................................ $300,000
July (budgeted)............................................ $400,000
August (budgeted) ....................................... $600,000
September (budgeted) ................................. $320,000

Past experience shows that 25% of a months sales are collected in the month of sale, 70% in the month
following sale, and 3% in the second month following sale. The remainder is uncollectible.

c. Budgeted merchandise purchases and budgeted expenses for the third quarter are given below:

July August September

Merchandise purchases .................. $240,000 $350,000 $175,000
Salaries and wages ......................... $45,000 $50,000 $40,000
Advertising ....................................... $130,000 $145,000 $80,000
Rent payments................................ $9,000 $9,000 $9,000
Depreciation .................................... $10,000 $10,000 $10,000

Merchandise purchases are paid in full during the month following purchase. Accounts payable for
merchandise purchases on June 30, which will be paid during July, total $180,000.

d. Equipment costing $10,000 will be purchased for cash during July.

e. In preparing the cash budget, assume that the $40,000 loan will be made in July and repaid in
September. Interest on the loan will total $1,200.

Required:

1. Prepare a schedule of expected cash collections for July, August, and September and for the
quarter in total.
2. Prepare a cash budget, by month and in total, for the third quarter.
3. If the company needs a minimum cash balance of $20,000 to start each month, can the loan be
repaid as planned? Explain.
Direct Labor and Manufacturing Overhead Budgets

The Production Department of Hruska Corporation has submitted the following forecast of units to be
produced by quarter for the upcoming fiscal year:

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Units to be produced .................. 12,000 10,000 13,000 14,000

Each unit requires 0.2 direct labor-hours and direct laborers are paid $12.00 per hour.

In addition, the variable manufacturing overhead rate is $1.75 per direct labor-hour. The fixed
manufacturing overhead is $86,000 per quarter. The only noncash element of manufacturing overhead is
depreciation, which is $23,000 per quarter.

Required:

1. Prepare the companys direct labor budget for the upcoming fiscal year, assuming that the direct labor
workforce is adjusted each quarter to match the number of hours required to produce the forecasted
number of units produced.
2. Prepare the companys manufacturing overhead budget.