Master BudgetFlexible Budget and Performance Analysis

7.1 Master Budget

After studying Master Budget, you should be able to:

Define budgeting and other terminologies Describe the purposes of budgeting Identify different types of budget period Understand budget sample committee Explain the budget management process Understand the master budget cycle and its preparation

What is a Budget?

o A budget is a financial plan of the resources needed to carry out tasks and meet financial goals. It is also the quantitative expression of the goals the organization wishes to achieve and the cost of attaining these goals.

o Budgeting is the act of preparing a budget.o Master Budget is a summary of all phases of a company’s plans and goals for the

future.o Budget committee is responsible for coordinating the preparation of the budget.o Planning involves developing objectives and preparing various budgets to achieve

the goals.o Control involves the steps taken by management to ensure that the objectives set

down at the planning stage are attained and to ensure that all parts of the organization function in a manner consistent with organizational policies.

An effective budgeting system must include both planning and control.

The Purposes of the Budget

• Defining broad objectives and goals;

• Coordinating the activities of the organization;

• Allocating resources;

• Communicating management’s approved plans;

• Uncovering and preparing for potential bottleneck in the operations before they occur;

• Motivating managers to achieve the desired results; and

• Setting a standard or benchmark for evaluating actual performance.

Types of Budget Period

• Master budget is usually prepared on a quarterly or an annual basis.

• Capital budget is for major expenditures for equipment or addition of product line and might cover as long as 5 – 10 years.

• Responsibility budget which are segments of the master budget relating to the aspect of business that is the responsibility of a particular manager are often prepared monthly.

• Cash budget may be prepared on a day-to-day or monthly basis.

Sample Budget Committee

The Budget Management Process 1. The top management will inform middle management about upcoming budget activities.

2. The middle management will then call the attention of the budget committee.

3. A budget committee with representation from the different functional areas is generally considered an effective body to oversee budget policies, preparation and administration.

4. The Controller or Chief Finance Officer may be selected to serve as head of the committee and coordinates the budgeting operation throughout the organization.

5. The budget committee decides how budgets shall be prepared, passes on the final budget ,and settles disputes in one segment of the business and another when differences of opinion arise.

6. Before submission of department’s budget, the budget committee will conduct budget hearing. The middle management will then decide whether to approve or reject as per resources and time.

7. The committee receives the approved budget report of different areas and arrange the plan based on the top priority.

8. Upon implementation, the CFO will then distribute financial resources.

9. Department heads must monitor and evaluate every projects.

Master Budget - Sales Budget Schedule

The first step in developing the master budget.

Modern Mountain Enterprise

Sales Budget

For the Year Ending December 31, 20x2

Quarter

1st 2nd 3rd 4th Year

Sales in units

5,000

15,000 20,000 10,000 50,000

Unit sales price

225 225 225 225 225 Total sales revenue

1,125,000

3,375,000

4,500,000

2,250,000

11,250,000

Master Budget - Production Budget Schedule Shows the number of units of services or goods that

are to be produced during a budget period.

Modern Mountain Enterprise

Production Budget

For the Year Ending December 31, 20x2

Quarter

1st 2nd 3rd 4th Year

Sales in units (Schedule 1)

5,000 15,000 20,000 10,000 50,000

Add: Desired ending inventory finished goods

1,500 2,000 1,000 500 500

Total units required

6,500 17,000 21,000 10,500 50,500

Less: Expected beginning inventory finished goods

500 1,500 2,000 1,000 500

Units to be produced

6,000 15,500 19,000 9,500 50,000

Master Budget – Direct Materials Budget Schedule Shows the number of units and the cost of material to be

purchased and used during a budget period.

Modern Mountain EnterpriseDirect Materials Budget

For the Year Ending December 31, 20x2Quarter

Raw Materials A - Tent Fabric 1st 2nd 3rd 4th Year

Tents or units to be produced (Schedule 2) 6,000 15,500 19,000 9,500 50,000

Raw Materials per unit yards of fabric 12 12 12 12 12

Raw Materials required for production 72,000 186,000 228,000 114,000 600,000

Add: Desired ending inventory of raw materials 18,600 22,800 11,400 7,200 7,200

Total raw materials required 90,600 208,800 239,400 121,200 607,200

Less: Expected beg. inventory of raw materials 7,200 18,600 22,800 11,400 7,200

Raw materials to be purchased 83,400 190,200 216,600 109,800 600,000

Cost per yard 9 9 9 9 9

Total raw materials purchases 750,600 1,711,800 1,949,400 988,200 5,400,000

Raw Materials B - Tent Poles

Tents to be produced (Schedule 2) 6,000 15,500 19,000 9,500 50,000

Poles kits required per tent 1 1 1 1 1

Tent pole kits to be purchased 6,000 15,500 19,000 9,500 50,000

Cost per tent pole kit 20 20 20 20 20

Total cost of tent pole kit purchases 120,000 310,000 380,000 190,000 1,000,000

Total cost of raw materials purchases 870,600 2,021,800 2,329,400 1,178,200 6,400,000

Master Budget – Direct Labor Budget ScheduleShows the number of hours and the cost of the direct labor

to be used during the budget period.

Modern Mountain EnterpriseDirect Labor Budget

For the Year Ending December 31, 20x2Quarter

1st 2nd 3rd 4th YearUnits to be produced (Schedule 2) 6,000 15,500 19,000 9,500 50,000 Direct labor required per unit 0.5 0.5 0.5 0.5 0.5Total direct labor hours required 3,000 7,750 9,500 4,750 25,000 Direct labor cost per hour 15 15 15 15 15 Total direct labor cost 45,000 116,250 142,500 71,250 375,000

Please Note:The company is using part-time laborers for seasonal demand and production. This is the strategy used by the company and direct labor may be adjusted up and down to meet short term needs. Since employees are on a part-time basis, it will fall under unit-level cost which is variable cost. But if employees were retained even with low production, it will fall under facility and general level cost which is fixed cost.

Master Budget - Manufacturing Overhead Budget Schedule Shows the cost of overhead expected to be incurred in the

production process during the budget period.Quarter

1st 2nd 3rd 4th YearUnit Level CostUnits (Schedule 2) 6,000 15,500 19,000 9,500 50,000 Indirect Material 18,000 46,500 57,000 28,500 150,000 Electricity for Machinery 6,000 15,500 19,000 9,500 50,000

Total unit level cost 24,000 62,000 76,000 38,000 200,000 Batch Level CostProduction Runs 12 31 38 19 100 Setup at $400 per run 4,800 12,400 15,200 7,600 40,000 Purchasing and material handling at $600 per run 7,200 18,600 22,800 11,400 60,000 Quality control and inspection at $500 per run 6,000 15,500 19,000 9,500 50,000

Total batch level cost 18,000 46,500 57,000 28,500 150,000 Product Level CostNew tent designs 1 1 1 1 4 Design Engineering 1,200 1,200 1,200 1,200 4,800

Total product level cost 1,200 1,200 1,200 1,200 4,800 Facility and general operation level costSupervisory salaries 52,500 52,500 52,500 52,500 210,000 Insurance and property taxes 11,300 11,300 11,300 11,300 45,200 Maintenance 47,500 47,500 47,500 47,500 190,000 Utilities 40,000 40,000 40,000 40,000 160,000 Depreciation 110,000 110,000 110,000 110,000 440,000

Total facility and general operation level cost 261,300 261,300 261,300 261,300 1,045,200 Total overhead 304,500 371,000 395,500 329,000 1,400,000 Less: Depreciation 110,000 110,000 110,000 110,000 440,000

Total cash disbursement for overhead 194,500 261,000 285,500 219,000 960,000

Master Budget Schedule – SGA Expense Budget Schedule Shows the planned amounts of expenditures for selling, general

and administrative expenses during the budget period.

Modern Mountain EnterpriseSelling, General, and Administrative Expense Budget

For the Year Ending December 31, 20x2Quarter

1st 2nd 3rd 4th YearUnit Level ExpensesUnits (Schedule 1) 5,000 15,000 20,000 10,000 50,000 Sales commissions 6,250 18,750 25,000 12,500 62,500

Total unit level expense 6,250 18,750 25,000 12,500 62,500 Customer level ExpensesSales personnel salaries 16,000 16,000 16,000 16,000 64,000 Computer operator salaries 18,000 18,000 18,000 18,000 72,000 Telephone operator salaries 6,000 6,000 6,000 6,000 24,000

Total customer level expenses 40,000 40,000 40,000 40,000 160,000 Facility and general operation level expensesSales manager's salary 15,000 15,000 15,000 15,000 60,000 Media Advertising 61,000 61,000 61,000 61,000 244,000 Administrative salaries 220,000 220,000 220,000 220,000 880,000 Total facility and general operation level expenses 296,000 296,000 296,000 296,000 1,184,000

Total SGA Expenses 342,250 354,750 361,000 348,500 1,406,500

Master Budget Schedule – Cash Receipts Budget Schedule Details the expected cash collections during a budget period.

Modern Mountain EnterpriseCash Receipts Budget

For the Year Ending December 31, 20x2Quarter

1st 2nd 3rd 4th Year

Sales Revenue (Schedule 1) 1,125,000

3,375,000 4,500,000 2,250,000

11,250,000 Collections in quarter of sale (80% of revenue) 900,000

2,700,000 3,600,000

1,800,000

9,000,000

Collections in quarter following sale (18% of prior quarter's revenue) 405,000 202,500 607,500

810,000

2,025,000

Total Cash Receipts 1,305,000

2,902,500 4,207,500

2,610,000

11,025,000

Quarter1st 2nd 3rd 4th Year

Expected uncollectible accounts (2% of revenue) 22,500

67,500 90,000

45,000

225,000

Master Budget - Cash Disbursement Budget Schedule Details the expected cash payment during a budget period.

Modern Mountain EnterpriseCash Disbursements Budget

For the Year Ending December 31, 20x2Quarter

1st 2nd 3rd 4th YearCost of raw materials purchases (Schedule 3) 870,600 2,021,800 2,329,400 1,178,200 6,400,000 Cash payments for purchases made during the quarter (60% of current quarter's purchases) 522,360 1,213,080 1,397,640 706,920 3,840,000 Cash payment for prior quarter's purchases (40% of prior quarter purchases) 471,280 348,240 808,720 931,760 2,560,000 Total Cash Purchases for raw materials purchases 993,640 1,561,320 2,206,360 1,638,680 6,400,000

Other Cash DisbursementsDirect Labor (Schedule 4) 45,000 116,250 142,500 71,250 375,000 Unit Level Cost (Schedule 5) 24,000 62,000 76,000 38,000 200,000 Batch and Product Level Cost (Schedule 5) 19,200 47,700 58,200 29,700 154,800 Facility and general operations (Schedule 5) 151,300 151,300 151,300 151,300 605,200 Unit Level Expenses (Schedule 6) 6,250 18,750 25,000 12,500 62,500 Customer Level Expenses (Schedule 6) 40,000 40,000 40,000 40,000 160,000 Facility and general operations (Schedule 6) 296,000 296,000 296,000 296,000 1,184,000 Total Other Cash Disbursements 581,750 732,000 789,000 638,750 2,741,500

Total Cash Disbursements 1,575,390 2,293,320 2,995,360 2,277,430 9,141,500

Master Budget - Cash Budget Schedule Details the expected cash receipts and disbursements during a budget period.

Modern Mountain Enterprise

Cash Budget

For the Year Ending December 31, 20x2

Quarter

1st 2nd 3rd 4th Year

Cash receipts (Schedule 7) 1,305,000 2,902,500 4,207,500 2,610,000 11,025,000

Less: Cash disbursement (Schedule 8) 1,575,390 2,293,320 2,995,360 2,277,430 9,141,500

Change in cash balance during quarter due to operations (270,390) 609,180 1,212,140 332,570 1,883,500

Proceeds from bank loan (1/2/x2) 1,000,000 1,000,000

Payments for construction of plant addition (500,000) (120,000) (80,000) (300,000) (1,000,000)

Repayment of principal on bank loan (end of each quarter) (250,000) (250,000) (250,000) (250,000) (1,000,000)

Interest on bank at 10% per year (25,000) (18,750) (12,500) (6,250) (62,500)

Change in cash balance during the year 821,000

Cash balance 1/1/x2 10,000

Cash balance 12/31/x2 831,000

Master Budget – COGMS Budget Schedule Details the direct material, direct labor, and manufacturing-overhead costs to be

incurred and shows the cost of the goods to be sold during the budget period.Modern Mountain Enterprise

Budgeted Cost of Goods and Manufactured and SoldFor the Year Ending December 31, 20x2

Direct materials (Schedule 3 for details): Raw materials inventory Jan. 1 (7,200 yards per fabric x $9 per yard)

64,800

Add: Purchases (Schedule 3)

6,400,000

Raw materials available for use

6,464,800

Less: Raw material inventory Dec. 31

64,800

Direct materials used

6,400,000

Direct labor (Schedule 4)

375,000

Manufacturing overhead (Schedule 5)

1,400,000

Total manufacturing cost

8,175,000 Add: Work in process Jan. 1 -

Subtotal

8,175,000 Less: Work in process Dec. 31 -

Cost of goods manufactured

8,175,000 Add: Finished goods inventory Jan. 1 (Schedule 2 - beg and end are the same)

81,750

Cost of goods available for sale

8,256,750

Less: Finished goods inventory Dec. 31 (500 units x $163.50)

81,750

Cost of goods sold

8,175,000

Type of manufacturing cost Amount

Materials, Tent fabric (Schedule 3: 12 x $9 per yard) 108.00

Materials, Tent poles (Schedule 3: 1 x $20 per kit) 20.00

Labor (Schedule 4: 0.5 x $15 per hour) 7.50

Unit level M. Overhead (Schedule 5: 200,000/50,000 units) 4.00

Batch level M. Overhead (Schedule 5: 150,000/50,000 units) 3.00

Product level M. Overhead (Schedule 5: 4,800/50,000 units) 0.10

Facility level M. Overhead (Schedule 5: 1,045,200/50,000 units) 20.90

Total absorption cost per unit 163.50

Modern Mountain EnterpriseManufacturing Cost Schedule

For the Year Ending December 31, 20x2

Master Budget – Budgeted Income Statement Schedule Shows the expected revenue and expenses for the budget period,

assuming that planned operations are carried out.

Modern Mountain Enterprise

Budgeted Income Statement

For the Year Ending December 31, 20x2

Sales revenue (Schedule 1) 11,250,000

Less: Cost of goods sold (Schedule 10) 8,175,000

Gross margin 3,075,000

Other expenses:

Selling, general, and administrative expenses (Schedule 6) 1,406,500

Uncollectible account expense (Schedule 7: 2% x 11,250,000) 225,000

Interest expense (Schedule 9) 62,500

Total other expenses 1,694,000

Net Income 1,381,000

Master Budget – Budgeted Cash Flow Schedule Provides information about the expected sources and uses of cash for operating, investing,

and financing activities during a particular period of time.

Modern Mountain EnterpriseBudgeted Statement of Cash Flows

For the Year Ending December 31, 20x2Cash flows from operating activities:Cash receipts from customers (Schedule 7) 11,025,000 Cash paymentsTo suppliers of raw materials (Schedule 8) 6,400,000 For direct labor (Schedule 4) 375,000 For manufacturing overhead expenditures (Schedule 5) 960,000 For selling, general, and administrative expenses (Schedule 6) 1,406,500 For interest (Schedule 9) 62,500 Total cash payments 9,204,000

Net cash flow from operating activities 1,821,000 Cash flow from investing activities:

Construction of building addition (Schedule 9) (1,000,000)Net cash used by investing activities: (1,000,000)

Cash flow from financing activities: Principle of bank loan 1,000,000 Repayment of bank loan (1,000,000)Net cash provided by financing activities - Net increase in cash and cash equivalents 821,000 Balance in cash and cash equivalents, beginning of year 10,000 Balance in cash and cash equivalents, end of year 831,000

Master Budget – Budgeted Balance Sheet Schedule Sheet Shows the expected end-of-period balances for the company’s assets, liabilities, and

owner’s equity, assuming that planned operations are carried out.Modern Mountain Enterprise

Budgeted Balance SheetFor the Year Ending December 31, 20x2

AssetsCurrent Assets:Cash (schedule 9) 831,000 Accounts receivables (Schedule 7: 18% of 4th quarter) 405,000 Inventory:Raw materials (schedule 10) 64,800 Finished goods (schedule 10) 81,750 Supplies 42,000 Total inventory 188,550

Total current assets 1,424,550 Long-lived assets:

Building (balance from last year plus 1M construction of plant) 9,200,000Equipment 2,280,000 Less: Accumulated depreciation on building and equipment (last year's + 440,000 in Sched. 5) (2,323,550) (43,500)Building and equipment, net of accumulated depreciation 9,156,450

Total assets 10,581,000 Liabilities and Owner's Equity

Current Liabilities:Accounts payable (Schedule 8) 471,280 Total current liabilities 471,280

Long-term liabilitiesNote payable (non-interest bearing; due on December 21, 20x4 4,100,000

Total liabilities 4,571,280 Owner's Equity (balance from last year's + net income) 6,009,720 Total liabilities and owner's equity 10,581,000

7.2 Flexible Budget and Performance Analysis

After studying flexible budget and performance analysis,

you should be able to:

• Identify the difference between static budget and flexible budget

• Prepare a static budget and explain the performance analysis

• Prepare a flexible budget and explain the performance analysis

Static Budget versus Flexible Budget

• Static budget is prepared at the beginning of the budgeting period and is valid for only the planned level of activity.

• A static budget is suitable for planning but is inappropriate for evaluating how well costs are controlled.

• A flexible budget shows what costs should be for various levels of activity.

• Flexible budget is an alternative to the static budget. A flexible budget adjusts revenues, costs, and expenses to the actual volume experienced and compares these amounts to actual results.

If the actual level of activity differs from what was planned, it would be misleading to compare actual cost to the static budget. If the activity is higher than expected, variable costs should be higher than expected; and if activity is lower than expected, variable costs should be lower than expected.

Maria's Parlor ShopStatic Budget

For the Month Ended March 31

Budgeted number of client-visits 5,000

Budgeted variable overhead cost:Hairstyling supplies (@ $1.20 per client-visit) 6,000 Client gratuities (@ $4 per client-visit) 20,000 Electricity (@ $0.20 per client-visit) 1,000

Total variable overhead cost 27,000

Budgeted fixed overhead cost:Support staff wages and salaries 8,000 Rent 12,000 Insurance 1,000 Utilities other than electricity 500

Total fixed overhead cost 21,500

Total budgeted overhead cost 48,500

Performance Analysis

Maria's Parlor ShopStatic Budget Performance Report

For the Month Ended March 31 Actual Budgeted Variances Results

Client-visits 5,200 5,000 200 F

Variable overhead costs:Hairstyling supplies 6,400 6,000 400 UClient gratuities 22,300 20,000 2,300 UElectricity 1,020 1,000 20 U

Total variable overhead cost 29,720 27,000 2,720 U

Fixed overhead cost:Support staff wages and salaries 8,100 8,000 100 URent 12,000 12,000 0Insurance 1,000 1,000 0Utilities other than electricity 470 500 30 F

Total fixed overhead cost 21,570 21,500 70 U

Total overhead cost 51,290 48,500 2,790 U

Maria's Parlor ShopFlexible Budget

For the Month Ended March 31

Budgeted number of client-visits 5,000

Cost per client-visit

Activity (in client-visits)

Overhead Costs 4,900 5,000 5,100 5,200

Variable overhead cost:Hairstyling supplies 1.20 $5,880 6,000 6,120 6,240 Client gratuities 4.00 19,600 20,000 20,400 20,800 Electricity 0.20 980 1,000 1,020 1,040

Total variable overhead cost $5.40 26,460 27,000 27,540 28,080

Budgeted fixed overhead cost:Support staff wages and salaries 8,000 8,000 8,000 8,000 Rent 12,000 12,000 12,000 12,000 Insurance 1,000 1,000 1,000 1,000 Utilities other than electricity 500 500 500 500

Total fixed overhead cost 21,500 21,500 21,500 21,500

Total budgeted overhead cost $47,960 48,500 49,040 49,580

Performance AnalysisMaria's Parlor Shop

Flexible Budget Performance AnalysisFor the Month Ended March 31

Budgeted number of client-visits 5,000 Actual number of client-visits 5,200

Cost per client-visit

Actual Costs Incurred for 5,200 Client-Visits

Flexible Budget Based on

5,200 Client-Visits Variance Results

Overhead CostsVariable overhead cost:Hairstyling supplies 1.20 $6,400 6,240 160 UClient gratuities 4.00 22,300 20,800 1,500 UElectricity 0.20 1,020 1,040 20 F

Total variable overhead cost $5.40 29,720 28,080 1,640 U

Budgeted fixed overhead cost:Support staff wages and salaries 8,100 8,000 100 URent 12,000 12,000 - Insurance 1,000 1,000 - Utilities other than electricity 470 500 30 F

Total fixed overhead cost 21,570 21,500 70 Total budgeted overhead cost $51,290 49,580 1,710 U

Case AnalysisMaria's Parlor Shop

Performances Between Static and FlexibleFor the Month Ended March 31

Overhead Costs Static Budget Flexible BudgetVariable overhead cost:Hairstyling supplies 400 U 160 UClient gratuities 2,300 U 1,500 UElectricity 20 U 20 F

Total variable overhead cost 2,720 U 1,640 U

Budgeted fixed overhead cost:Support staff wages and salaries 100 U 100 URent - 0 - 0Insurance - 0 - 0Utilities other than electricity 30 F 30 F

Total fixed overhead cost 70 U 70 U

Total Budgeted Overhead Cost 2,790 U 1,710 U