Chapter 7Chapter 7

The Master Budget and Flexible The Master Budget and Flexible BudgetingBudgeting

Learning ObjectivesLearning Objectives

LO1LO1 Explain the general principles involved in Explain the general principles involved in the budgeting process.the budgeting process.

LO2LO2 Identify and prepare the components of Identify and prepare the components of the the master budget.master budget.

LO3LO3 Identify and prepare components of the Identify and prepare components of the flexible budget.flexible budget.

LO4LO4 Explain the procedures to determine Explain the procedures to determine standard amounts of factory overhead at standard amounts of factory overhead at different levels of production.different levels of production.

Principles of BudgetingPrinciples of Budgeting

1.1. Define objectives.Define objectives.2.2. Set realistic, possible goals.Set realistic, possible goals.3.3. Carefully consider economic developments, the Carefully consider economic developments, the

general business climate, and the condition of the general business climate, and the condition of the industry.industry.

4.4. Constantly analyze the actual results as compared Constantly analyze the actual results as compared with the budget.with the budget.

5.5. Create a budget flexible enough to modify in the light Create a budget flexible enough to modify in the light of changing conditions.of changing conditions.

6.6. Clearly define the responsibility for forecasting costs Clearly define the responsibility for forecasting costs and the accountability for actual results.and the accountability for actual results.

Preparing the Master Preparing the Master BudgetBudget

MasterMaster or or static budgetstatic budget is prepared for is prepared for a single level of volume based on best a single level of volume based on best estimate of the level of production and estimate of the level of production and sales for the coming period.sales for the coming period.

The sales budget is the starting point.The sales budget is the starting point. From the sales budget, production From the sales budget, production

requirements are determined.requirements are determined.

Budgeted Income Budgeted Income StatementStatement

Sales budgetSales budget Cost of goods sold budgetCost of goods sold budget

Production budgetProduction budget Direct materials budgetDirect materials budget Direct labor budgetDirect labor budget Factory overhead budgetFactory overhead budget

Selling and administrative expenses Selling and administrative expenses budgetbudget

Sales BudgetSales Budget

This is the basis for This is the basis for preparing all other preparing all other budgets.budgets.

Projects the volume Projects the volume of sales both in units of sales both in units and dollars.and dollars.

Production BudgetProduction Budget

After the sales forecast and inventory levels After the sales forecast and inventory levels have been determined, management can have been determined, management can determine production requirements.determine production requirements.

Units to be soldUnits to be sold 100,000100,000

Ending inventory requiredEnding inventory required 4,5004,500

TotalTotal 104,500104,500

Beginning inventoryBeginning inventory 2,5002,500

Units to be manufacturedUnits to be manufactured 102,000102,000

Units per month (102,000/12)Units per month (102,000/12) 8,5008,500

Direct Materials BudgetDirect Materials Budget

The The direct materials budgetdirect materials budget is prepared is prepared once the production requirements have once the production requirements have been determined.been determined.

The desired ending inventory for each The desired ending inventory for each material is added to the quantity needed to material is added to the quantity needed to meet production needs, and that total is meet production needs, and that total is reduced by the estimated beginning reduced by the estimated beginning inventory to determine the amount of inventory to determine the amount of materials to be purchased.materials to be purchased.

Direct Labor BudgetDirect Labor Budget

The production The production requirements are used to requirements are used to prepare the prepare the direct labor direct labor budgetbudget..

Standard labor time Standard labor time allowed per unit is allowed per unit is multiplied by the number multiplied by the number of required units to of required units to obtain the total direct obtain the total direct manufacturing labor manufacturing labor hours.hours.

Factory Overhead BudgetFactory Overhead Budget

Consists of the estimated individual factory Consists of the estimated individual factory overhead items needed to meet production overhead items needed to meet production requirements.requirements.

Factory Overhead BudgetFactory Overhead Budget

Indirect materialsIndirect materials $225,000$225,000

Indirect laborIndirect labor 375,250375,250

Depreciation of buildingDepreciation of building 85,00085,000

Depreciation of machinery and Depreciation of machinery and equipmentequipment

67,50067,500

Total factory overhead costTotal factory overhead cost $$752,750752,750

Cost of Goods Sold Cost of Goods Sold BudgetBudget

Budget is prepared once the direct Budget is prepared once the direct material, direct labor, and factory material, direct labor, and factory overhead budgets have been completed.overhead budgets have been completed.

The estimated beginning inventories and The estimated beginning inventories and the desired ending inventories of WIP the desired ending inventories of WIP and Finished Goods are included to and Finished Goods are included to compute the cost of goods sold.compute the cost of goods sold.

Selling & Administrative Selling & Administrative Expenses BudgetExpenses Budget

The The selling and selling and administrative administrative expenses budgetexpenses budget may may be prepared once the be prepared once the sales forecast has been sales forecast has been made.made.

This budget has This budget has separate sections for separate sections for selling and selling and administrative expenses.administrative expenses.

Budgeted Income Budgeted Income StatementStatement

Once the preceding budgets have been Once the preceding budgets have been completed, the completed, the budgeted income budgeted income statementstatement may be prepared. may be prepared.

If the budgeted profit does not meet If the budgeted profit does not meet expectation, management may wish to expectation, management may wish to reevaluate their original expectations.reevaluate their original expectations.

Budgeted Balance SheetBudgeted Balance Sheet

Cash budgetCash budget Shows the anticipated cash flow and the timing of cash Shows the anticipated cash flow and the timing of cash

receipts and disbursements.receipts and disbursements. Accounts receivable budgetAccounts receivable budget

Based on anticipated sales, credit terms, the economy, Based on anticipated sales, credit terms, the economy, and other relevant factors.and other relevant factors.

Liabilities budgetLiabilities budget Reflects how the company’s cash position will be Reflects how the company’s cash position will be

affected by paying their liabilities.affected by paying their liabilities. Capital expenditures budgetCapital expenditures budget

A plan for the timing of acquisitions of buildings, A plan for the timing of acquisitions of buildings, equipment, or other significant assets during the period.equipment, or other significant assets during the period.

Flexible BudgetingFlexible Budgeting

A plan of what will happen to a company under A plan of what will happen to a company under varying sets of conditions.varying sets of conditions.

The company plans in advance what the effect The company plans in advance what the effect will be on revenue, expense, and profit if sales will be on revenue, expense, and profit if sales or production differ from the budget.or production differ from the budget.

Standard production is determined and the Standard production is determined and the initial calculation of variable and fixed costs is initial calculation of variable and fixed costs is based on this level of production.based on this level of production.

Preparing the Flexible Preparing the Flexible BudgetBudget

28,000 units28,000 units 30,000 30,000 unitsunits

32,000 units32,000 units

Sales ($150/unitSales ($150/unit $4,200,000$4,200,000 $4,500,000$4,500,000 $4,800,000$4,800,000

Direct materials:Direct materials:

Lumber ($20/unit)Lumber ($20/unit) 560,000560,000 600,000600,000 640,000640,000

Paint ($4/unit)Paint ($4/unit) 112,000112,000 120,000120,000 128,000128,000

Direct labor:Direct labor:

Cutting ($3.75/unit)Cutting ($3.75/unit) 105,000105,000 112,500112,500 120,000120,000

Assembly ($2.40/unit)Assembly ($2.40/unit) 67,20067,200 72,00072,000 76,80076,800

Variable FOH ($6.93/unit)Variable FOH ($6.93/unit) 194,040194,040 207,90207,9000 221,760221,760

Contribution MarginContribution Margin $3,161,760$3,161,760 $3,387,600$3,387,600 $3,613,440$3,613,440

Fixed FOH and S & A Fixed FOH and S & A expenseexpense

773,825773,825 773,825773,825 773,825773,825

Operating incomeOperating income $$2,387,9352,387,935 $$2,613,7752,613,775 $$2,839,6152,839,615

Performance Report Based Performance Report Based on Flexible Budgetingon Flexible Budgeting

Budget Budget

(28,000 units)(28,000 units)Actual Actual

(28,000 units)(28,000 units)VarianceVariance

Sales ($150/unit)Sales ($150/unit) $4,200,000$4,200,000 $4,250,000$4,250,000 $50,000 F$50,000 F

Direct materials:Direct materials:

Lumber ($20/unit)Lumber ($20/unit) 560,000560,000 585,000585,000 25,000 U25,000 U

Paint ($4/unit)Paint ($4/unit) 112,000112,000 108,000108,000 4,000 F4,000 F

Direct labor:Direct labor:

Cutting ($3.75/unit)Cutting ($3.75/unit) 105,000105,000 120,000120,000 15,000 U15,000 U

Assembly ($2.40/unit)Assembly ($2.40/unit) 67,20067,200 72,00072,000 4,800 U4,800 U

Variable FOH ($6.93/unit)Variable FOH ($6.93/unit) 194,040194,040 206,823206,823 12,763 U12,763 U

Contribution MarginContribution Margin $3,161,760$3,161,760 $3,158,177$3,158,177 $3,583 F$3,583 F

Fixed FOH and S & A expenseFixed FOH and S & A expense 773,825773,825 770,550770,550 3,275 F3,275 F

Operating incomeOperating income $$2,387,9352,387,935 $$2,387,6272,387,627 $$308 F308 F

Preparing the Flexible Preparing the Flexible Budget for Factory Budget for Factory OverheadOverhead

The standard production level must first The standard production level must first be determined.be determined.

The manufacturing capacity must be The manufacturing capacity must be determined.determined.

1.1. Theoretical capacityTheoretical capacity

2.2. Practical capacityPractical capacity

3.3. Normal capacityNormal capacity

Semifixed CostsSemifixed Costs

Semifixed costsSemifixed costs are are those that generally those that generally remain the same in remain the same in dollar amount dollar amount through a wide range through a wide range of activity, but of activity, but increase when increase when production exceeds production exceeds certain limits.certain limits.

Semivariable CostsSemivariable Costs

Semivariable costsSemivariable costs are those that may are those that may change with change with production but not production but not necessarily in direct necessarily in direct proportion.proportion.

Service Department Service Department Budgets and VariancesBudgets and Variances

Expenses are estimated at different levels of Expenses are estimated at different levels of production, a standard rate for application of production, a standard rate for application of service department expenses to production service department expenses to production departments is determined based on the type of departments is determined based on the type of service and usage by the production service and usage by the production departments.departments.

Production departments are charged with service Production departments are charged with service department expenses at a standard rate, using department expenses at a standard rate, using their actual activity base.their actual activity base.

Summary of the Summary of the Budgeting ProcessBudgeting Process

1 1 A Sales ForecastA Sales Forecast in units, considering the in units, considering the

2 2 Inventory PolicyInventory Policy,, minimum-maximum and stable or fluctuating, helps in minimum-maximum and stable or fluctuating, helps in developing thedeveloping the

3 3 Production PlanProduction Plan in units and by periods. in units and by periods.

This information aids in developing theThis information aids in developing the

4(a) Requirements for 4(a) Requirements for Direct MaterialsDirect Materials

(quantities and prices)(quantities and prices)

4(b) Requirements for 4(b) Requirements for Direct LaborDirect Labor

(hours and rates)(hours and rates)

4(c) Requirements for 4(c) Requirements for Indirect Costs, Indirect Costs,

Facilities, and SuppliesFacilities, and Supplies

(fixed and variable costs)(fixed and variable costs)

From this information is developed theFrom this information is developed the

5(a) Direct Materials 5(a) Direct Materials BudgetBudget

5(b) Direct Labor 5(b) Direct Labor BudgetBudget

5(c) Factory Overhead 5(c) Factory Overhead BudgetBudget

From these budgets are developed theFrom these budgets are developed the

6(a) Standard Unit Cost 6(a) Standard Unit Cost for Direct Materialsfor Direct Materials

6(b) Standard Unit Cost 6(b) Standard Unit Cost for Direct Laborfor Direct Labor

6(c) Standard Unit Cost 6(c) Standard Unit Cost for Factory Overheadfor Factory Overhead

(These combined figures determine the (These combined figures determine the Standard Unit Cost for the ProductStandard Unit Cost for the Product.).)