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Master Budgets and

Planning

C H A P T E R 27

© 2007 McGraw-Hill Ryerson Ltd.

 Learning Objectives
1. Explain the importance and benefits of
budgeting.
2. Describe the process of budget
administration.
3. Describe a master budget and the process
of preparing it.
4. Prepare each component of a master
budget and link them to the budgeting
process.
© 2007 McGraw-Hill Ryerson Ltd.
 Learning Objectives
5. Link both operating and capital expenditure
budgets to budgeted financial statements.
6. Analyze expense planning using zero-based
budgeting.
7. Prepare production and manufacturing
budgets.

© 2007 McGraw-Hill Ryerson Ltd.

 Budgets
 A budget is a formal statement of a
company’s plans expressed in monetary
terms.
 Budgets attempt to capture the future
activities of an organization.
 Budgets are used by businesses, not-for-
profit, government, educational, and other
types of organizations.

© 2007 McGraw-Hill Ryerson Ltd.

 Importance of Budgeting
Defines goals
and objectives

Promotes analysis and

Communicates plans
a focus on the future
and instructions

Advantages

Coordinates
business activities Motivates employees

Provides a basis for

evaluating performance
© 2007 McGraw-Hill Ryerson Ltd.
 Budget Committee
 Consists of managers from all departments
of the organization.
 Provides central guidance to insure that
individual budgets submitted from all
departments are realistic and coordinated.

© 2007 McGraw-Hill Ryerson Ltd.

 Budget Committee

Top M an ag em en t

M id d le M id d le
M an ag em en t M an ag em en t

S u p ervis or S u p ervis or S u p ervis or S u p ervis or

Flow of budget data is a bottom-up process.

© 2007 McGraw-Hill Ryerson Ltd.
 Budget Horizon/Cycle
Budget horizons are usually for one year but
may extend for several years.
Operating Budget

2007 2008 2009 2010

The annual operating budget

may be divided into quarterly
or monthly budgets.

© 2007 McGraw-Hill Ryerson Ltd.

 Rolling Budgets

Continuous or
Rolling Budget

2004 2005 2006 2007

The budget may be a twelve-month

budget that rolls forward one month
as the current month is completed.

© 2007 McGraw-Hill Ryerson Ltd.

 Master Budget
 A formal, comprehensive plan for the future
of a company.
 It consists of several budgets linked
together to form a coordinated plan for the
organization.

© 2007 McGraw-Hill Ryerson Ltd.

Master Budget Sequence for a
Merchandising Company
Prepare
Prepare Develop Selling and
Sales Merchandise general
budget Purchase
budget administrative
budgets

Prepare
financial Prepare
budgets: Capital
 cash expenditure
 income
budget
 balance sheet

© 2007 McGraw-Hill Ryerson Ltd.

 Sales Budget

 The sales budget is the starting point in

the budgeting process.
 Most of the other budgets are linked to the
sales budget.
 Sales personnel are often involved in
developing the sales budgets.

© 2007 McGraw-Hill Ryerson Ltd.

 Preparing the Sales Budget
Sales
Budget

Estimated Estimated
Unit Sales Unit Price

Analysis of economic and market conditions

+
Forecasts of customer needs from marketing personnel
© 2007 McGraw-Hill Ryerson Ltd.
 Sales Budget

In September, Toronto Sticks Company sold 700

hockey sticks at $60 each. Toronto Sticks
prepared the following sales budget for the next
three months:

26-14 Copyright © 2005 McGraw-Hill Ryerson Limited.

 Merchandise Purchases Budget
Provides detailed information about the
purchases necessary to fulfill the sales
budget and provide adequate inventories.

Merchandise Budgeted Budgeted Budgeted

inventory to = ending + sales for the _ beginning
be purchased inventory period inventory

© 2007 McGraw-Hill Ryerson Ltd.

Merchandise Purchases Budget

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.

© 2007 McGraw-Hill Ryerson Ltd.

 Mini-Quiz
S & S Corporation desires a December 31 ending
inventory of 1,420 units. Budgeted sales for
December are 2,000 units. The November 30
inventory was 900 units. Budgeted purchases
are:
A)2,520 units.
B)1,620 units.
C)3,420 units.
D)2,000 units.
E)2,900 units.
© 2007 McGraw-Hill Ryerson Ltd.
 Mini-Quiz
S & S Corporation desires a December 31 ending
inventory of 1,420 units. Budgeted sales for
December are 2,000 units. The November 30
inventory was 900 units. Budgeted purchases
are:
A)2,520 units. (1,420 + 2000 – 900)
B)1,620 units.
C)3,420 units.
D)2,000 units.
E)2,900 units.
© 2007 McGraw-Hill Ryerson Ltd.
 Selling Expense Budget

 This budget lists the types and amounts of

selling expenses.
 Predictions of expenses are based on the
sales budget and past experience.

© 2007 McGraw-Hill Ryerson Ltd.

 General and Administrative
Expense Budget

 This budget lists the predicted operating

expenses not listed in the sales budget.
 Includes both cash and non-cash
expenses.
 Often prepared by the office manager or
person responsible for general
administration.

© 2007 McGraw-Hill Ryerson Ltd.

 Capital Expenditures Budget
 This budget lists the cash inflows or outflows
pertaining to the disposal or acquisition of
capital equipment.
 It is usually affected by the organization’s
long-term plans.

© 2007 McGraw-Hill Ryerson Ltd.

 Cash Budget
 This budget lists the expected cash inflows
and outflows for the period.
 It is a tool used by management to avoid
excess cash balances or cash shortages.
 Information from other budgets is used in
its preparation.
 Information from the cash budget is used
to prepare the budgeted income statement
and balance sheet.
© 2007 McGraw-Hill Ryerson Ltd.
 Cash Budget
The next step is to prepare the cash budget, which shows budged
cash receipts and cash payments during the budget period.

The general formula for a cash budget is:

26-23 Copyright © 2005 McGraw-Hill Ryerson Limited.

 Monthly Sales 2024
January February March April May June
$15,000 $10,000 $15,000 $25,000 $15,000 $20,000

Budgeted Monthly cash receipts from Sales

Dec. Jan. Feb. Mar. Apr. May June
Sales $12,000 $15,000 $10,000 $15,000 $25,000 $15,000 $20,000
Collections:
(20% of current
sales) 3,000 2,000 3,000 5,000 3,000 4,000
Collections:
(80% of
previous
month’s sales) 9,600 12,000 8,000 12,000 20,000 12,000
Total cash
receipts $12,600 $14,000 $11,000 $17,000 $23,000 $16,000

26-24 Copyright © 2005 McGraw-Hill Ryerson Limited.

 Budgeted Cash Payments
 Selling Expense Budget
 Capital Expenditures Budget
 General and Administrative Expense
Budget

26-25 Copyright © 2005 McGraw-Hill Ryerson Limited.

 Monthly Cash Flows

January February March April May June

Total $ 12,600 $ 14,000 $ 11,000 $ 17,000 $ 23,000 $ 16,000
receipts
Total (11,220) (20,452) (14,955) (12,452) (12,452) (27,955)
payments
Net cash $ 1,380 ($6,452) ($3,955) $ 4,548 $ 10,548 ($11,955)
flow

26-26 Copyright © 2005 McGraw-Hill Ryerson Limited.

 Preparing Cash Budget
Jan Feb Mar Apr May June
Net cash flow $ 1,380 ($6,452) ($3,955) $4,548 $10,548 ($11,955)
Beginning
5,000* 6,380 5,000 5,000 5,000 11,069
cash balance
Cumulative
$ 6,380 $ (72) $1,045 $9,548 $15,548 $ (886)
cash balance
Monthly loan
— 5,072 3,955 (4,548) (4,479) 5,886
(or repayment)
Cumulative
— 5,072 9,027 4,479 — 5,886
loan balance
Ending cash
$ 6,380 $5,000 $5,000 $5,000 $ 11,069 $ 5,000
balance
*Assume beginning cash balance in January of $5,000, minimum balance $5,000.

26-27 Copyright © 2005 McGraw-Hill Ryerson Limited.

 Preparing Financial Budgets

Cash
Budget Budgeted Budgeted
Expected Income Balance
Receipts Statement Sheet
and
Disbursements

© 2007 McGraw-Hill Ryerson Ltd.

 Mini-Quiz
The master budget includes:
A) Operating budgets.
B) A capital expenditures budget.
C) A budgeted income statement.
D) All of the above.
E) Both A and B only.

© 2007 McGraw-Hill Ryerson Ltd.

 Mini-Quiz
The master budget includes:
A) Operating budgets.
B) A capital expenditures budget.
C) A budgeted income statement.
D) All of the above.
E) Both A and B only.

© 2007 McGraw-Hill Ryerson Ltd.

Preparing a Budgeted Income
Statement

Cash Budgeted
Budget Income
Statement
t ed
e
pl
om
C

Let’s prepare the budgeted income

statement for Hockey Den.
© 2007 McGraw-Hill Ryerson Ltd.
 From the Sales Budget
HOCKEY DEN
Budgeted Income Statement
For Three Months Ended December 31, 2007
Sales (3,200 units @ $100) $ 320,000
Cost of goods sold (32,00 units @ $60) 192,000
Gross profit $ 128,000
Operating expenses:
Sales commissions $ 32,000
Sales salaries 6,000
Administrative salaries 13,500
Equipment amortization 4,500
Bad debt expense 1,920
Interest expense 332 58,252
Net income before taxes $ 69,748
Income tax expense (40%) 27,899
Net income $ 41,849
© 2007 McGraw-Hill Ryerson Ltd.
 From the Sales and
Merchandise
HOCKEY Purchase
DEN
BudgetedBudgets
Income Statement
For Three Months Ended December 31, 2007
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 amortization 4,500
Bad debt expense 1,920
Interest expense 332 58,252
Net income before taxes $ 69,748
Income tax expense (40%) 27,899
Net income $ 41,849

© 2007 McGraw-Hill Ryerson Ltd.

 HOCKEY DEN
Budgeted Income Statement
For Three Months Ended December 31, 2007
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 amortization 4,500
Bad debt expense 1,920
Interest expense 332 58,252
Net income before taxes
From the Selling $ 69,748
Income tax expense (40%)
Expense Budget 27,899
Net income $ 41,849

© 2007 McGraw-Hill Ryerson Ltd.

 HOCKEY DEN
Budgeted Income Statement
For Three Months Ended December 31, 2007
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 amortization 4,500
Bad debt expense 1,920
Interest expense 332 58,252
Net incomeFrom
beforethe General and Administrative
taxes $ 69,748
Expense Budget
Income tax expense (40%) 27,899
Net incomeAmortization is a non-cash expense. $ 41,849

© 2007 McGraw-Hill Ryerson Ltd.

 HOCKEY DEN
Budgeted Income Statement
For Three Months Ended December 31, 2007
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 amortization 4,500
Bad debt expense 1,920
Interest expense 332 58,252
Net income before taxes $ 69,748
Income tax expense (40%) 27,899
Net income From the Cash Budget $ 41,849

© 2007 McGraw-Hill Ryerson Ltd.

 HOCKEY DEN
Budgeted Income Statement
For Three Months Ended December 31, 2007
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 amortization 4,500
Bad debt expense 1,920
Interest expense 332 58,252
Net income before taxes $ 69,748
Income tax expense (40%) $69,748 × .40 27,899
Net income $ 41,849

© 2007 McGraw-Hill Ryerson Ltd.

 Preparing a Budgeted Balance
Sheet
 Amounts on the budgeted balance sheet
are derived from the other budgets and the
prior balance sheet.

© 2007 McGraw-Hill Ryerson Ltd.

 Preparing a Budgeted
Balance Sheet

Budgeted
Income Budgeted
Statement Balance
ed Sheet
l et
p
om
C

Let’s prepare the budgeted balance

sheet for Hockey Den.
© 2007 McGraw-Hill Ryerson Ltd.
 HOCKEY DEN
Budgeted Balance Sheet
December 31, 2007
Assets
Cash From the Cash Budget $ 20,000
Accounts receivable 84,000
Less allowance for bad debts (840) 83,160
Inventory 48,600
Equipment $ 225,000
Less accumulated amortization 40,500 184,500
Total assets $ 336,260

Liabilities and Shareholders' Equity

Liabilities
Accounts payable $ 57,000
Income taxes payable 27,899
Bank loan payable 21,132 $ 106,031
Shareholders' equity
Common shares $ 150,000
Retained earnings 80,229 230,229
Total liabilities and shareholders' equity $ 336,260
© 2007 McGraw-Hill Ryerson Ltd.
 HOCKEY DEN
Budgeted Balance Sheet
December 31, 2007
From the Sales Budget
Assets
Cash $ 20,000
Accounts receivable 84,000
Less allowance for bad debts (840) 83,160
Inventory 48,600
Equipment $ 225,000
Less accumulated amortization 40,500 184,500
Total assets $ 336,260

Liabilities and Shareholders' Equity

Liabilities
Accounts payable $ 57,000
Income taxes payable 27,899
Bank loan payable 21,132 $ 106,031
Shareholders' equity
Common shares $ 150,000
Retained earnings 80,229 230,229
Total liabilities and shareholders' equity $ 336,260
© 2007 McGraw-Hill Ryerson Ltd.
 HOCKEY DEN
Budgeted Balance Sheet
December 31, 2007
Assets
Cash 1% of A/R balance $ 20,000
Accounts receivable 84,000
Less allowance for bad debts (840) 83,160
Inventory 48,600
Equipment $ 225,000
Less accumulated amortization 40,500 184,500
Total assets $ 336,260

Liabilities and Shareholders' Equity

Liabilities
Accounts payable $ 57,000
Income taxes payable 27,899
Bank loan payable 21,132 $ 106,031
Shareholders' equity
Common shares $ 150,000
Retained earnings 80,229 230,229
Total liabilities and shareholders' equity $ 336,260
© 2007 McGraw-Hill Ryerson Ltd.
 HOCKEY DEN
Budgeted Balance Sheet
December 31, 2007
Assets
From
Cash the Merchandise Purchases Budget $ 20,000
8,100 units @ $6 per unit 84,000
Accounts receivable
Less allowance for bad debts (840) 83,160
Inventory 48,600
Equipment $ 225,000
Less accumulated amortization 40,500 184,500
Total assets $ 336,260

Liabilities and Shareholders' Equity

Liabilities
Accounts payable $ 57,000
Income taxes payable 27,899
Bank loan payable 21,132 $ 106,031
Shareholders' equity
Common shares $ 150,000
Retained earnings 80,229 230,229
Total liabilities and shareholders' equity $ 336,260
© 2007 McGraw-Hill Ryerson Ltd.
 HOCKEY DEN
Budgeted Balance Sheet
December 31, 2007
Assets
$200,000
Cash September 30 balance plus the $ 20,000
$25,000
Accounts December acquisition 84,000
receivable
Less allowance for bad debts (840) 83,160
Inventory 48,600
Equipment $ 225,000
Less accumulated amortization 40,500 184,500
Total assets $ 336,260

Liabilities and Shareholders' Equity

Liabilities
Accounts payable $ 57,000
Income taxes payable 27,899
Bank loan payable 21,132 $ 106,031
Shareholders' equity
Common shares $ 150,000
Retained earnings 80,229 230,229
Total liabilities and shareholders' equity $ 336,260
© 2007 McGraw-Hill Ryerson Ltd.
 HOCKEY DEN
Budgeted Balance Sheet
December 31, 2007
Assets
$36,000
Cash September 30 balance plus the $ 20,000
$4,500
Accounts from the General and 84,000
receivable
LessAdministrative
allowance for bad Expense
debts Budget (840) 83,160
Inventory 48,600
Equipment $ 225,000
Less accumulated amortization 40,500 184,500
Total assets $ 336,260

Liabilities and Shareholders' Equity

Liabilities
Accounts payable $ 57,000
Income taxes payable 27,899
Bank loan payable 21,132 $ 106,031
Shareholders' equity
Common shares $ 150,000
Retained earnings 80,229 230,229
Total liabilities and shareholders' equity $ 336,260
© 2007 McGraw-Hill Ryerson Ltd.
 HOCKEY DEN
Budgeted Balance Sheet
December 31, 2007
Assets
Cash $ 20,000
Accounts receivable 84,000
Less allowance for bad debts (840) 83,160
Inventory 48,600
Equipment
From the Merchandise $ 225,000
Less accumulated amortization 40,500 184,500
Total assets Purchases Budget $ 336,260

Liabilities and Shareholders' Equity

Liabilities
Accounts payable $ 57,000
Income taxes payable 27,899
Bank loan payable 21,132 $ 106,031
Shareholders' equity
Common shares $ 150,000
Retained earnings 80,229 230,229
Total liabilities and shareholders' equity $ 336,260
© 2007 McGraw-Hill Ryerson Ltd.
 HOCKEY DEN
Budgeted Balance Sheet
December 31, 2007
Assets
Cash $ 20,000
Accounts receivable 84,000
Less allowance for bad debts (840) 83,160
Inventory 48,600
Equipment $ 225,000
Less accumulated amortization 40,500 184,500
Total assets From the Budgeted $ 336,260
Income Statement
Liabilities and Shareholders' Equity
Liabilities
Accounts payable $ 57,000
Income taxes payable 27,899
Bank loan payable 21,132 $ 106,031
Shareholders' equity
Common shares $ 150,000
Retained earnings 80,229 230,229
Total liabilities and shareholders' equity $ 336,260
© 2007 McGraw-Hill Ryerson Ltd.
 HOCKEY DEN
Budgeted Balance Sheet
December 31, 2007
Assets
Cash $ 20,000
Accounts receivable 84,000
Less allowance for bad debts (840) 83,160
Inventory 48,600
Equipment $ 225,000
Less accumulated amortization 40,500 184,500
Total assets $ 336,260

From the Cash

Liabilities Budget
and Shareholders' Equity
Liabilities
Accounts payable $ 57,000
Income taxes payable 27,899
Bank loan payable 21,132 $ 106,031
Shareholders' equity
Common shares $ 150,000
Retained earnings 80,229 230,229
Total liabilities and shareholders' equity $ 336,260
© 2007 McGraw-Hill Ryerson Ltd.
 HOCKEY DEN
Budgeted Balance Sheet
December 31, 2007
Assets
Cash $ 20,000
Accounts receivable 84,000
Less allowance for bad debts (840) 83,160
Inventory 48,600
Equipment $ 225,000
Less accumulated amortization 40,500 184,500
Total assets $ 336,260
Beginning retained earnings
Liabilities and Shareholders' Equity
$ 41,380
Liabilities Add net income 41,849
Accounts Deduct
payabledividends $ 57,000 (3,000)
Income Ending retained earnings 27,899 $ 80,229
taxes payable
Bank loan payable 21,132 $ 106,031
Shareholders' equity
Common shares $ 150,000
Retained earnings 80,229 230,229
Total liabilities and shareholders' equity $ 336,260
© 2007 McGraw-Hill Ryerson Ltd.
 Zero-Based Budgeting
 These budgets are prepared assuming no
previous activities for the activities being
planned.
 Managers must justify the amounts
budgeted for each activity.
 This type of budgeting is popular among
government and non-profit organizations.

© 2007 McGraw-Hill Ryerson Ltd.

 Review
Describe at least five benefits of budgeting.

Benefits of budgeting are:

 Budgeting promotes good decision-making processes.
 Budgeting focuses management's attention on the future.
 Budgeting provides a basis for evaluating performance.
 Budgeting can be used as a motivator.
 Budgeting provides a means of coordinating activities.
 Budgeting serves as a tool for communicating plans and
instructions.

© 2007 McGraw-Hill Ryerson Ltd.

 Review
Why is the sales budget prepared first?

The sales budget is prepared first because the other

operating and financial budgets depend on information
provided by this particular budget. The plans of most
departments are related to, and dependent upon, sales and
expected revenue.

© 2007 McGraw-Hill Ryerson Ltd.

Production and Manufacturing
Budgets- Appendix 27A
Manufacturing companies need to prepare
additional budgets that include:
 Production budgets
 Direct materials purchase budgets

 Direct labour budgets

 Manufacturing overhead budgets

© 2007 McGraw-Hill Ryerson Ltd.

 Production Budget
 Provides detailed information about the
production necessary to fulfill the sales
budget and provide adequate inventories.

Number of Budgeted Budgeted Budgeted

units to be = ending + sales for the _ beginning
produced inventory period inventory

© 2007 McGraw-Hill Ryerson Ltd.

 Direct Materials Budget
 Provides detailed information about the
purchases of raw materials necessary to
fulfill the production budget and provide
adequate inventories.
Units of raw Materials Budgeted Budgeted
materials to = needed for + ending _ beginning
be purchased production inventory inventory

Cost of raw Units of raw Material price

materials to = materials to x per unit of
be purchased be purchased raw material
© 2007 McGraw-Hill Ryerson Ltd.
Direct Labour and Manufacturing
Overhead Budgets
 Provides information about the labour
and manufacturing overhead costs
given the level of production for the
period.

© 2007 McGraw-Hill Ryerson Ltd.

End of Chapter

© 2007 McGraw-Hill Ryerson Ltd.