Master Budgets and Planning

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

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Master Budgets and Planning

Chapter

2323


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Learning objectivesLearning objectives

1. Budget Process

2. Budget Administration

3. Master Budget

4. Decision Analysis:

• Activity-Based Budget


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Advantages

Communicates plansand instructions

Promotes analysis anda focus on the future

Motivates employees

Provides a basis forevaluating performance against

past or expected results

Coordinatesbusiness activities

Defines goalsand objectives

1. Budget Process1. Budget Process


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Consists of managers from all departmentsof the organization.

Provides central guidance to insure that individual budgets submitted from all

departments are realistic and coordinated.

2. Budget Administration - Budget Committee2. Budget Administration - Budget Committee


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Flow of Budget Data is a bottom-up process.

S u p erv iso r S u p erv iso r

M id d leM a na ge m e nt

S u p erv iso r S u p erv iso r

M id d leM a na ge m e nt

T o p M an a ge m e nt

Budget CommitteeBudget Committee


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1999 2000 2001 2002

Operating Budget

The annual operating budget may be divided into quarterly

or monthly budgets.

Budget TimingBudget Timing


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Continuous or Rolling Budget

The budget may be a twelve-month budget that rolls forward one month as the current month is completed.

1999 2000 2001 2002

Budget TimingBudget Timing


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3. Master Budget - Master Budget Components3. Master Budget - Master Budget Components

Salesbudget

MerchandisePurchases

Prepare financial budgets: cash income balance sheet

Preparecapital

expenditurebudget

Prepareselling and

generaladministrative

budgets


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SalesBudget

EstimatedUnit Sales

EstimatedUnit Price

Analysis of economic and market conditions

+Forecasts of customer needs from marketing personnel

3. Master Budget - Sales Budget3. Master Budget - Sales Budget


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In September 2005, Hockey Den sold 700 hockey sticks at $100 each.

Hockey Den prepared the following sales budget for the next four months:

Sales BudgetSales Budget


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HOCKEY DENMonthly Sales Budget

October 2005 – January 2006

Budgeted Budgeted BudgetedUnit Sales Unit Price Total Sales

September 2005 (actual) 700 100$ 70,000$

October 2005 1,000 100$ 100,000$ November 2005 800 100 80,000 December 2005 1,400 100 140,000 Total 3,200 100$ 320,000$

January 2006 900 100$ 90,000$

Sales BudgetSales Budget Exh. 23-6


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The quantity purchased is affected by:

Just-in-time inventory systems that enable purchases of smaller, frequently

delivered quantities.

Safety stock inventory systems that provide protection against lost sales

caused by delays in supplier shipments.

3. Master Budget - Merchandise Purchases Budget3. Master Budget - Merchandise Purchases Budget


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Hockey Den buys hockey sticks for $60.00 each and maintains an ending inventory equal to 90 percent of the next month’s budgeted sales. 900 hockey sticks are on

hand on September 30.

Inventoryto be

purchased=

Budgetedending

inventory+

Budgeted cost of salesfor the period

–Budgetedbeginninginventory

Let’s prepare the purchases budget for Hockey Den.

Merchandise Purchases BudgetMerchandise Purchases Budget Exh. 23-7


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HOCKEY DENMerchandise Purchases BudgetOctober 2005 – December 2005

October November DecemberNext month's unit sales 800 1,400 900 Ending inventory percentage × 90% × 90% × 90%Budgeted ending inventory units 720 1,260 810 Add current month's unit salesTotal units neededDeduct beginning inventory unitsNumber of units to be purchasedBudgeted cost per unitBudgeted cost of purchases



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October November DecemberNext month's unit sales 800 1,400 900 Ending inventory percentage × 90% × 90% × 90%Budgeted ending inventory units 720 1,260 810 Add current month's unit sales 1,000 800 1,400 Total units needed 1,720 2,060 2,210 Deduct beginning inventory unitsNumber of units to be purchasedBudgeted cost per unitBudgeted cost of purchases



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October November DecemberNext month's unit sales 800 1,400 900 Ending inventory percentage × 90% × 90% × 90%Budgeted ending inventory units 720 1,260 810 Add current month's unit sales 1,000 800 1,400 Total units needed 1,720 2,060 2,210 Deduct beginning inventory units 900 Number of units to be purchased 820 Budgeted cost per unit × $ 60Budgeted cost of purchases 49,200$

Beginning inventory is last month's ending inventory.



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October November DecemberNext month's unit sales 800 1,400 900 Ending inventory percentage × 90% × 90% × 90%Budgeted ending inventory units 720 1,260 810 Add current month's unit sales 1,000 800 1,400 Total units needed 1,720 2,060 2,210 Deduct beginning inventory units 900 720 1,260 Number of units to be purchased 820 1,340 950 Budgeted cost per unit × $ 60 × $ 60 × $ 60Budgeted cost of purchases 49,200$ 80,400$ 57,000$

Beginning inventory is last month's ending inventory.



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Let’s prepare the sales budget for Hockey Den.

Hockey Den pays sales commissions equal to 10 percent of total sales.

Hockey Den pays a monthly salary of $2,000 to its sales manager.

3. Master Budget - Selling Expense Budget3. Master Budget - Selling Expense Budget


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HOCKEY DENSelling Expense Budget

October 2005 – December 2005

October November December TotalBudgeted sales 100,000$ 80,000$ 140,000$ 320,000$ Sales commission % × 10% × 10% × 10% × 10%Sales commission 10,000$ 8,000$ 14,000$ 32,000$ Sales manager salary 2,000 2,000 2,000 6,000 Total selling expenses 12,000$ 10,000$ 16,000$ 38,000$

From Hockey Den’s sales budget

Selling Expense BudgetSelling Expense Budget Exh. 23-9


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Let’s prepare the general and administrativeexpense budget for Hockey Den.

General and administrative salaries are $4,500 per month.

Depreciation of equipment is $1,500 per month.

3. Master Budget - General and Administrative Expense Budget3. Master Budget - General and Administrative Expense Budget


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HOCKEY DENGeneral and Administrative Expense budget


October November December TotalAdministrative salaries 4,500$ 4,500$ 4,500$ 13,500$ Equipment depreciation 1,500 1,500 1,500 4,500 Total 6,000$ 6,000$ 6,000$ 18,000$

General and Administrative Expense BudgetGeneral and Administrative Expense Budget

Exh. 23-10


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CashBudget

ExpectedReceipts

andDisbursements

BudgetedIncome

Statement

BudgetedBalance

Sheet

3. Master Budget - Financial Budgets3. Master Budget - Financial Budgets


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Forty percent of Hockey Den’s sales are for cash.

The remaining sixty percent are credit sales that are collected in full in the month following sale.

Let’s prepare the cash receipts budget for Hockey Den.

Budgeted Cash ReceiptsBudgeted Cash Receipts


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HOCKEY DENCash Receipts Budget


September October November DecemberBudgeted sales 70,000$ 100,000$ 80,000$ 140,000$

Accounts receivable

Cash receipts from:Cash sales Collection of receivablesTotal cash receipts

60 percent of September sales are collected in October

From Hockey Den’s sales budget

Budgeted Cash ReceiptsBudgeted Cash Receipts Exh. 23-12


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Accounts receivable 42,000$ 60,000$ 48,000$ 84,000$

Cash receipts from:Cash sales 40,000$ 32,000$ 56,000$ Collection of receivablesTotal cash receipts

40% of sales60% of sales



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Accounts receivable 42,000$ 60,000$ 48,000$ 84,000$

Cash receipts from:Cash sales 40,000$ 32,000$ 56,000$ Collection of receivables 42,000 60,000 48,000 Total cash receipts 82,000$ 92,000$ 104,000$



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Hockey Den’s purchases of merchandise are entirely on account.

Full payment is made in the month following purchase.

The September 30 balance of Accounts Payable is $58,200.

Let’s look at cash disbursementsfor purchases for Hockey Den.

Cash Disbursements for PurchasesCash Disbursements for Purchases


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HOCKEY DENCash Disbursements for Purchases

October 2005 - December 2005

October payments (September 30 balance) 58,200$ November payments (October purchases) 49,200 December payments (November purchases) 80,400

From merchandise purchases budget

Cash Disbursements for PurchasesCash Disbursements for Purchases Exh. 23-13


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Hockey Den:

Will pay a cash dividend of $3,000 in November.

Will purchase $25,000 of equipment in December.

Has an income tax liability of $20,000 from the previous quarter that will be paid in October.

Has a September 30 cash balance of $20,000.

Has an agreement with its bank for loans at the end of each month to enable a minimum cash balance of $20,000.

Continue

Cash BudgetCash Budget


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Hockey Den:

Pays interest equal to one percent of the prior month’s ending loan balance.

Repays loans when the ending cash balance exceeds $20,000.

Owes $10,000 on this loan arrangement on September 30.

Has 40 percent income tax rate.

Will pay taxes for current quarter next year.

Let’s prepare the cash budget for Hockey Den.

Cash BudgetCash Budget


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HOCKEY DENCash Budget


October November DecemberBeginning cash balance 20,000$ Receipts from customers 82,000 92,000 104,000 Total cash available 102,000$ DisbursementsPayments for merchandiseSales commissionsSales salariesAdministrative salariesIncome taxesDividendsInterestEquipment purchaseTotal disbursementsPreliminary balance

From Cash Receipts Budget

Exh. 23-11


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October November DecemberBeginning cash balance 20,000$ Receipts from customers 82,000 92,000 104,000 Total cash available 102,000$ DisbursementsPayments for merchandise 58,200$ 49,200$ 80,400$ Sales commissionsSales salariesAdministrative salariesIncome taxesDividendsInterestEquipment purchaseTotal disbursementsPreliminary balance

From Cash Disbursementsfor Purchases

Exh. 23-11


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October November DecemberBeginning cash balance 20,000$ Receipts from customers 82,000 92,000 104,000 Total cash available 102,000$ DisbursementsPayments for merchandise 58,200$ 49,200$ 80,400$ Sales commissions 10,000 8,000 14,000 Sales salaries 2,000 2,000 2,000 Administrative salariesIncome taxesDividendsInterestEquipment purchaseTotal disbursementsPreliminary balance

From Selling Expense Budget

Exh. 23-11


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October November DecemberBeginning cash balance 20,000$ Receipts from customers 82,000 92,000 104,000 Total cash available 102,000$ DisbursementsPayments for merchandise 58,200$ 49,200$ 80,400$ Sales commissions 10,000 8,000 14,000 Sales salaries 2,000 2,000 2,000 Administrative salaries 4,500 4,500 4,500 Income taxesDividendsInterestEquipment purchaseTotal disbursementsPreliminary balance

From General andAdministrative Expense Budget

Depreciation is anon-cash expense.

Exh. 23-11


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October November DecemberBeginning cash balance 20,000$ Receipts from customers 82,000 92,000 104,000 Total cash available 102,000$ DisbursementsPayments for merchandise 58,200$ 49,200$ 80,400$ Sales commissions 10,000 8,000 14,000 Sales salaries 2,000 2,000 2,000 Administrative salaries 4,500 4,500 4,500 Income taxes 20,000 DividendsInterest 100 Equipment purchaseTotal disbursements 94,800$ Preliminary balance 7,200$

.01 × $10,000

Because Hockey Denmaintains a minimum

cash balance of $20,000,the company must

borrow $12,800.

Exh. 23-11


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October November DecemberPreliminary balance 7,200$ Additional borrowing 12,800 Loan repaymentEnding cash balance 20,000$

Ending loan balance 22,800$

Ending cash balance for October is the beginning November balance.

Cash Budget ContinuedCash Budget Continued Exh. 23-11


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October November DecemberBeginning cash balance 20,000$ 20,000$ Receipts from customers 82,000 92,000 104,000 Total cash available 102,000$ 112,000$ DisbursementsPayments for merchandise 58,200$ 49,200$ 80,400$ Sales commissions 10,000 8,000 14,000 Sales salaries 2,000 2,000 2,000 Administrative salaries 4,500 4,500 4,500 Income taxes 20,000 Dividends 3,000 Interest 100 228 Equipment purchaseTotal disbursements 94,800$ 66,928$ Preliminary balance 7,200$ 45,072$

.01 × $22,800

Exh. 23-11

Cash balanceis sufficientto repay the

$22,800 loan.


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October November DecemberPreliminary balance 7,200$ 45,072$ Additional borrowing 12,800 Loan repayment (22,800) Ending cash balance 20,000$ 22,272$

Ending loan balance 22,800$ $ 0

Ending cash balance for November is the beginning December balance.



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October November DecemberBeginning cash balance 20,000$ 20,000$ 22,272$ Receipts from customers 82,000 92,000 104,000 Total cash available 102,000$ 112,000$ 126,272$ DisbursementsPayments for merchandise 58,200$ 49,200$ 80,400$ Sales commissions 10,000 8,000 14,000 Sales salaries 2,000 2,000 2,000 Administrative salaries 4,500 4,500 4,500 Income taxes 20,000 Dividends 3,000 Interest 100 228 Equipment purchase 25,000 Total disbursements 94,800$ 66,928$ 125,900$ Preliminary balance 7,200$ 45,072$ 372$

Exh. 23-11


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October November DecemberPreliminary balance 7,200$ 45,072$ 372$ Additional borrowing 12,800 19,628 Loan repayment (22,800) Ending cash balance 20,000$ 22,272$ 20,000$

Ending loan balance 22,800$ $ 0 19,628$



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Let’s prepare the budgeted incomestatement for Hockey Den.

Cash Budget

BudgetedIncome

Statement

Complete

d

Budgeted Income StatementBudgeted Income Statement


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HOCKEY DENBudgeted Income Statement

For Three Months Ended December 31, 2005

Sales (3,200 units @ $100) 320,000$ Cost of goods sold (3,200 units @ $60) 192,000 Gross profit 128,000$ Operating expenses: Sales commissions 32,000$ Sales salaries 6,000 Administrative salaries 13,500 Equipment depreciation 4,500 Interest expense 328 56,328 Net income before taxes 71,672$ Income tax expense 28,669 Net income 43,003$

Exh. 23-14

From the Sales Budget


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From the Merchandise Purchases Budget

Exh. 23-14


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From the SellingExpense Budget

Exh. 23-14


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From the General and Administrative Expense Budget

Depreciation is a non-cash expense.

Exh. 23-14


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Sales (3,200 units @ $100) 320,000$ Cost of goods sold (3,200 units @ $60) 192,000 Gross profit 128,000$ Operating expenses: Sales commissions 32,000$ Sales salaries 6,000 Administrative salaries 13,500 Equipment depreciation 4,500 Interest expense 328 56,328 Net income before taxes 71,672$ Income tax expense 28,669 Net income 43,003$ From the Cash Budget

Exh. 23-14


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$71,672 × .40

Exh. 23-14


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Let’s prepare the budgeted balancesheet for Hockey Den.

BudgetedBalance

Sheet

Complete

d

BudgetedIncome

Statement

Budgeted Balance SheetBudgeted Balance Sheet


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Hockey Den reports the following account balances on September 30 prior to preparing its budgeted financial statements:Equipment $200,000Accumulated depreciation $ 36,000Common stock $150,000Retained earnings $ 41,800

Let’s prepare the budgeted balancesheet for Hockey Den.

Preparing a Budgeted Balance SheetPreparing a Budgeted Balance Sheet


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HOCKEY DENBudgeted Balance Sheet

December 31, 2005

AssetsCash 20,000$ Accounts receivable 84,000 Inventory 48,600 Equipment 225,000$ Less accumulated depreciation 40,500 184,500 Total assets 337,100$

Liabilities and EquityLiabilities Accounts payable 57,000$ Income taxes payable 28,669 Bank loan payable 19,628 105,297$ Stockholders' equity Common stock 150,000$ Retained earnings 81,803 231,803 Total liabilities and equity 337,100$

Exh. 23-15


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December 31, 2005



From the Cash Budget

Exh. 23-15


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December 31, 2005



From the Cash Receipts Budget

Exh. 23-15


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December 31, 2005



From the Merchandise Purchases Budget8,100 units @ $6

Exh. 23-15


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December 31, 2005



$200,000 September 30 balance plus the $25,000 December acquisition

Exh. 23-15


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December 31, 2005



$36,000 September 30 balance plus the $4,500 from the General and

Administrative Expense Budget

Exh. 23-15


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December 31, 2005



From the MerchandisePurchases Budget

Exh. 23-15


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December 31, 2005



From the Budgeted Income Statement

Exh. 23-15


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December 31, 2005



From the Cash Budget

Exh. 23-15


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December 31, 2005



Beginning retained earnings 41,800$ Add net income 43,003 Deduct dividends (3,000) Ending retained earnings 81,803$

Exh. 23-15


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4. Decision Analysis - Activity-Based Budgeting4. Decision Analysis - Activity-Based Budgeting

Activity-based budgeting is based on activities rather than traditional items such as salaries, supplies, depreciation, and utilities.

Exh. 23-16


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End of Chapter 23End of Chapter 23

Master Budgets and Planning

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