Introduction To Budgets and Preparing The Master Budget

Introduction to Budgets
and Preparing the Master Budget
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 7 - 1
Learning
Objective 1
Goals and
Budgets
objectives
A budget provides a comprehensive financial

overview of planned company operations.
Compel
managers
to think
ahead Provide an opportunity to
reevaluate existing activities
and evaluate new ones.
Aid managers in communicating

objectives and coordinating actions
across the organization.
Learning
Objective 2
1. Low levels of participation in the budget process and

Lack of acceptance of responsibility for the final
budget.
2. Incentives to lie and cheat in the budget process.
3. Difficulties in obtaining accurate sales forecasts.
Management
Managementshould
shouldseek
seekto
tocreate
create
an
anenvironment
environmentwhere
wherethere
thereisisaa
true
truetwo-way
two-wayflow
flowof
ofinformation.
information.
Participative budgets are formulated with
the active participation of
all affected employees.
Message conveyed by
the budget system may
be misaligned with
incentives provided by
the compensation
system.
Learning
Objective 3
Dysfunctional
incentives lead
managers to make
poor decisions.
Lying can arise if the
budget process creates
incentives to bias the
budget information.
Budgetary Slack (budget padding) is the
overstatement or understatement of budgeted
revenue to create a goal that is easier to achieve.
Learning
Objective 4
A sales forecast is a prediction of sales

under a given set of conditions.
Sales forecasts are usually prepared under

the direction of the top sales executive.
The sales budget is the result of decisions to create

Conditions that will generate a desired level of sales.
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es c Comaction
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A and tio c t in
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Learning
Objective 5
Strategic plan Long-range planning
Master budget
Capital budget Continuous budget
The most forward-looking budget is the
strategic plan, which sets the overall
goals and objectives of the organization.
The strategic plan leads to long-range

planning, which produces
forecasted financial statements
for five- to ten-year periods.
Long-range plans…
are coordinated with capital budgets,

which detail the planned expenditures
for facilities, equipment, new products,
and other long-term investments.
Master budgets link to both long-range

plans and short-term budgets.
The master budget
Sales
is a detailed and
comprehensive analysis
of the first year of the Production
long-range plan.
It summarizes the Distribution
planned activities
of all subunits of Finance
an organization.
Rolling budgets...
are a common form of
master budgets that
add a month in the
future as the month
just ended is dropped.
Operating budget Financial budget. . .
(Profit plan). . .
Focuses on the Income Focuses on the effects

Statement and that the operating budget
supporting schedules and other plans will have
or budgeted expenses. on cash balances.
Learning
Objective 6
1. Basic data
2. Operating budget
3. Financial budget
The principal steps in preparing
the master budget:
1. Basic data
a. Sales budget
b. Cash collections from customers
c. Purchases and cost-of-goods sold budget
d. Cash disbursements for purchases
e. Operating expense budget
f. Cash disbursements for operating expenses
Operating Budget
2. Prepare budgeted income statement using basic data in step 1.
Financial Budget
3. Prepare forecasted financial statements:
b. Capital budget
c. Cash budget
d. Budgeted Balance sheet
Learning
Objective 7
Sales Cash collections

budget from customers
Purchases Disbursements
budget for purchases
Operating expenses Disbursements for

budget operating expenses
It is easiest to prepare budgeted
cash collections at the same
time as the sales budget.
Cash collections include the current

month’s cash sales plus the
previous month’s credit sales.
Budgeted purchases
= Desired ending inventory
+ Cost of goods sold
– Beginning inventory
Disbursements could include 50% of the current month’s

purchases and 50% of the Previous month’s purchases.
The budgeting of operating expenses depends on several factors.
Month-to-month changes in sales volume and other cost-driver

activities directly influence many operating expenses.
Expenses driven by
sales volume include
sales commissions and
many delivery expenses.
Other expenses are not influenced by sales
or other cost-driver activity and are regarded
as fixed, within appropriate relevant ranges.
Rent Depreciation
Insurance
Salaries
Disbursements for operating expenses are
based on the operating expense budget.
Disbursements may include 50% of last month’s and this month’s

wages and commissions plus miscellaneous and rent expenses.
The total of these disbursements is then

used in preparing the cash budget.
The income statement will be complete
after addition of the interest expense,
which is computed after the cash
budget has been prepared.
Budgeted income from operations

is often a benchmark for judging
management performance.
Learning
Objective 8
The cash budget is a statement of

planned
cash receipts and disbursements.
The Cash budget contains these major sections:

 available cash balance
 net cash receipts and disbursements
financing
Available cash balance
= Beginning cash balance
– Minimum cash balance desired.
Cash receipts depend on collections from

customers’ accounts receivable, cash sales,
and on other operating income sources.
Cash disbursements for purchases depend
on the credit terms extended by suppliers
and the bill-paying habits of the buyer.
Payroll depends on wage, salary, and

commission terms and on payroll dates.
Disbursements for some costs and expenses
depend on contractual terms for installment
payments, mortgage payments, rents,
leases, and miscellaneous items.
Other disbursements include outlays for

fixed assets, long-term investments,
dividends, and the like.
Management determines the minimum
cash balance desired depending
on the nature of the business
and credit arrangements.
Financing requirements depend on how
the total cash available compares
with the total cash needed.
Needs include the disbursements plus

the desired ending cash balance.
Ending cash balance
= Beginning cash balance
+ Receipts – Disbursements
+ Cash from financing
The cash from financing can be

either positive (borrowing)
or negative (repayment).
The final step in preparing the master budget
is to construct the budgeted balance sheet
that projects each balance sheet item in
accordance with the business plan.
Management then considers all the major

financial statements as a basis for changing
the course of events.
Functional budgeting focuses on
preparing budgets for various
functions such as production,
selling, and administrative support.
An activity-based budgetary system

emphasizes the planning and control
purpose of cost management.
Financial planning models are mathematical models
that can incorporate the effects of alternative
assumptions about sales, costs, or product mix.
Financial models are only as good as the assumptions

and the inputs used to build and manipulate them.
Learning
Objective 9
Financial planning models are mathematical models

that can incorporate the effects of alternative
assumptions about sales, costs, or product mix.
Spreadsheet software for personal computers is

a powerful and flexible tool for budgeting that
can be used to prepare mathematical models.
Arithmetic errors are virtually nonexistent.

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Introduction to Budgets

and Preparing the Master Budget

A budget provides a comprehensive financial

Aid managers in communicating

1. Low levels of participation in the budget process and

A sales forecast is a prediction of sales

Sales forecasts are usually prepared under

The sales budget is the result of decisions to create

Strategic plan Long-range planning

Capital budget Continuous budget

The strategic plan leads to long-range

are coordinated with capital budgets,

Master budgets link to both long-range

Focuses on the Income Focuses on the effects

Sales Cash collections

Operating expenses Disbursements for

Cash collections include the current

Disbursements could include 50% of the current month’s

Month-to-month changes in sales volume and other cost-driver

Disbursements may include 50% of last month’s and this month’s

The total of these disbursements is then

Budgeted income from operations

The cash budget is a statement of

The Cash budget contains these major sections:

Cash receipts depend on collections from

Payroll depends on wage, salary, and

Other disbursements include outlays for

Needs include the disbursements plus

The cash from financing can be

Management then considers all the major

An activity-based budgetary system

Financial models are only as good as the assumptions

Financial planning models are mathematical models

Spreadsheet software for personal computers is

Arithmetic errors are virtually nonexistent.

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