it is more detail about cost accounting give very detail and clear insights about the cost accounting. it will give valuable support for students, professional and practitioners especially for students of social science like accounting, management, business administration and marketing.

1. CHAPTER THREE
MASTER BUDGET

2. 1.Master Budget
 A budget: quantitative expression of a proposed plan of action by management for a specified
period & an aid to coordinate what needs to be done to implement that plan.
 A budget includes both financial and nonfinancial aspects of plan.
 It serves as a blueprint for company to follow in upcoming period.
 A financial budget quantifies management’s expectations regarding income, cash flows, & financial
position.
 Just as financial statements are prepared for past periods, financial statements can be prepared for
future periods like:
 A budgeted income statement
 A budgeted statement of cash flows
 A budgeted balance sheet.

3. Strategic Plan and Operating Plan
 Budgeting is most useful when it is integrated with a company’s strategy.
 Strategy specifies how organization matches its own capabilities with opportunities in market
place to accomplish its objectives.
 In developing successful strategies, managers consider following basic questions:
 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?
 How we are affected by economy, our industry & our competitors?
 What organizational and financial structures serve us best?
 What are risks and opportunities of alternative strategies?
 What are our contingency plans if our preferred plan fails?

4. Strategy, planning and budgeting process
 In planning for profits, managers must consider two time horizons:
 Short Term and Long Term

5. A. Short-term planning is process of deciding:
 What objectives to pursue during a short, near-future period, usually one year
 What to do to achieve those objectives.
 Typical short-term budget covers one year & is broken down into monthly or
quarterly units.
 Another method frequently used to prepare a short-term budget is continuous budget.
 This kind of budget starts with annual budget broken down into 12 monthly
units.
 As each month arrives, it is dropped from plan and replaced by new month so
that at any given time, next 12 months are always shown.

6. B. Long-term planning (strategic planning) is process of setting long-term goals & determining means to
attain them.
 Short-term planning is concerned with operating details for next accounting period,
 But, long-term planning addresses broad issues, such as:
 New product development,
 Plant and equipment replacement
 Other matters that require years of advance planning.
 Time frame for long-range planning may extend as far as 20 years in the future, but its usual range is from
2 to 10 years.
 An important part of long-term planning is preparation of capital budget, which details plans for
acquisition and replacement of major portions of property, plant, and equipment.

7. 1.Budgeting Cycle and Master Budget
 Well-managed companies usually cycle through following budgeting steps during
course of fiscal year:
1. Working together: Managers & management accountants plan performance of
company as a whole & performance of its subunits (departments or divisions).
 Taking into account past performance & anticipated changes in 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 non-financial expectations against which actual results will be compared.

8. 3. Management accountants help managers to investigate variations from plans, such
as 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.
For example: a decline in sales may cause managers to make changes in product
features for the next period.

9. The preceding four steps describe ongoing budget process.
The working document at core of this process is called the master budget.
Master Budget:
 Expresses management’s operating & financial plans for specified period
(usually a fiscal year)
 It includes a set of budgeted financial statements.
 It is initial plan of what company intends to accomplish in budget period.
 Evolves from both operating and financing decisions made by managers.
 Operating decisions deal with how to best use limited resources of organization.
 Financing decisions deal with how to obtain funds to acquire those resources.

10. Advantageous of budget
 Budgets are an integral part of management control systems.
 When administered thoughtfully by managers, budgets do the following:
Promote coordination & communication among subunits within company
Provide a framework for judging performance and facilitating learning
Motivate managers and other employees
Means of allocation resources and create cost awareness.

11. A. Coordination and Communication
 Coordination: Meshing & balancing all aspects of production or service and all departments in
company in best way for company to meet its goals.
 Communication : Making sure those goals are understood by all employees.
 Coordination forces executives to think of relationships among individual departments within
company, as well as between company and its supply chain partners.
 Production manager can achieve more timely production by coordinating &
communicating with company’s marketing team to understand when set-top boxes
will be needed.
 Marketing team can make better predictions of future demand for set-top boxes by
coordinating and communicating with pace’s customers.

12. B . Framework for judging performance & facilitating learning
 Budgets enable a company’s managers to measure actual performance against predicted performance.
 Budgets can overcome two limitations of using past performance as a basis for judging actual results.
 One limitation is past results often incorporate past miscues & substandard
performance.
 Other limitation of using past performance is that future conditions can be expected
to differ from past.
 Budgeting helps managers to gather relevant information for improving future performance.
 When actual outcomes fall short of budgeted or planned results, it prompts thoughtful senior managers to ask
questions about:
 What happened and why?

13. C. Motivate managers and other employees
Most employees are motivated to work more intensely to avoid failure than to
achieve success.
As employees get closer to a goal, they work harder to achieve it.
D. Means of Allocating Resources
 Because we live in a world of limited resources, virtually all individuals & organizations must
ration their resources.
 It needs to compare costs and benefits of each potential project or activity and choose those
that result in most appropriate resource allocation decision.
 Generally, organizations resources are limited, & budgets provide one means of allocating
resources among competing uses.

14. E. Creating Cost Awareness
 Accountants and financial managers are concerned daily about cost implications of
decisions and activities, but many other managers are not.
 Production managers focus on input, marketing manager’s focuses on sales, and
so forth.
 All managers with budget responsibility must convert their plans for projects &
activities to costs and benefits.
 This cost awareness provides a common ground for communication among
various functional areas of the organization.

15. Challenges In Budget Administration
The budgeting process involves all levels of management
Budgets should not be administered rigidly
Attaining budget is not end in itself, especially when
conditions change dramatically

16. Components of Master Budget
Master budget is principal output of a budgeting system that shows a
comprehensive operating and financial plans of management.
The usual master budget for non-manufacturing company, for instance,
merchandising firm has the following components:

17. 1.Operating Budget (profit plan)
A. Sales budget
B. Purchases budget
C. Cost of goods sold budget
D. Operating expenses budget
E. Budgeted income statement
2. Financial Budget
F. Capital budget
G. Cash budget
H. Budgeted balance sheet
I. Budgeted cash flow statement

18. 1. Operating Budget (Profit Plan)
Focuses on income statement & its supporting schedules & used to budget expenses
in organization or agency with no sales revenue & may show a budgeted loss
Budgeting process normally begins with preparation of operating budgets.
It is prepared by individual sections within company & becomes part of company’s
master budget.
Number of operating budgets depends on nature of business entity.
For instance, some operating budgets prepared for manufacturing companies may
not be required for merchandising concerns.

19. A. Sales Budget
It is starting point for budgeting b/c inventory levels, purchases & operating
expenses are geared to rate of sales activities & other cost drivers.
It is detailed schedule showing expected sales for budget period.
Expressed in both sales birr & units of product
Accurate sales budget is key to entire budgeting process.
All of other parts of master budget are dependent on sales budget.

20. Sales budget is done sloppily or messily, then rest of budgeting process
is largely a waste of time.
To prepare sales budget, budgeted cash sales & budgeted credit sales
information of original data are used & that this information can be
obtained from marketing department or any other sales forecast related
units.
Total Budgeted sales= Budgeted cash sales + Budgeted credit sales

21. B. Cash Collection Budget
Cash collection is prepared at same time of preparing sales budget.
After sales budget is prepared, cash collections budget is prepared to show
how much cash is expected to be received from customers.
It include to current month’s cash sales plus previous month’s credit sales to
be collected in current month.
Cash collection budget = Previous period credit sales that collected in
current period + Current period cash sales

22. C. Purchases Budget
 It is prepared to show amount of goods to be purchased from suppliers during
period.
 After sales budget is prepared, inventory purchases budget is prepared to show
amount of inventory that will be needed to satisfy amount of projected sales.
 Meeting sales demand requires having enough inventories to cover expected sales
& future sales between reorder points.
 Total amount of inventory needed for each month = amount needed to fulfill
budgeted sales demand plus desired ending inventory.

23. January February March Quarterly
Budgetedcostsofgoodssold BirrXX BirrXX BirrXX BirrXX
Add:Desiredendinginventory BirrXX BirrXX BirrXX BirrXX
Totalinventoryneeded BirrXX BirrXX BirrXX BirrXX
Less:Beginninginventory BirrXX BirrXX BirrXX BirrXX
Requiredpurchases BirrXXXX BirrXXXX BirrXXXX BirrXXXX

24. D. Disbursement For Purchase Budget
 It is based on purchases budget and needed to prepare overall cash budget.
 Disbursements for inventory purchases consist of payments for purchases on account made in
prior periods plus any payment for inventory purchases made in current budget period.
 Total disbursements for purchases = Accounts payable-beginning balance + current period
purchases
E. Operating Expenses Budget
 It lists budgeted operating expenses for budget period.
 All budgeted selling and administrative expenses would be compiled and listed down.
 For example, marketing manager in large organization would submit budget detailing advertising
expenses for each budget period.

25.  Budgeting of operating expenses depends on various factors.
 Month-to-month fluctuations in sales volume & other cost-driver activities directly
influence many operating expenses.
 Other expenses are not influenced by sales or other cost-driver activity, & such
expenses include rent, insurance, depreciation, & salaries within appropriate relevant
ranges & are regarded as fixed.
 Operating expenses budget does not contain a provision for interest expense,
because amount of interest expense cannot be determined until amount of expected
borrowing has been established through preparation of the cash budget.
 Operating expense budget, needed to prepare the budgeted income statement.

26. ABC Company
Operating Expense Budget
For the Quarter Ended December 31, 20XX
Months
Quarters
January February March
Salaries & wages Birr XX Birr XX Birr XX Birr XX
Advertising Birr XX Birr XX Birr XX Birr XX
Shipping Birr XX Birr XX Birr XX Birr XX
Depreciation Birr XX Birr XX Birr XX Birr XX
Other expenses Birr XX Birr XX Birr XX Birr XX
Total budgeted operating
expenses
Birr XXXX Birr XXXX Birr XXXX Birr XXXX

27. E. Disbursements For Operating Expenses Budget
 It is based on operating expenses budget.
 For e.g. if information available states that cash expenses are paid as incurred it means that all
cash expenses incurred in first month will be paid in that month
 Depreciation expense is not included in cash disbursements for operating expenses, because
depreciation is a non-cash expense.
 Cash outflow for investments in plant assets is shown as an investing activity at the time cash is
paid to purchase plant assets.
 At this time, investing activity will be shown on a separate line on cash budget.
 Depreciation is recognized as expense by rationally & systematically allocating cost of plant assets
over their useful life.
 Such allocation, however, does not represent expense that calls for payment of cash.

28. ABC Company
Cash Disbursements for Operating Expense Budget
For the Quarter Ended December 31, 20XX
Months
Quarters
January February March
Salaries and wages Birr XX Birr XX Birr XX Birr XX
Advertising Birr XX Birr XX Birr XX Birr XX
Shipping Birr XX Birr XX Birr XX Birr XX
Other expenses Birr XX Birr XX Birr XX Birr XX
Disbursements for
operating expenses
Birr XXXX Birr XXXX Birr XXXX Birr XXXX

29. G. Budgeted Income Statement
It is one of key schedules in budget process.
It shows company’s planned profit for upcoming budget period & it
stands as benchmark against which subsequent company performance
can be measured.
Income statement will be complete after addition of interest expense,
which is computed after the cash budget, has been prepared.

30. Budgeted income statement
 Interest expense will be computed later when cash budget is prepared. Main reason why budgeted income statement is
prepared before the cash budget is to show that ultimate output of operating budgets is Performa or budgeted income
ABC Company
Budgeted Income Statement
For the Quarter Ended December 31, 20XX
Sales Birr XX
Less cost of goods sold Birr XX
Gross margin Birr XX
Less operating expenses:
Salaries and wages Birr XX
Advertising Birr XX
Shipping Birr XX
Depreciation Birr XX
Other expenses Birr XX
Total operating expenses Birr XX
Net operating income Birr XX
Less interest expense Birr XX
Net income Birr XX

31. 2. Financial Budget
1. Capital Budget
2. Cash Budget
3. Budgeted Balance Sheet
4. Budgeted statement of cash flows

32. Financial Budget
It consists capital budget, cash budget, budgeted balance sheet, & budgeted
statement of cash flows.
Capital expenditure budget or capital budget is a very important budget as it throws
light on a firm’s outlay & expansion & diversification program.
This budget may not be restricted to a single year & may be prepared to cover long
period of years.
While preparing this budget, factors such as sales potential for increased
production, possibility of price reduction, & increased selling & administrative costs
are to be considered.

33. Capital expenditure budget enables firm to establish a system of
priorities, and serves as a tool for controlling expenditure.
It also facilitates cost reduction program particularly when
modernization and renovation is covered by this budget.
The financial budget focuses on effects that operating budget
and other plans (such as capital budgeting and repayment of
debt) will have on cash.

34. A.Capital Budget
 Prepared for additions to property and equipment.
 This budget is used to describe a company’s long-term plans regarding investment in
facilities, equipment, new products, store outlets, and lines of business.
B. Cash Budget
 Prepared to ensure that cash will be available throughout the budget year.
 Once operating budgets have been established, cash budget & other financial budgets
can be prepared.
 A cash budget is a detailed plan showing how cash resources will be acquired and used
over some specified time period.

35. All of operating budgets have impact on cash budget.
In case of sales budget, impact comes from planned cash receipts to be collected from sales to
customers.
In case of other budgets, impact comes from planned cash expenditures within budgets
themselves.
Cash budget is statement of planned cash receipts and disbursements and pulls together much of
data developed in the preceding steps.
Most of raw data needed to prepare cash budget are included in cash receipts and disbursements
schedules.
However, further refinements of these data are sometimes necessary.
The cash budget is composed of four major sections listed below

36. 1. Receipts Section: Consists of listing of all of cash inflows, except for financing, expected
during budget period.
 Generally, major source of receipts will be from sales.
2. Disbursements Section: Consists of all cash payments that are planned for budget period.
 These payments will include raw materials purchases, direct labor payments, manufacturing
overhead costs, operating expenses, and so on, as contained in their respective budgets.
 In addition, other cash disbursements such as equipment purchases, dividends, and other
cash withdrawals by owners are listed.
 This additional information that does not appear on any of earlier schedules.
3. Cash Excess or Deficiency Section. The cash excess or deficiency is computed as follows:

37.  If there is a cash deficiency during any budget period, the company will need to borrow funds.
 If there is cash excess during any budget period, funds borrowed in previous periods can be
repaid or idle funds can be placed in short-term or other investments.
4. Financing Section.
 This section provides a detailed account of borrowings and repayments projected to take place
during the budget period.
 It also includes a detail of interest payments that will be due on money borrowed.
Cash Balance, Beginning Birr XX
Add Cash Received Birr XX
Total cash available before financing Birr XX
Less disbursement Birr XX
Excess (deficiency) of cash Birr XX

38. The following points are worth mentioning about the cash budget
A. Cash balance, beginning. It is taken from original information given or
available
Ending cash balance of December becomes beginning cash balance of January.
Moreover, beginning cash balance for quarter means same as beginning cash
balance for January, b/c quarter begins on January 1.
B. Collections from customers.: Collections from customers are brought from
schedule of expected cash collections.

39. Cont..
C. Purchases of inventory: Figures for purchases of inventory are taken from
schedule of expected cash disbursements for purchases.
D. Operating expenses. Figures for operating expenses are taken from schedule of
expected cash disbursements for operating expenses.
E. Purchases of equipment & cash dividends. Figures for purchases of equipment
are taken from information given or available & figure for cash dividends.
F. Financing.

40. ABC Company
Cash Budget
For the Quarter Ended December 31, 20XX
Months
Quarters
January February March
Cash balance, beginning Birr XX - - Birr XX
Add Cash Received
Collection from customers Birr XX Birr XX Birr XX Birr XX
Total cash available [a] Birr XX Birr XX Birr XX Birr XX
Less disbursements:
Purchases of inventory Birr XX Birr XX Birr XX Birr XX
Operating expenses Birr XX Birr XX Birr XX Birr XX
Purchases of equipment - Birr XX Birr XX Birr XX
Cash dividends Birr XX - - Birr XX
Total disbursements [b] Birr XX Birr XX Birr XX Birr XX
Excess (deficiency) of cash [c] = [a] + [b] Birr XX Birr XX Birr XX Birr XX
Financing:
Borrowings (at beginning) Birr XX - - Birr XX
Repayments (at ending) - - Birr XX Birr XX
Interest - - Birr XX Birr XX
Total financing [d] Birr XX - Birr XX Birr XX
Cash balance, ending [e] = [c] + [d] Birr XXXX
Birr
XXXX
Birr
XXXX
Birr
XXXX

41. C. Budgeted Balance Sheet
 Financial budgets are concerned with inflows and outflow of cash, which may be detailed in
cash budget and showing expected financial position at end of budget period in budgeted
balance sheet.
 Preparation of operating budget should precede preparation of financial budget because many
of financing activities are not known until the operating budgets are known.
 The budgeted balance sheet projects each balance sheet item in accordance with business plan
as expressed in the previous schedules.
 To construct budgeted balance sheet, start with general ledger account balances as of
December and adjust each balance sheet account balance for changes expected to take place
during period

42. ABC Company
Budgeted Balance Sheet
December 31, 20XX
Assets
Current assets:
Cash Birr XX
Accounts receivable Birr XX
Inventory Birr XX
Total current assets Birr XX
Plant assets:
Building and equipment (net) Birr XX
Total Assets (Current asset + Plant asset) Birr XX
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable Birr XX
Stockholders’ equity:
Capital stock Birr XX
Retained earnings Birr XX
Total stockholders’ equity Birr XX
Total Liabilities and Stockholders’ Equity Birr XXX

43. Figures Contained in Budgeted Balance Sheet.
A. Cash: Figure for cash is brought from cash budget prepared before and shows
ending cash balance for month of March or for quarter in general
B. Accounts Receivable: Figure for A/R represents credit sales expected to be made
in March (I.e from schedule of expected cash collections).
C. Inventory: Figure for inventory is brought from inventory purchases budget
schedule and shows desired ending inventory for month of March or for the
quarter in general.
D. Plant assets (net): Figure for plant assets (net) is computed from acquisition cost of

44. E. Accounts payable: Figure for A/P represents amount of inventory
purchases & other items acquired on account in March.
F. Capital stock: Figure for capital stock is taken as it is directly from
information given on general ledger account balances as of date of
incorporation & any other paid in capital in excess of par value.
G. Retained earnings: Figure for retained earnings is computed projected
retained earnings and adding it to net income projected and deducting
dividends to paid.

45. Next Lesson Illustration
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