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Chapter 6
Budgets and the Budgeting Cycle
A budget is (a) the quantitative expression of a proposed plan of action by management for a
specified period and (b) an aid to coordinate what needs to be done to implement that plan.
A budget generally includes both financial and nonfinancial data

Budgeting Cycle and Master Budget

1) Working together, managers and management accountants plan the performance of the
company as a whole and Taking into account past performance and anticipated changes in
the future, managers at all levels reach a common understanding on what is expected.
2) Senior managers give subordinate managers a frame of reference, a set of specific
financial or nonfinancial expectations against which actual results will be compared.
3) Management accountants help managers investigate variations from plans, such as an
unexpected decline in sales. If necessary, corrective action follows, such as a reduction
in price to boost sales or cutting of costs to maintain profitability.
4) Managers and management accountants take into account market feedback, changed
conditions, and their own experiences as they begin to make plans for the next period.
Advantages of Budgets
 Provides a framework for judging performance
 Motivates managers and other employees
 Promotes coordination and communication among subunits within the company
Note that
The master budget expresses management’s operating and financial plans for a specified period
(usually a fiscal year), and it includes a set of budgeted financial statements.
Components of Master Budgets
 Operating budget—building blocks leading to the creation of the budgeted income
statement
 Financial budget—building blocks based on the operating budget that lead to the
creation of the budgeted balance sheet and the budgeted statement of cash flows
Steps in Preparing an Operating Budget
1. Identify the problem and uncertainties.
2. Obtain information.
3. Make predictions about the future.
4. Make decisions by choosing among alternatives.
5. Implement the decision, evaluate performance, and learn.

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Basic Operating Budget Steps
1) Prepare the revenues budget.
2) Prepare the production budget (in units).
3) Prepare the direct materials usage budget and direct materials purchases budget.
4) Prepare the direct manufacturing labor budget.
5) Prepare the manufacturing overhead costs budget.
6) Prepare the ending inventories budget.
7) Prepare the cost of goods sold budget.
8) Prepare the operating expense (period cost) budget.
9) Prepare the budgeted income statement.
Operating budget

The revenue (sales) budget

= budgeted selling price per unit x budgeted units sold

The production budget in (units)

= budget sales + ending inv. F.G – beginning inv. F. G

The direct material usage budget or production requirement of direct

material
= production budget in units X No. of D. mat. Needed in units for produced
one unit of F. G

The Direct material purchase budget in units

= D. Mat usage budget + desired ending inv. D. Mat – Beg. Inv. D. Mat
Note: D. Mat purchase budget in $ = budget in units x cost per unit
The Direct manufacture labor budget in hours
= production budget in units x labor hours required for produced each unit
Note: D. mfg. labor in $ = budget in hours x wage rate per hours
 mfg overhead budget
= fixed overhead + variable overhead

Cost of goods sold budget:

Beginning finished goods inventory

+ Cost of goods manufactured
= Goods available for sale
– Ending finished goods inventory
= Cost of goods sold

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Exercise (1):
Suppose that the budget of production is 10000 units of product (A) to produce each unit
of product (A), we need 3 k.g of material (x) which selling price is $ 10/ k.g and 0.5 litre
of material (y) which selling price is $ 8/L and ending & beginning inventory regarding the
two materials appeared as follows:
End Beg.
X 8000 5000 k.g
Y 7000 9000 L
each unit required 5 labor hours, wage rate/ hours $ 10, assume variable overhead $ 8
per Direct Labor Hours & fixed overhead = $ 5400
Required:
1- Determine the requirement budget regarding the two materials (x & y) for production.
2- Determine the raw material purchase budget of direct material in units & $.
3- Direct Mfg labor budgeted in hours & $.
4- Mfg overhead budget.
‫ ــــــــــــــــــــــــــ‬Solution ‫ــــــــــــــــــــــــــ‬
1- Requirement of D. mat for production:
No. of D. mat needed in units
= production budget in units x
for produced one units of F. G
x = 10000 u x 3 k.g = 30000 k.g
y = 10000 u x 0.5 litre = 5000 litre
2- R. material purchase budget:
= requirement of D.mat + desire ending inv. D. mat – begin inv. D. m
x = 30000 k.g + 8000 – 5000 = 33000 k.g x $ 10 = 330000$
y = 5000 L + 7000 – 9000 = 3000 L x $ 8 = 24000 $
3- D. Mfg labor budget:
labor hours required for
= production budget in units x
produced each unit of F. G
10000 u x 5 hours = 50000 hrs x $ 10 = 500000$
4- Mfg overhead budget:
Fixed overhead + V. overhead (V. overhead per D. L. H.) x D.L. hrs
= $ 5400 + ($ 8 x 50000 hrs) = 405400$

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6-17 The Mendez Company expects sales in 2012 of 200,000 units of serving trays. Mendez’s
beginning inventory for 2012 is 15,000 trays and its target ending inventory is 25,000 trays.
Compute the number of trays budgeted for production in 2012.

6-18 Inglenook Co. produces wine. The company expects to produce 2,500,000 two-liter bottles of
Chablis in 2012. Inglenook purchases empty glass bottles from an outside vendor. Its target ending
inventory of such bottles is 80,000; its beginning inventory is 50,000. For simplicity, ignore
breakage. Compute the number of bottles to be purchased in 2012.

6-19 The Mahoney Company has prepared a sales budget of 45,000 finished units for a three-
month period. The company has an inventory of 16,000 units of finished goods on hand at December
31 and has a target finished goods inventory of 18,000 units at the end of the succeeding quarter.
It takes three gallons of direct materials to make one unit of finished product. The company has an
inventory of 60,000 gallons of direct materials at December 31 and has a target ending inventory of
50,000 gallons at the end of the succeeding quarter. How many gallons of direct materials should be
purchased during the three months ending March 31?

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6-20 Purity, Inc., bottles and distributes mineral water from the company’s natural springs in
northern Oregon. Purity markets two products: twelve-ounce disposable plastic bottles and four-gallon
reusable plastic containers.
1. For 2012, Purity marketing managers project monthly sales of 400,000 twelve-ounce bottles and
100,000 fourgallon containers. Average selling prices are estimated at $0.25 per twelve-ounce bottle
and $1.50 per fourgallon container. Prepare a revenues budget for Purity, Inc., for the year ending
December 31, 2012.
2. Purity begins 2012 with 900,000 twelve-ounce bottles in inventory. The vice president of
operations requests that twelve-ounce bottles ending inventory on December 31, 2012, be no less than
600,000 bottles. Based on sales projections as budgeted previously, what is the minimum number of
twelve-ounce bottles Purity must produce during 2012?
3. The VP of operations requests that ending inventory of four-gallon containers on December 31,
2012, be 200,000 units. If the production budget calls for Purity to produce 1,300,000 four-gallon
containers during 2012, what is the beginning inventory of four-gallon containers on January 1, 2012?

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6-21 Xerxes Manufacturing Company manufactures blue rugs, using wool and dye as direct
materials. One rug is budgeted to use 36 skeins of wool at a cost of $2 per skein and 0.8 gallons of
dye at a cost of $6 per gallon. All other materials are indirect. At the beginning of the year Xerxes
has an inventory of 458,000 skeins of wool at a cost of $961,800 and 4,000 gallons of dye at a cost
of $23,680. Target ending inventory of wool and dye is zero. Xerxes uses the FIFO inventory cost
flow method.

Xerxes blue rugs are very popular and demand is high, but because of capacity constraints the firm
will produce only 200,000 blue rugs per year. The budgeted selling price is $2,000 each. There are
no rugs in beginning inventory. Target ending inventory of rugs is also zero.

Xerxes makes rugs by hand, but uses a machine to dye the wool. Thus, overhead costs are
accumulated in two cost pools—one for weaving and the other for dyeing. Weaving overhead is
allocated to products based on direct manufacturing labor-hours (DMLH). Dyeing overhead is
allocated to products based on machine-hours (MH).

There is no direct manufacturing labor cost for dyeing. Xerxes budgets 62 direct manufacturing
laborhours to weave a rug at a budgeted rate of $13 per hour. It budgets 0.2 machine-hours to dye
each skein in the dyeing process.

The following table presents the budgeted overhead costs for the dyeing and weaving cost
pools:

1. Prepare a direct material usage budget in both units and dollars

2. Calculate the budgeted overhead allocation rates for weaving and dyeing.
3. Calculate the budgeted unit cost of a blue rug for the year.
4. Prepare a revenue budget for blue rugs for the year, assuming Xerxes sells (a) 200,000 or (b)
185,000 blue rugs (that is, at two different sales levels).
5. Calculate the budgeted cost of goods sold for blue rugs under each sales assumption.
6. Find the budgeted gross margin for blue rugs under each sales assumption.