J. Keith Baker © 2015Master Budgeting &Responsibilit.docx

J. Keith Baker © 2015
Master Budgeting &
Responsibility Accounting
Chapter 6
ACCT 3270
Spring - 2016
Jay K. Baker,
MSFS, MBA, CPA, CFP®
Chapter 6: Master Budgeting and Responsibility Accounting
A budget is a plan that covers a specific period of time that
helps management determine how best to use its resources –
both materials and manpower. Management estimates future
cost and revenues.
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Budget DefinedThe quantitative expression of a proposed plan

of action by management for a specified period, andAn aid to
coordinating what needs to be done to implement that planMay
include both financial and nonfinancial data
LO 6-1 Describe the Master Budget & Explain its Benefits
A budget is a plan that covers a specific period of time. It helps
management determine how best to use its resources – both
materials and manpower. Management estimates future cost and
revenues
A quantitative expression of management’s plan for the future
can best be seen in governmental budgeting. When the governor
of a state, for example, presents his budget to the legislature, it
includes what that governor wants to emphasize during his term.
If he wants to be known as an education governor, there will be
a large appropriation for education.
Budgets force manager to:
1. Plan: Preparing a budget makes managers take time from the
day to day management of a company to think about the future.
By preparing a budget, management can anticipate where
problems might arise in the future.
2. Promote coordination: Managers must coordinate the
activities of the entire company. If sales are 1,000 units, and
the company manufactures 2,000 units, the use of materials and
manpower has been inefficient.
3. Communicate: The budget is based on the organization’s
goals and serves as a way of communicating those goals, as well
as a plan for achieving them, throughout the company.
4. Benchmarking: The budget sets performance targets.
Managers can compare the actual results with the targets. This
can motivate managers to achieve the goals set for their unit and
can serve as a basis for evaluating management performance.
*

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Strategy, Planning, and Budgets, Illustrated
Effective budgeting integrates the company’s strategy into the
budget process. Strategy specifies how an organization matches
its own capabilities with the opportunities in the marketplace to
accomplish its objectives.
*
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Budgets help managers….Communicate directions and goals to
different departments of a company to help them coordinate the
actions they must pursue to satisfy customers and succeed in the
marketplace.Judge performance by measuring financial results
against planned objectives, activities, and timelines to learn
about potential problems.Motivate employees to achieve their
goals.
Budgets serve many purposes for firms including those seen
here:
Communicate directions and goals to different departments of a
company to help them coordinate the actions they must pursue
to satisfy customers and succeed in the marketplace
Judge performance by measuring financial results against
planned objectives, activities, and timelines to learn about
potential problems
Motivate employees to achieve their goals.
*

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Strategic plans and operating plans
To develop successful strategies, managers must consider
questions such as the following:
What are our objectives?
How do we create value for our customers while distinguishing
ourselves from our competitors?
Are the markets for our products local, regional, national or
global?
What trends affect our markets?
What organizational and financial structures serve us best?
What are risks and opportunities of alternative strategies and
what are our contingency plans if our preferred plan fails?
As managers work to develop successful strategies, they must
consider various questions including the risks and opportunities
of alternative strategies, contingency plans if the preferred plan
fails, how the economy, industry and competitors affect the
business as well as, and in addition to, the questions shown
here:
To develop successful strategies, managers must consider
questions such as the following:What are our objectives?How
do we create value for our customers while distinguishing
ourselves from our competitors?Are the markets for our
products local, regional, national or global? What trends affect
our markets?What organizational and financial structures serve
us best?
*
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Budgeting cycle:
Before the start of a fiscal year, managers at all levels take into
account past performance, market feedback, anticipated future
changes and other indicators to initiate plans for the next
period.
Senior managers give subordinate managers a frame of
reference against which they will compare actual results.
Managers and management accountants investigate any
deviations from the plan.
Well managed companies usually cycle through these steps
during the course of a fiscal year:Before the start of a fiscal
year, managers at all levels take into account past performance,
market feedback, anticipated future changes and other
indicators to initiate plans for the next period.Senior managers
give subordinate managers a frame of reference against which
they will compare actual results.Managers and management
accountants investigate, during the course of the year, changes.
*
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Working document: Master Budget
The master budget is at the core of the budgeting process. It
expresses management’s operating and financial plans for a
specified period:Operating decisions deal with how to best use
the limited resources of an organization. (the operating
budget)Financial decisions deal with how to obtain the funds to
acquire those resources. (the financial budget)
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The working document at the core of the budget-related process
is known as the master budget. It expresses management’s
operating and financial plans for a specified period and includes
a set of budgeted financial statements.
*
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Master Budget Components
Master Budget
Operating
Budget
Financial
Budget
Capital
Expenditure
Budget
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
Capital expenditures – plan for purchasing PP&E – is also done
during most Master Budget cycles that managers use for
planning that the text doesn’t make an emphasis.
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Master Budget ComponentsOperating budget
Supporting budget schedules
Revenue budget
Production budget in units
Direct materials purchase budget
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Master Budget Components
Direct labor budget
Cost of goods sold budget
Nonmanufacturing costs budget
Budgeted income statement
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Master Budget ComponentsFinancial budget
Capital budget
Cash budget
Budgeted balance sheet
Budgeted statement of cash flows
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Advantages of Budgets
LO 6-2 Describe the Advantages of budgets.
Provides a framework
for judging performance
#2

Promotes coordination
and communication
#1
Motivates employees
and managers
#3
Budgets are an integral part of management control systems.
There are at least three advantages of budgeting.
Promote coordination and communication.
Coordination is the meshing and balancing of all aspects of
production in a company in the best way for the company to
meet its goals.
Communication is making sure those goals are understood by all
employees. Budgets provide a framework for judging
performance and facilitating learning. Budgeting can overcome
two limitations of using past performance as a basis for
judging actual results.
Past results often incorporate past miscues and substandard
performance.
Future conditions can be expected to differ from the past,
budgets account for these changed conditions. Budgets can be
used to motivate managers and other employees. Studies have
shown that challenging budgets improve employee performance.
*
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Challenges in administering a budgetTop managers want lower-
level managers to participate in the budgeting process because
they have more specialized knowledge of day-to-day
management, however…The budgeting process is time-

consuming, andUpper-level management’s support is crucial
Of course, challenges are also associated with budgets and the
budget process.
The budget process is time-consuming, requires lower-level
managers “buy-in” and upper-level management support.
*
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The Ongoing Budget Process:
Managers and accountants plan the performance of the
company, taking into account past performance and anticipated
future changes.
Senior managers distribute a set of goals against which actual
results will be compared.
*
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The Ongoing Budget Process:
Accountants help managers investigate deviations from budget.
Corrective action occurs at this point.
Managers and accountants assess market feedback, changed
conditions, and their own experiences as plans are laid for the
next budget period.

*
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Basic Operating Budget Steps
Prepare the revenues budget (schedule 1; the starting point)
Page 206
Prepare the production budget (schedule 2; in units). Page 207
Prepare the direct materials usage budget and direct materials
purchases budget (schedule 3) Pages 207 and 208
Prepare the direct manufacturing labor budget (schedule 4) Page
208
LO 6-3 Preparing the Operation Budget.
The revenue budget is usually based on expected demand
because demand for a company’s products is invariably the
limiting factor for achieving profit goals.
The logical next step is to plan the production so that the
product is available when customers need it.
The number of units to be produced is the key to computing the
usage of direct materials in both quantity and dollars. This will
be based on quantity required for each unit to be produced from
the production budget
To create the budget for direct manufacturing labor costs,
managers estimate wage rates, production methods, process and
efficiency improvements and hiring plans.
*
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Basic Operating Budget Steps
Prepare the manufacturing overhead costs budget (schedule 5)
Page 210
Prepare the ending inventories budget (schedule 6A, units;
schedule 6B, dollars) Pages 211 and 212
Prepare the cost of goods sold budget (schedule 7) Page 212
Prepare the operating expense (period cost) budget (schedule 8)
Page 213
Prepare the budgeted income statement Exhibit 6-3 page 213
The next schedule to be created (schedule #5) is the
manufacturing overhead costs budget. Managing overhead costs
is both challenging and important because of the required
understanding of the activities required for production and the
cost driver of those activities.
Inventories are essential for proper customer service and play
an important role in the determination of the budget. The
production budget already included a determination of the target
ending finished goods inventory.
Cost of Goods Sold are calculated by adding additional
production costs to beginning finished goods inventory and
subtracting ending finished goods inventory.
Non-manufacturing costs are included in the operating expense
budget.
Formats differ for the budgeting income statement but
generally, information from schedules 1, 7 and 8 are used to
generate the budgeted income statement.
*
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Operating Budget
Sales budget
Operating expense budget
Purchases & cost of goods sold budget
Inventory
budget
Budgeted income statement
*
The master budget is the financial plan for the entire
organization. The operating budget is the sales budget, the
cornerstone of the master budget. This is true because sales
affect most other components of the master budget.
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Basic Financial Budget Steps
Based on the operating budgets:
Prepare the capital expenditures budget.
Prepare the cash budget.
Prepare the budgeted balance sheet.
Prepare the budgeted statement of cash flows.
*
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Sample

Master
Budget,
Illustrated
*
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Operating Budget Example
Hawaii Diving expects 1,100 units to be sold
during the month of August 2013.
Selling price is expected to be $240 per unit.
How much are budgeted revenues for the month?
1,100 × $240 = $264,000
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Two pounds of direct materials are budgeted per
unit at a cost of $2.00 per pound, $4.00 per unit.
Three direct labor-hours are budgeted per unit
at $7.00 per hour, $21.00 per unit.
Variable overhead is budgeted at $8.00
per direct labor-hour, $24.00 per unit.
Fixed overhead is budgeted at $5,400 per month.

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Variable nonmanufacturing costs are
expected to be $0.14 per revenue dollar.
Fixed nonmanufacturing costs are
$7,800 per month.
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Production Budget Example
Budgeted sales (units)
Target ending finished goods inventory (units)
Beginning finished goods inventory (units)
Budgeted production (units)
+
–
=
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Assume that target ending finished goods
inventory is 80 units.
Beginning finished goods inventory is 100 units.
How many units need to be produced?

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Hawaii Diving Production Budget
for the Month of August 2015
Units required for sales 1,100
Add ending inv. of finished units 80
Total finished units required 1,180
Less beg. inv. of finished units 100
Units to be produced 1,080
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Direct Materials Usage Budget
Each finished unit requires 2 pounds of direct
materials at a cost of $2.00 per pound.
Desired ending inventory equals 15% of the
materials required to produce next month’s sales.
September sales are forecasted to be 1,600 units.
What is the ending inventory in August?
480 pounds
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September sales: 1,600 × 2 pounds per unit

= 3,200 pounds
3,200 × 15% = 480 pounds
(the desired ending inventory)
What is the beginning inventory in August?
1,100 units × 2 × 15% = 330 units
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How many pounds are needed to produce
1,080 units in August?
1,080 × 2 = 2,160 pounds
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Material Purchases Budget
Hawaii Diving Direct Material Purchases Budget for the Month
of August 2015
Units needed for production 2,160
Target ending inventory 480
Total material to provide for 2,640
Less beginning inventory 330
Units to be purchased 2,310
Unit purchase price $ 2.00
Total purchase cost $4,620
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Direct Manufacturing
Labor Budget
Hawaii Diving Direct Labor Budget
Units produced: 1,080
Direct labor-hours/unit 3
Total direct labor-hours: 3,240
Total budget @ $7.00/hour: $22,680
Each unit requires 3 direct labor-hours
at $7.00 per hour.
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Manufacturing Overhead Budget
Variable overhead is budgeted at $8.00
per direct labor-hour.
Fixed overhead is budgeted at $5,400 per month.
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Manufacturing Overhead Budget
Hawaii Diving Manufacturing Overhead
Budget for the Month of August 2015
Variable Overhead:
(3,240 × $8.00) $25,920
Fixed Overhead 5,400
Total

$31,320
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Ending Inventory Budget
Cost per finished unit:
Materials $ 4
Labor 21
Variable manufacturing overhead 24
Fixed manufacturing overhead 5*
Total $54
*$5,400 ÷ 1,080 = $5
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Ending Inventory Budget
What is the cost of the target
ending inventory for materials?
480 × $2 = $960
What is the cost of the target
finished goods inventory?
80 × $54 = $4,320
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Cost of Goods Sold Budget
Direct materials used:

2,160 × $2.00 $ 4,320
Direct labor 22,680
Total overhead 31,320
Cost of goods manufactured $58,320
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Ending finished goods inventory is $4,320.
What is the cost of goods sold?
Assume that the beginning finished
goods inventory is $5,400.
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Beginning finished goods inventory $ 5,400
+ Cost of goods manufactured $58,320
= Goods available for sale $63,720
– Ending finished goods inventory $ 4,320
= Cost of goods sold $59,400
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Nonmanufacturing Costs Budget
Hawaii Diving Other Expenses Budget

Variable Expenses:
($0.14 × $264,000) $36,960
Fixed expenses 7,800
Total
$44,760
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Cost of goods sold are budgeted at $59,400.
What is the budgeted gross margin?
Hawaii Diving has budgeted sales of
$264,000 for the month of August.
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Budgeted Statement of Income
Hawaii Diving Budgeted Income Statement
for the Month ending August 31, 2015
Sales $264,000 100%
Less cost of sales 59,400 22%
Gross margin $204,600 78%
Other expenses 44,760 17%
Operating income $159,840 61%
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Learning Objective 4
Use computer-based financial
planning models in
sensitivity analysis.
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Revenues/Sales Budget
Plan for sales revenues in a future periodBudgeted sales revenue
= sale price per unit x expected number of units to be sold
*
The forecast of sales revenue is the cornerstone of the master
budget because the level of sales affects expenses and almost all
other elements of the master budget. The sales manager prepares
the sales budget, taking into consideration past trends and
current economic factors, market demand and so forth. This
budget helps the sale manager plan advertising and selling
activities. The rest of the operating budget depends on the
sales budget.
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E 6-16 1. Sales Budget Example
Rouse & Sons 2011 Selling Change in Volume - Expected
2012 Volume Volume Prices
Radon Tests 12,200 $290 +6% 12,932
Lead Tests 16,400 $240 -10% 14,760
Rouse & Sons Sales Budget

For the Year Ended December 31, 2012
Selling Units
Price Sold Total Revenues
Radon Tests $290 12,932 $ 3,750,280
Lead Tests $240 14,760 3,542,400
$ 7,292,680
*
Exercise 6-16 1. Shows us a sales budget for Radon and Lead
Test are expected sales/revenues of $7,292,680.
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E 6-16 2. Sales Budget Example
Rouse & Sons 2011 Selling Change in Volume - Expected
2012 Volume Volume Prices
Radon Tests 12,200 $290 +6% 12,932
Lead Tests 16,400 $230 -7% 15,252
Rouse & Sons Sales Budget
For the Year Ended December 31, 2012
Selling Units
Price Sold Total Revenues
Radon Tests $290 12,932 $ 3,750,280
Lead Tests $230 15,252 3,507,960
$ 7,258,240
Expected revenues at the new 2012 prices are $7,258,240, which
is lower than the expected 2012 revenues of $7,292,680 if the
prices are unchanged. So, if the goal is to maximize sales
revenue and if Jim Rouse’s forecasts are reliable, the company
should not lower its price for a lead test in 2012.

*
Expected revenues at the new 2012 prices are $7,258,240, which
is lower than the expected 2012 revenues of $7,292,680 if the
prices are unchanged. So, if the goal is to maximize sales
revenue and if Jim Rouse’s forecasts are reliable, the company
should not lower its price for a lead test in 2012.
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Purchases = Cost of goods sold +
Ending inventory– Beginning inventory
Inventory, Purchases, and Cost of Goods Sold Budget
Cost of goods sold =
Beginning inventory + Purchases– Ending inventory
Known
Compute
Compute
Unknown
*
Once you know how much is predicted to be sold, you can plan
on how much inventory you need to purchase. Remember the

equation to compute cost of goods sold. The only element that
is not known or can not be computed is purchases. Rearrange
the equation to solve for Purchases.
6-*
E 6-20 Revenues & Production Budget
1.
Selling Units
Price Sold Revenues
12-ounce bottles $0.25 4,800,000a
$1,200,000
4-gallon units 1.50 1,200,000b 1,800,000
$3,000,000
a 400,000 × 12 months = 4,800,000
b 100,000 × 12 months = 1,200,000
2.
Budgeted unit sales (12-ounce bottles) 4,800,000
Add target ending finished goods inventory 600,000
Total requirements 5,400,000
Deduct beginning finished goods inventory 900,000
Units to be produced 4,500,000
3.
BeginningBudgeted Target _ Budgeted
inventory = sales + ending inventory
production
= 1,200,000 + 200,000 −
1,300,000
= 100,000 4-gallon units

*
Example S10-3 shows us a sales budget for January and
February with total sales of $1,510,000.
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Financial Budget Components
Cash budgetBudgeted balance sheetBudgeted statement of cash
flows
*
Recall that the financial budget includes the cash budget, the
budgeted balance sheet and the budgeted statement of cash
flows.
6-*
Cash Budget ComponentsCash receipts and cash payments for a
future periodThe Cash Budget has 5 major partsCollections
from customersCash payments for purchasesCash payments for
operating expensesCash payments for capital expendituresCash
Financing – borrowings, repayments and interest
*
The cash budget, or statement of budgeted cash receipts and
payments, details how the business expects to go from the
beginning cash balance to the desired ending balance. There are
5 major parts to the cash budget:Collections from
customers.Cash payments for purchases.Cash payments for
operating expenses.Cash payments for capital expenditures.Cash

Financing – borrowings, repayments and interest.
Cash collections and payments depend heavily on revenues and
expenses, which appear in the operating budget. This is why
the cash budget cannot be prepared until the operating budget
has been completed.
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Cash Payment ComponentsCash paymentsFor inventory
purchasesFor operating expensesPurchase long-term
assetsPayment on loansPayment to owners
*
Businesses use cash payments for purchasing inventory or long-
term assets; for making payments on loans or to owners; or for
operating expenses.
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Cash Budget Minimum Requirement
Beginning cash balance
+ Cash receipts
= Cash available
- Cash payments (for inventory, operating expenses, purchase of
long-term assets)
= Ending balance before financing
- Minimum balance
= Excess (deficiency)

*
Companies have a desired minimum balance in cash to keep
operations moving smoothly. If cash falls below the minimum
balance, the company will have to borrow some money.
6-*
Cash Budget Financing Section
Financing:
+Borrow
- Principal payments
- Interest expense
Total Effects of financing
Ending Cash Balance
*
If the cash budget prior to financing is in a deficit position, the
organization will need to borrow funds to eliminate the deficit.
6-*
E 6-36: Continuation of Cash Budget
*
Continuing with the Cash Budget, prepare the cash budget using
the format from slide 22.

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10-*
*
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10-*
*
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Other Budgeting IssuesFinancial-planning software may be
employed to conduct sensitivity (“what-if”) analysis to assist in
the budgetary process.Kaizen budgeting—incorporating

continuous improvement factors in the budgeting
process.Activity-based budgeting—incorporating activity-based
costing in the budgetary process.
*
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Financial-planning models & sensitivity analysis:Financial
planning models may be employed to conduct sensitivity
(“what-if”) analysis to assist in the budgetary process.A “what-
if” analysis or sensitivity analysis is a technique that examines
how a result will change if the original predicted data or
underlying assumption change.
Financial planning models are mathematical representations of
the relationships among operating activities, financing activities
and other factors that affect the master budget.
*
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Sensitivity Analysis
Let’s Consider Hawaii Diving.
What if some parameters in the budget model
were to change?
For example, what if the selling price is
expected to be $230 instead of $240?

What are expected revenues?
1,100 × $230 = $253,000 instead of $264,000
6-*
What if the materials cost is expected to increase to $2.50 per
pound instead of $2.00.
What is the cost of goods sold?
1,100 × $55 = $60,500 instead of $59,400
Why the increase?
Because materials cost per unit become
$5.00 instead of $4.00.
6-*
Sensitivity analysis is used to assist managers in planning and
budgeting.
Sensitivity analysis is a “what if” technique that illustrates the
impact of changes from the predicted data.
Two scenarios are being considered for Stylistic Furniture’s
budget for 2015.
*
6-*

What is Kaizen?
The Japanese use the term “kaizen”
for continuous improvement.
Kaizen budgeting is an approach that
explicitly incorporates continuous
improvement during the budget
period into the budget numbers.
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Kaizen Budgeting
It was previously estimated that it should take 3 labor-hours
for Hawaii Diving to manufacture its product.
A kaizen budgeting approach would
incorporate future improvements.
6-*
Kaizen Budgeting
Budgeted Hours/Item
January – March 2014 3.00
April – June 2014 2.95
July – September 2014 2.90
October – December 2014 2.85

6-*
Activity-Based Budgeting
Activity-based costing reports and analyzes past and current
costs.
Activity-based budgeting (ABB) focuses
on the budgeted cost of activities necessary
to produce and sell products and services.
6-*
Product A Product B
Units produced: 880 200
Labor-hours per unit: 3 3
Budgeted setup-hours: 5 5
Total budgeted machine setup related cost is
$25,920 per month.
6-*
Total budgeted labor-hours are:
Product A: 880 × 3 2,640
Product B: 200 × 3 600
Total 3,240

What is the allocation rate per labor-hour?
$25,920 ÷ 3,240 = $8.00
6-*
Product A: $8.00 × 2,640 = $21,120
Total cost allocated to each product line:
Product B: $8.00 × 600 = $ 4,800
6-*
$25,920 budgeted machine setup cost
÷ 10 budgeted machine setup-hours
= $2,592 allocation rate per machine setup-hour.
Under ABB, the number of setups is the cost driver.
How much machine setup related costs are
allocated to each product line?
6-*
Product A Product B
$2,592 × 5 $12,960
$2,592 × 5 $12,960
Setup-related cost per unit:

Product A: $12,960 ÷ 880 $14.73
Product B: $12,960 ÷ 200$64.80
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Budgeting and the Organization:
Responsibility AccountingResponsibility center—a part,
segment, or subunit of an organization whose manager is
accountable for a specified set of activities.Responsibility
accounting—a system that measures the plans, budgets, actions,
and actual results of each responsibility center.
Responsibility accounting is a system for evaluating the
performance of each center and its manager. Responsibility
accounting performance reports compare plans (budgets) with
actions (actual results) for each center. Superiors then evaluate
how well each manager used the budgeted resources to achieve
the responsibility center’s goals, and thereby, controlled the
operations for which he or she was responsible.
*
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Types of Responsibility Centers
Cost—accountable for costs only
Revenue—accountable for revenues only
Profit—accountable for revenues and costs
Investment—accountable for investments, revenues, and costs

There are 4 types of responsibility centers: Cost Center: In a
cost center, managers are accountable for costs (expenses)
only.Revenue Center: In a revenue center, managers are
primarily accountable for revenues.Profit Center: In a profit
center, managers are accountable for both revenues and costs
(expenses) and, therefore, profits.Investment Center: In an
investment center, managers are accountable for investments,
revenues and costs. Managers of investment centers are
responsible for generating sales, controlling expenses and
managing the amount of investment required to earn the income.
*
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Responsibility AccountingPerformance reports compare
budgeted and actual amountsManagement by exception –
management technique that focuses on important differences
between budget and actual
*
In responsibility accounting, performance reports compare
budgeted to actual amounts are used to evaluate results.
Management by exception uses these reports to focus on the
differences between budgeted and actual results. The question is
not who to blame for the difference, but who can best explain
why a specific variance occurred.
6-*
Budgets and FeedbackBudgets offer feedback in the form of
variances: actual results deviate from budgeted

targets.Variances provide managers with:Early warning of
problemsA basis for performance evaluationA basis for strategy
evaluation
The master budget model the company’s planned activities.
Actual results often differ from plans, so management wants to
know how budgeted income and cash flows would change if key
assumptions turned out to be incorrect. Spreadsheet programs
take the drudgery out of hand-computed master budget
sensitivity analyses, making it cost-effective to perform more
comprehensive sensitivity analyses.
*
6-*
ControllabilityControllability is the degree of influence that a
manager has over costs, revenues, or related items for which he
is being held responsible.Responsibility accounting focuses on
information sharing, not in laying blame on a particular
manager.
*
6-*
ControllabilityResponsibility accounting focuses on information
and knowledge, not control.A responsibility accounting system
could exclude all uncontrollable costs from a manager’s
performance report.In practice, controllability is difficult to

pinpoint.
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Budgeting and Human BehaviorThe budgeting process may be
abused both by superiors and subordinates, leading to negative
outcomes.Superiors may dominate the budget process or hold
subordinates accountable for events they have no control
over.Subordinates may build “budgetary slack” into their
budgets.
*
6-*
Budgetary SlackThe practice of underestimating budgeted
revenues, or overestimating budgeted expenses, in an effort to
make the resulting budgeted goals (profits) more easily
attainable.
*
Exercise 6-19
Budgeting material purchases. The Howell Company has

prepared a sales budget of 43,000 finished units for a three-
month period. The company has an inventory of 11,000 units of
finished goods on hand at December 31 and has a target finished
goods inventory of 19,000 units at the end of the succeeding
quarter.
It takes 4 gallons of direct materials to make one unit of
finished product. The company has an inventory of 66,000
gallons of direct materials at December 31 and has a target
ending inventory of 56,000 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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Budgeting Materials Purchases
Production Budget:
Finished Goods
(units)
Budgeted sales 43,000
Add target ending finished goods inventory 19,000
Total requirements 62,000
Deduct beginning finished goods inventory 11,000
Units to be produced 51,000
Direct Materials Purchases Budget:
Direct Materials
(in gallons)

204,000
Add target ending direct materials inventory
56,000
Total requirements 260,000
Deduct beginning direct materials inventory
66,000
Direct materials to be purchased 194,000
*
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Responsibility and controllability.
Consider each of the following independent situations for
Happy Tours. Happy Tours to schools and other groups. Happy
Tours owns a fleet of 10 motor coaches and employs 12 drivers.
1 maintenance technician, 3 sales representatives and an office
manager. Happy Tours pays for all fuel and maintenance on the
coaches. Drivers are paid 50¢ per mile while in transit, plus
$15 an hours while idle (TIME SPENT WAITING WHILCE
TOUR GROUPS ARE VISITING THEIR DESTINATIONS. The
maintenance Technician and office manager are both full-time
salaried employees. The sales representatives work on straight
commission.
Problem 6-28
*

6-*
1. The office manager has the responsibility to follow company
guidelines and write contracts herself for customers who call
her directly. Diverting potential customers to the sales
representative costs the company a sales commission that would
not have otherwise been paid. If satisfaction surveys are sent to
customers asking about their first contact with the company,
this may be enough to prevent the office manager from breaking
the rules.
2. Each driver is responsible for keeping an accurate
accounting of his or her time. Because the drivers are paid for
mileage while driving and an hourly rate while in idle, there is
an incentive to report less travel time and more idle time. The
cost could be controlled by using global positioning systems
(GPS) to track the movement and location of the motor coaches.
Problem 6-28
6-*
3. The drivers are responsible for driving the motor coaches at
fuel-efficient speeds on the highway. The maintenance
technician is responsible for maintaining the vehicles to
improve efficiency. An increase in fuel consumption would be
difficult to pin on either employee because either could be
responsible. Further, there is no incentive for the drivers to

drive slower, as they are paid by the mile. Again, global
positioning systems (GPS) could be used to track the movement
of the vehicles. Some kind of bonus could be offered to the
technician for improvements in fuel efficiency.
4. The maintenance technician is clearly responsible for
completing all of the preventative maintenance. If he cannot
complete the tasks during busy months, the company should
consider outsourcing some of the more routine maintenance
jobs. Requiring the technician to work significant overtime will
likely decrease his efficiency. Ignoring routine maintenance
will end up costing the company more money in fuel and repair
costs.
Problem 6-28
*
6-*
5. Haslett has designed the stretch target system correctly.
Taking advantage of loss aversion, Haslett has set a stretch
target of 50 contracts rewarding the representative with a 12
percent commission (assuming paying this amount of
commission is profitable). If the target is not met, the
commission decreases to 8 percent. This will motivate the
representatives to achieve 50 contracts.
In establishing “stretch targets,” Haslett should be sure
that there are sufficient potential contracts to allow all three
sales representatives to achieve the higher target. Otherwise, the
stretch target may cause friction among the representatives. One
or more of representatives may decide that the 8 percent

commission is not sufficient incentive to stay with the company,
and may leave to work for a competitor, resulting in overall
reduced sales.
Problem 6-28
*
6-*
End of Chapter 6
End of Chapter 9.
Master Budget Project
Congratulations! You have just been hired as controller for a
growing company that manufactures green products. It is
October 1 and time for creation of the budget for the next year.
The budget will be created in quarters using each month as a
period of sales/production.
Your first task is to create the budget for the first quarter of
2016. This involves completing budgets for January, February,
March and the first quarter in total for 2016. You seek out last
year’s data, recent costing information and follow up on
important assumptions.
The CFO wants to see the first quarter budget before you
complete the rest of the year, as adjustments may be needed.
You will need to create the following sub-budgets as part of the

overall master budget.
1. Sales Budget for the 1st quarter
2. Production Budget for the 1st quarter
3. Materials Purchases Budget for the 1st quarter
4. Direct Labor Budget for the 1st quarter
5. Overhead Budget for the 1st quarter
6. Cash Receipts of Sales Revenue for the 1st quarter
7. Cash Payments for Material Purchases for the 1st quarter
8. Overall Cash Budget for the 1st quarter
9. Income Statement for the quarter ended March 31, 2016
10. Statement of Cash Flows for the quarter ended March 31,
2016
Several assumptions are needed to work into your models for
computation. These are determined as follows and have been
approved by the CFO. These are summarized on the following
page.

This page illustrates all assumptions needed to create the master
budget, income statement and statement of cash flows. These
assumptions have been approved by the CFO. You will use
them to create the master budget for January, February, March
and in total for the first quarter.
JanuaryFebruaryMarchAprilMay
Unit Sales24,00025,00026,50026,50027,000
Sales Price$10
Desired Ending Inventory for Finished Goods20%of next
month's sales in units
Desired Ending Inventory for Material Units10%of next month's
materials needed for production
Cost of one lb.of materials (1 lb =1 material unit)$0.35
Units of Direct Materials to make one unit4
Minutes of Direct Labor to make one unit15
Direct Labor Costs per Hour$15
Overhead Costs percentage of Direct Labor150%
Minimum cash balance (Assume you start with this)10,000.00$
Cash collections in month of sale70%
Cash collections in first month after sale25%
Cash collections in second month after sale5%
Cash Payments in month of purchase65%
Cash Payments in the first month after purch35%
Selling Costs per month (for cash budget)11,000.00$

Administrative Costs per month (for cash budget)15,000.00$
Annual Interest Rate for Letter of Credit12%
Annual Interest Rate Earned on Excess Cash4%
Sales Revenue for November$325,000
Sales Revenue for December$325,000
Material Purchases for November$25,000
Material Purchases for December
$22,000
Depreciation Expense for the quarter (Operating Exp)
$5,000
Income Tax Rate25%

J. Keith Baker © 2015Master Budgeting &Responsibilit.docx

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