- The document discusses the importance of budgeting for businesses. It describes how budgets help with planning, control, and formalizing expectations. - Budgeting involves both planning for the future and controlling results by comparing actual to planned outcomes. The master budget is the comprehensive financial plan that includes operating and financial budgets. - Key components of the operating budget include sales, production, materials, labor, overhead, expenses, and inventory budgets. These are used to create a budgeted income statement. The financial budgets include cash flow and projected balance sheet.

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Budgeting

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Description of Budgeting
►All businesses should prepare budgets.
►Budgets help business owners and managers to
plan ahead, and later, exercise control by
comparing what actually happened to what was
expected in the budget.
►Budgets formalize managers’ expectations
regarding sales, prices, and costs.
►Even small businesses and nonprofit entities can
benefit from the planning and control provided
by budgets.
1

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Budgeting and Planning and Control
►Planning and control are linked.
►Planning is looking ahead to see what actions should be taken to
realize particular goals.
►Control is looking backward, determining what actually happened
and comparing it with the previously planned outcomes.
►Budgets are financial plans for the future and are a key
component of planning. They identify objectives and the actions
needed to achieve them.
►Before preparing a budget, an organization should develop a
strategic plan.
►The strategic plan plots a direction for an organization’s future
activities and operations; it generally covers at least five years.
1

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Advantages of Budgeting
1
A budgetary system gives an organization
several advantages.
Planning
Information for Decision Making
Standards for Performance
Evaluation
Improved Communication
& Coordination

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The Master Budget
►The master budget is the comprehensive financial plan
for the organization as a whole.
►Typically, the master budget is for a one-year period,
corresponding to the fiscal year of the company.
►Yearly budgets are broken down into quarterly and
monthly budgets.
►The use of smaller time periods allows managers to
compare actual data with budgeted data more
frequently, so problems may be noticed and resolved
sooner.
1

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Master Budget:
Major Components
►A master budget can be divided into operating and financial
budgets:
►Operating budgets describe the income-generating activities of a
firm: sales, production, and finished goods inventories. The ultimate
outcome of the operating budgets is a pro forma or budgeted
income statement.
►Financial budgets detail the inflows and outflows of cash and the
overall financial position. Planned cash inflows and outflows appear
in the cash budget. The expected financial position at the end of the
budget period is shown in a budgeted, or pro forma, balance sheet.
►Since many of the financing activities are not known until
the operating budgets are known, the operating budget is
prepared first.
1

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The Master Budget and
Its Interrelationships
1

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Preparing the Operating Budget
►The operating budget consists of a budgeted income
statement accompanied by the following supporting
schedules:
►sales budget
►production budget
►direct materials purchases budget
►direct labor budget
►overhead budget
►selling and administrative expenses budget
►ending finished goods inventory budget
►cost of goods sold budget
2

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Sales Budget
►The sales budget is approved by the budget committee
and describes expected sales in units and dollars.
►Because the sales budget is the basis for all of the other
operating budgets and most of the financial budgets, it
is important that it be as accurate as possible.
►The first step in creating a sales budget is to develop the
sales forecast.
►The sales forecast is just the initial estimate, and it is
often adjusted by the budget committee.
2

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2
Cornerstone 9-1
Preparing a Sales Budget

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Production Budget
►The production budget tells how many units must be
produced to meet sales needs and to satisfy ending
inventory requirements.
►To compute the units to be produced, both unit sales
and units of beginning and ending finished goods
inventory are needed:
Units to be produced = Expected unit sales + Units in
desired ending inventory (EI) – Units in beginning
inventory (BI)
2

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2
Cornerstone 9-2
Preparing a Production Budget

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2
Cornerstone 9-2
Preparing a Production Budget (continued)

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Direct Materials Purchases Budget
►After the production budget is completed, the budgets
for direct materials, direct labor, and overhead can be
prepared.
►The direct materials purchases budget tells the amount
and cost of raw materials to be purchased in each time
period.
►The formula used for calculating purchases is as follows:
2

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2
Cornerstone 9-3
Preparing a Direct Materials Purchases
Budget

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2
Cornerstone 9-3
Preparing a Direct Materials Purchases Budget
(continued)

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2
Cornerstone 9-3
Preparing a Direct Materials Purchases Budget
(continued)

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Direct Labor Budget
►The direct labor budget shows the total direct
labor hours and the direct labor cost needed for
the number of units in the production budget.
►As with direct materials, the budgeted hours of
direct labor are determined by the relationship
between labor and output.
2

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2
Cornerstone 9-4
Preparing a Direct Labor Budget

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Overhead Budget
►The overhead budget shows the expected cost of all
production costs other than direct materials and
direct labor.
►Many companies use direct labor hours as the driver
for overhead.
►Then costs that vary with direct labor hours are
pooled and called variable overhead.
►The remaining overhead items are pooled into fixed
overhead.
2

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Cornerstone 9-5
Preparing an Overhead Budget
2
Information:
Refer to the direct labor budget below. The variable overhead rate is $5
per direct labor hour. Fixed overhead is budgeted at $1,645 per quarter
(this amount includes $540 per quarter for depreciation).
Required:
Prepare an overhead budget.

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Cornerstone 9-5
Preparing an Overhead Budget (continued)
2
Solution:

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Ending Finished Goods Inventory
Budget
►The ending finished goods inventory budget
supplies information needed for the balance sheet
and also serves as an important input for the
preparation of the cost of goods sold budget.
►To prepare this budget, the unit cost of producing
finished goods must be calculated by using
information from the direct materials, direct labor,
and overhead budgets.
2

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2
Cornerstone 9-6
Preparing an Ending
Finished Goods Inventory Budget
Information:
Refer to the direct materials, direct labor,
and overhead budgets prepared previously
and shown here.

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2
Cornerstone 9-6
Preparing an Ending
Finished Goods Inventory Budget (continued)

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Cost of Goods Sold Budget
►Assuming that the beginning finished
goods inventory is valued at $1,251, the
budgeted cost of goods sold schedule
can be prepared using information from
Cornerstones 9-3 to 9-6.
►The cost of goods sold budget reveals
the expected cost of the goods to be
sold.
2

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2
Cornerstone 9-7
Preparing a Cost of Goods Sold Budget

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Selling and Administrative
Expenses Budget
►The selling and administrative expenses budget
outlines planned expenditures for nonmanufacturing
activities.
►As with overhead, selling and administrative
expenses can be broken down into fixed and variable
components.
►Such items as sales commissions, freight, and
supplies vary with sales activity.
2

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2
Cornerstone 9-8
Preparing a Selling and Administrative
Expenses Budget
Information:
Refer to the sales budget below. Variable expenses are $0.10 per unit sold. Salaries
average $1,420 per quarter; utilities, $50 per quarter; and depreciation, $150 per
quarter. Advertising for Quarters 1 through 4 is $100, $200, $800, and $500,
respectively.
Required:
Prepare a selling and administrative expenses budget.

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2
Cornerstone 9-8
Preparing a Selling and Administrative
Expenses Budget (continued)

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Budgeted Income Statement
►With the completion of the budgeted cost of
goods sold schedule and the budgeted selling
and administrative expenses budget, a
company has all the operating budgets
needed to prepare an estimate of operating
income.
2

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Preparing the Financial Budget
►The remaining budgets found in the master
budget are the financial budgets.
►The usual financial budgets prepared are:
►cash budget
►budgeted balance sheet
►budget for capital expenditures
3

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2
Cornerstone 9-9
Preparing a Budgeted Income Statement
Information:
Refer to Cornerstones 9-1, 9-7, 9-8, and 9-12 for the sales budget, the cost of
goods sold budget, the selling and administrative expenses budget, and the cash
budget. Assume that the tax rate is 40 percent.
Required:
Prepare a budgeted income statement.

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Cash Budget
► Understanding cash flows is critical in managing a business.
► Often, a business successfully produces and sells products but fails
because of timing problems associated with cash inflows and
outflows.
► Because cash flow is the lifeblood of an organization, the cash
budget is one of the most important budgets in the master budget.
► The basic structure of a cash budget includes cash receipts,
disbursements, any excess or deficiency of cash, and financing as
shown below:
3

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Cash Budget: Cash Available
►Cash available consists of the beginning cash balance and the
expected cash receipts. Expected cash receipts include all
sources of cash for the period being considered.
►The principal source of cash is from sales.
►Since a large proportion of sales is usually on account, a major
task of an organization is to determine the pattern of
collection for its accounts receivable.
►If a company has been in business for a while, it can use past
experience to determine what percentage of credit sales are
paid in the month of and months following sales.
►This is used to create a schedule of cash collections on
accounts receivable.
3

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Cornerstone 9-10
Preparing a Schedule for Cash Collections
on Accounts Receivable
3
Information:
From past experience, Texas Rex expects that, on average, 25 percent of total sales
are cash and 75 percent of total sales are on credit. Of the credit sales, Texas Rex
expects that 90 percent will be paid in cash during the quarter of sale, and the
remaining 10 percent will be paid in the following quarter. Recall from Cornerstone
9-1 that Texas Rex expects the following total sales:
Quarter 1 $10,000
Quarter 2 $12,000
Quarter 3 $15,000
Quarter 4 $20,000
The balance in accounts receivable as of the last quarter of 2011 was $1,350. This
will be collected in cash during the first quarter of 2012.
Required:
1. Calculate cash sales expected in each quarter of 2012.
2. Prepare a schedule showing cash receipts from sales expected in each quarter of
2012.

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Cornerstone 9-10
Preparing a Schedule for Cash Collections
on Accounts Receivable (continued)
3

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Cash Budget:
Cash Disbursements
►The cash disbursements section lists all planned cash outlays
for the period.
►All expenses that do not require a cash outlay are excluded
from the list (e.g., depreciation is never included in the
disbursements section).
►Just as sources of cash may require a schedule of cash
collections on accounts receivable to calculate cash expected
from credit sales, the disbursements section may require care
in handling payments on account.
3

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Cornerstone 9-11
Determining Cash Payments
on Accounts Payable
3

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Cornerstone 9-11
Determining Cash Payments
on Accounts Payable (continued)
3

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Cash Budget:
Cash Excess or Deficiency
►Some companies expand the basic cash budget format by
adding lines to show any borrowing or repayment necessary
to achieve a minimum desired cash amount.
►When this is done, the preliminary ending cash balance is
called cash excess or deficiency.
►The cash excess or deficiency line is compared to the
minimum cash balance (or lowest amount of cash acceptable
as noted by company policy).
►If a cash deficiency exists with less cash on hand than is
needed, the company usually obtains a short-term loan.
►A cash excess is usually used to repay loans or used to make
temporary investments.
3

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Cash Budget: Borrowings and Repayments,
Ending Cash Balance
►Borrowings and Repayments: If a company converts its
preliminary cash balance line to a cash excess (deficiency)
line, it may be borrowing or repaying money. If there is a
deficiency, this section shows the necessary amount to be
borrowed. When excess cash is available, this section shows
planned repayments, including interest expense.
►Ending Cash Balance: The last line of the cash budget is the
ending cash balance. This is the planned amount of cash to be
on hand at the end of the period after all receipts and
disbursements, as well as borrowings and repayments, are
considered.
3

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Cornerstone 9-12
Preparing a Cash Budget
3

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Cornerstone 9-12
Preparing a Cash Budget (continued)
3