Topic 2: Master Budget (Profit Plan)

Master Budget

Consists of a number of separate but interdependent budgets that formally lay out the companys sales, production, financial goals.

It culminates in a cash budget, a budgeted income statement, and a budgeted balance sheet.

Importance of master budget in a companys operations

It is used as a tool for financial planning and allows everyone in the organization to manage financial situations more effectively and efficiently.

Allows the company management to see how the actions of different departments feed throughout the organization.

Allows the company to realistically project future cash flows which would help in getting certain types of financing.

It maps out budget targets and can be used to identify areas of a business operations which need to be adjusted in order to bring them in line with the budget.

Components of a Master Budget

Operating Budget Comprise of the individual budgets that result in the

preparation of the budgeted income statement.

They establish goals for the companys sales and

production personnel.

Financial Budget Focus primarily on the cash resources needed to fund expected operations and

planned capital expenditures.

Parts of an operating budget

Sales budget Cash collection budget * Production budget Direct materials budget Cash disbursements budget * Direct labor budget Manufacturing overhead budget Ending finished goods inventory budget Operating expenses (SAE) budget Cost of goods sold budget Budgeted income statement

Those without * are supporting schedules to

create the budgeted income

statement (those with *

are supporting schedules to

create the cash budget)

Parts of a financial budget

Cash budget

Budgeted statement of financial position or budgeted balance sheet

Budget for capital expenditures

Operating budget components: Sales budget

The first step in the budgeting process, it is the key to the entire budgeting process.

This budget is derived from a sales forecast, the latter of which shows potential sales for the industry and the companys expected share of such sales.

It involves a consideration of various factors: general economic conditions, industry trends, market research studies, anticipated advertising and promotion, previous market share, changes in prices, and technological development.

Total Sales = Expected unit sales x Unit sales

P1 P2 P3 P4 Total Budgeted sales in units xxx xxx xxx xxx xxx x) Unit selling price xxx xxx xxx xxx xxx Total sales xxx xxx xxx xxx xxx

Making a sales budget:

Midwest Products sells its products for $100 per unit. For the third quarter , it estimates that it will sell 6000 units in July, 9,000 units in August, and 5,000 units in September. Construct the sales budget for the third quarter.

Operating budget components: Cash collection budget

Shows how much cash is collected (on sales) during a particular period.

P1 P2 P3 P4 TOTAL A/R beginning balance xxx xxx Sales in P1 xxx xxx xxx Sales in P2 xxx xxx xxx Sales in P3 xxx xxx xxx Sales in P4 xxx xxx Total cash collections xxx xxx xxx xxx xxx *assuming that sales per period is collected within the period of sale and the immediate period after the sale. *the uncollected balance from sales in P4 will become the A/R, end in the companys balance sheet.

Making a cash collection budget (Exercise 7-1)

Midwest Products is a wholesale distributor of leaf rakes. Thus, peak sales occur in August of each year as shown in the companys sales budget for the 3rd quarter given below:

Jul Aug Sept Total

Budgeted sales (all on account) 600k 900k 500k 2,000k

From past experience, the company has learned that 20% of a months sales are collected in the month of sale, another 70% are collected in the month following sale, and the remaining 10% are collected in the second month following sale. Bad debts are negligible and can be ignored. May sales totaled P430,000 and June sales totaled P540,000.

1. Prepare a schedule of expected cash collections from sales, by month and in total, for the 3rd quarter.

2. Assume that the company will prepare a budgeted balance sheet as of September 30. Compute the accounts receivable as of that date.

Operating budget components: Inventory purchases budget (Merchandising)

Shows the amount of goods to be purchased from suppliers during the period.

Required Purchases = Budgeted CGS + Desired Ending merchandise inventory Beginning merchandise inventory

Budgeted cost of goods sold xxx

+) Desired ending merchandise inventory xxx

Total needs xxx

) Beginning merchandise inventory xxx

Required purchases xxx

Making a purchases budget Concept Check (pg.294)

If a company has a beginning merchandise inventory of $50,000, a desired ending merchandise inventory of $30,000 and a budgeted CGS of $300,000, what is the amount of required inventory purchases?

Operating budget components: Production budget (Manufacturing)

Shows the number of units of a product to produce to meet anticipated sales demand.

Required Production Units = Budgeted sales units + Desired Ending Finished Goods Inventory in units Beginning Finished Goods Inventory in units

Budgeted unit sales xxx

+) Desired ending inventory of finished goods xxx

Total needs xxx

) Beginning inventory of finished goods xxx

Required production xxx

Making a production budget (Exercise 7-2)

Crystal Telecom has budgeted the sales (in units) of its innovative mobile phone over the next four months as follows: July 30,000, August 45,000, September 60,000, and October 50,000. The company is now in the process of preparing a production budget for the third quarter. Past experience has shown that end of month finished goods inventories must equal 10% of the next months sales. Prepare a production budget for the third quarter showing the number of units to be produced each month and for the quarter in total.

Operating budget components: Direct materials budget

Prepared after the production requirements have been computed. It details the raw materials that must be purchased to fulfill the production budget and to provide for adequate inventories.

Required production in units of finished goods xxx Times raw materials required per unit of finished goods xxx Raw materials needed to meet the production schedule xxx +) Desired ending raw materials inventory xxx Total raw material needs xxx ) Beginning raw materials inventory xxx Raw materials to be purchased xxx Times unit cost of raw materials xxx Cost of raw materials to be purchased xxx

Cash disbursement budget Shows how much cash is budgeted to be spend or disbursed (for

material purchases) during a particular period.

Making a direct materials budget (Exercise 7-3)

Micro Products Inc. has developed a very powerful electronic calculator. Each calculator requires three small chips that cost $2 each and are purchased form an overseas supplier. Micro Products has prepared a production budget for the calculator by quarters for Year 2 and for the first quarter of Year 3, as shown below:

Budgeted production, in calculators: Year 2 Q1 60,000 Year 3 Q1 80,000 Q2 90,000 Q3 150,000 Q4 100,000

The chip used in production of the calculator is sometimes hard to get, so it is necessary to carry large inventories as a precaution against stockouts. For this reason, the inventory of chips at the end of a quarter must equal 20% of the following quarters production needs.

Prepare a direct materials budget for chips, by quarter and in total, for Year 2. At the bottom of your budget, show the dollar amount of purchases for each quarter and for the year in total.

Operating budget components: Direct labor budget

Shows the direct labor hours required to satisfy the production budget

Total direct labor cost = Units to be produced x Direct labor time per unit x Direct labor cost per hour

Required production in units xxx

x) Direct labor hour per unit xxx

Total direct labor hours needed xxx

x) Direct labor cost per hour xxx

Total direct labor cost xxx

Making a direct labor budget (Exercise 7-4)

The production manager of Junnen Corporation has submitted the following forecast of units to be produced for each quarter of the upcoming fiscal year:

Q1 Q2 Q3 Q4

Units to be produced 5,000 4,400 4,500 4,900

Each unit requires 0.40 direct labor hours and direct labor hour workers are paid $11 per hour.

REQUIREMENT 1

Construct the companys direct labor budget for the upcoming fiscal year, assuming that the direct labor workforce is adjusted each quarter to match the number of hours required to produce the forecasted number of units produced.

Making a direct labor budget (Exercise 7-4)

REQUIREMENT 2:

Construct the company direct labor budget for the upcoming fiscal year, assuming that the direct labor workforce is not adjusted each quarter. Instead, assume that the companys direct labor workforce consists of permanent employees who are guaranteed to be paid for at least 1,800 hours of work each quarter. If the number of required direct labor hours is less than this number, the workers are paid for 1,u00 hours anyway. Any hours worked in excess of 1,800 hours in a quarter are paid at a rate of 1.5 times the normal hourly rate for direct labor.

Operating budget components: Manufacturing overhead budget

Lists all costs of production other than direct materials and direct labor.

Budgeted direct labor hours xxx x) Variable manufacturing overhead rate xxx Variable manufacturing overhead xxx +) Fixed manufacturing overhead xxx Total manufacturing overhead xxx ) Depreciation xxx Cash disbursements for manufacturing overhead xxx Total manufacturing overhead xxx Divided by budgeted direct labor hours xxx Predetermined overhead rate for the year xxx

Making a manufacturing overhead budget (Exercise 7-5)

The direct labor budget of Krispin Corporation for the upcoming fiscal year includes the following budgeted direct labor hours: Q1: 5,000 Q3: 5,200 Q2: 4,800 Q4: 5,400 The companys variable manufacturing overhead rate is $1.75 per direct labor hour and the companys fixed manufacturing overhead is $35,000 per quarter. The only noncash item included in fixed manufacturing overhead is depreciation, which is P15,000 per quarter. Construct the companys manufacturing overhead budget for the upcoming fiscal year. Compute the companys manufacturing overhead rate (including both variable and fixed manufacturing overhead) for the upcoming fiscal year.

Operating budget components: Ending finished goods inventory budget

Calculates the cost of finished goods inventory at the end of each budget period. Unit product cost is computed to determined the cost of goods sold and to know how much the unsold units are worth.

Ending finished goods inventory = Ending finished goods units x total cost per unit

Making an ending finished goods inventory budget (Page 299 Schedule 6)

Hampton Freeze Inc. estimates that it needs 3,000 cases of its product as ending inventory. The production cost per case are as follows: Direct materials 15 lbs @ 0.20 per pound Direct labor 0.40 hours @ $15 per hour MOH 0.40 hours @ $10 per hour Construct the companys ending finished goods inventory in dollars.

Operating budget components: Operating (Selling and Administrative) expense

budget

Lists the budgeted expenses for areas other than manufacturing and in large organizations, is a compilation of many smaller, individual budgets submitted by department heads and other persons responsible for selling and administrative expenses.

Making a selling and administrative expense budget (Exercise 7-6)

The budgeted unit sales of Haerve Company for the upcoming fiscal year are provided below: Q1 Q2 Q3 Q4 12,000 14,000 11,000 10,000 The companys variable selling and administrative expenses per unit are $2.75. Fixed selling and administrative expenses include advertising expenses of $12,000 per quarter, executive salaries of $40,000 per quarter, and depreciation of $16,000 per quarter. In addition, the company will make insurance payments of $6,000 in the 2nd Quarter and $6,000 in the 4th Quarter. Finally, property taxes of $6,000 will be paid in the 3rd Quarter. Prepare the companys selling and administrative expense budget for the upcoming fiscal year.

Operating budget components: Budgeted income statement

Indicates the overall profitability of operations for the budget period and serves as a benchmark against which subsequent company performance can be measured.

Making a budgeted income statement (Exercise 7-8)

Seattle Cat is the wholesale distributor of a small recreational catamaran sailboat. Management has prepared the following summary data to use in its annual budgeting process: Budgeted unit sales 380 Selling price per unit $1,850 Cost per unit $1,425 Variable selling and admin expenses (per unit) $85 Fixed selling and admin expenses (per year) $105,000 Interest expense for the year $11,000 Prepare the companys budgeted income statement using an absorption income statement format.

Financial budget components: Cash budget

Shows anticipated cash flows. This is considered as the most important financial budget because cash is so vital. It is composed of four sections: receipts, disbursements, cash excess or deficiency, and financing.

Receipts Lists all cash inflows except from financing expected from the budget

period.

Disbursements Summarizes all cash payments that are planned for the budget

period.

Cash excess or deficiency Beg. Cash + receipts = Total cash available disbursements = excess

(deficiency) of cash available over disbursements.

Financing Shows expected borrowings and repayment of the borrowed funds +

interest

Making a cash budget (Exercise 7-7)

Forest Outfitters is a retailer that is preparing its budget for the upcoming fiscal year. Management has prepared the following summary of its budgeted cash flows: Q1 Q2 Q3 Q4 Total cash receipts $340k $670k $410k $470k Total cash disbursements $530k $450k $430k $480k The companys beginning cash balance for the upcoming fiscal year will be $50,000. The company requires a minimum cash balance of $30,000 and may borrow any amount needed from a local bank at a quarterly interest rate of 3%. The company may borrow any amount at the beginning of any quarter and may repay its loans, or any part of its loans, at the end of any quarter. Interest payments are due on any principal at the time it is repaid. Prepare the companys cash budget for the upcoming fiscal year.

Financial budget components: Budgeted statement of financial position

A projection of financial position at the end of the budget period and is also known as budgeted balance sheet.

Making a budgeted balance sheet (Exercise 7-9)

The management of Academic Copy, a photocopying center located on University Avenue has compiled the following data to use in preparing its budgeted balance sheet for next year: Ending Balances (in $) Cash ? Accounts receivable 6,500 Supplies inventory 2,100 Equipment 28,000 Accumulated depreciation 9,000 Accounts payable 1,900 Common stock 4,000 Retained earnings ? The beginning balance of retained earnings was $21,000, net income is budgeted to be $8,600, and dividends are budgeted to be $3,500. Prepare the companys budgeted balance sheet.

Sample Comprehensive Problem Lotte Company is preparing budgets for the second quarter ending June 30, 2013. The budgeted sales of the companys only product for the next five months are as follows:

April 20,000 units June 30,000 units August 15,000

May 50,000 units July 25,000 units

The selling price is P10 per unit. All sales are on account. The company collects 70% of these credit sales in the month of sale, 25% are collected in the month following the sale, and the remaining 5% are uncollectible. The accounts receivable on March 31, 2013 was P30,000. All of this balance was collectible.

The company desires to have inventory on hand at the end of each month equal to 20% of the following months budgeted unit sales. On March 31, 2013, 4,000 units were on hand. In addition, 5 pounds of materials are required per unit of product. Management desires to have materials on hand at the end of each month equal to 10% of the following months production needs. The beginning materials inventory was 13,000 pounds. The materials cost P0.40 per pound. Each unit produced requires 0.05 hour of direct labor. Each hour of direct labor costs the company P10. Management fully adjusts the workforce to the workload each month.

Half of a months purchases are paid for in the month of purchase, and the other half is paid for in the following month. No discounts are given for early payment. The accounts payable on March 31, 2013 was P12,000.

Variable manufacturing overhead is P20 per direct labor hour. Fixed manufacturing overhead is P50,500 per month. This includes P20,500 in depreciation. Lotte Company uses absorption costing in its budgeted income statement and balance sheet. Manufacturing overhead is applied to units of product on the basis of direct labor hours. The company has no work in process inventories.

Sample Comprehensive Problem

Variable selling and administrative expenses are P0.50 per unit sold. Fixed selling and administrative expenses are P70,000 per month and include P10,000 in depreciation.

A line of credit is available at a local bank that allows the company to borrow up to P75,000. All borrowing occurs at the beginning of the month, and all repayments occur at the end of the month. The interest is 1% per month. The company does not have to make any payments until the end of the quarter.

Lotte desires a cash balance of at least P30,000 at the end of each month. The cash balance at the beginning of April was P40,000. Cash dividends of P51,000 are to be paid to stockholders in April. Equipment purchases of P143,700 are scheduled for May and P48,800 for June. The equipment will be installed and tested during the second quarter and will not become operational during July, when depreciation charges will commence.

Beginning balances for the following balance sheet items are:

Raw materials inventory P5,200 Accumulated depreciation P750,000

Finished goods inventory P20,000 Common stock P200,000

Land P400,000 Retained earnings P1,143,200

Buildings and equipment P1,610,000

Required:

Prepare a master budget for Lotte Company, along with all the necessary supporting schedules.

International aspects of budgeting

Exchange rate fluctuations.

High inflation rates in some countries.

Economic conditions abroad.

Government policies abroad.

Other Short Problems

Short problems:

Philip Company collects 20% of a months sales in the month of sale, 70% in the month following sale, and 6% in the second month following sale. The remainder is uncollectible. Budgeted sales for the next four months are: January 200,000 March 350,000 February 300,000 April 250,000 What is the budgeted cash collections in the month of April?

Short problems:

Alex Inc. manufactures and sells box trailers for semi trucks. Each trailer requires two axles. For next quarter, Alex has scheduled 720 trailers for production and 750 for sale. Alex is also moving to just-in-time purchasing next quarter and plans on reducing its inventory of trailer axles by 100. How many axles should Alex budget for purchase for next quarter?

Short problems:

Darna Corporation is working on its direct labor budget for the next two months. Each unit of output requires 0.41 direct labor-hours. The direct labor rate is $8.10 per direct labor-hour. The production budget calls for producing 5,000 units in May and 5,400 units in June. If the direct labor work force is fully adjusted to the total direct labor-hours needed each month, what would be the total combined direct labor cost for the two months?

Short problems:

The manufacturing overhead budget at Finn Corporation is based on budgeted direct labor-hours. The direct labor budget indicates that 5,800 direct labor-hours will be required in May. The variable overhead rate is $9.10 per direct labor-hour. The company's budgeted fixed manufacturing overhead is $104,400 per month, which includes depreciation of $8,120. All other fixed manufacturing overhead costs represent current cash flows. The company recomputes its predetermined overhead rate every month. The predetermined overhead rate for May should be:

Short problems:

The selling and administrative expense budget of Chase Corporation is based on budgeted unit sales, which are 4,600 units for August. The variable selling and administrative expense is $7.30 per unit. The budgeted fixed selling and administrative expense is $51,980 per month, which includes depreciation of $6,440 per month. The remainder of the fixed selling and administrative expense represents current cash flows. The cash disbursements for selling and administrative expenses on the August selling and administrative expense budget should be:

Short problems:

Vee makes all sales on account, subject to the following collection pattern: 20% are collected in the month of sale; 70% are collected in the first month after sale; and 10% are collected in the second month after sale. If sales for October, November, and December were $70,000, $60,000, and $50,000, respectively, what was the budgeted receivables balance on December 31?

Short problems:

The beginning cash balance is $20,000. Sales are forecasted at $800,000 of which 80% will be on credit. 70% of credit sales are expected to be collected in the year of sale. Cash expenditures for the year are forecasted at $500,000. Accounts receivable from previous accounting periods totaling $12,000 will be collected in the current year. The company is required to make a $20,000 loan payment and an annual interest payment on the last day of the year. The loan balance as of the beginning of the year is $120,000, and the annual interest rate is 10%.

Short problems: X Co. manufactures toy airplanes. Information on X Co.s labor costs follow:

Sales commissions $5 per plane Administration $10,000 per month Indirect factory labor $3 per plane Direct factory labor $5 per plane The following information applies to the upcoming month of July for X Co.: Budgeted production 1,200 units Budget sales 1,000 units

What amount of budgeted labor cost would appear in the July selling, general, and administrative expense budget?