2. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 1 The Master Budget Chapter 7

3. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 2 Objective 1 Explain the major features and advantages of a master budget.

4. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 3 Advantages of Budgets Budgets Goals and objectives A budget allows systematic rather than chaotic reaction to change.

5. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 4 Advantages of Budgets Provides definite expectations that are the best framework to evaluate performance Aids managers in coordinating their efforts Compelsmanagers to think ahead

6. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 5 Types of Budgets Strategic plan Long-range plan Capital budget Master budget Continuous budget

7. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 6 Strategic Plan The most forward-looking budget is the strategic plan, which sets the overall goals and objectives of the organization.

8. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 7 Long-Range Plan The strategic plan leads to long-range planning, which produces forecasted financial statements for five- to ten-year periods.

9. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 8 Capital Budget Long-range plans… are coordinated with capital budgets, which detail the planned expenditures for facilities, equipment, new products, and other long-term investments.

10. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 9 Master Budget Sales Production Distribution Finance The master budget summarizes the planned activities of all subunits of an organization.

11. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 10 Continuous Budget Rolling budgets... are a common form of master budgets that add a month in the future as the month just ended is dropped.

12. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 11 Operating budget Financial budget Components of Master Budget

13. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 12 Objective 2 Follow the principal steps in preparing a master budget.

14. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 13 Steps in Preparing the Master Budget 1. Basic data a.Sales budget b.Cash collections from customers c.Purchases budget d.Disbursements for purchases e.Operating expense budget f.Disbursements for operating expenses The principal steps in preparing the master budget are:

15. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 14 Steps in Preparing the Master Budget 1. Basic data 2. Operating budget 3. Financial budget

16. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 15 Objective 3 Prepare the operating budget and the supporting schedules.

17. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 16 Operating Budget Salesbudget Cash collections from customers Disbursements for purchases Disbursements for operating expenses Purchasesbudget Operating expenses budget

18. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 17 Cash Collections 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.

19. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 18 Purchases Budget Budgeted purchases = Desired ending inventory + Cost of goods sold – Beginning inventory

20. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 19 Disbursements for Purchases For example, 50% of the current month’s purchases and 50% of the previous month’s purchases may be included. The total disbursements are then used in preparing the cash budget.

21. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 20 Operating Expense Budget 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.

22. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 21 Operating Expense Budget Expenses driven by sales volume include sales commissions and many delivery expenses.

23. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 22 Operating Expense Budget Other expenses are not influenced by sales or other cost-driver activity and are regarded as fixed, within appropriate relevant ranges. Rent Insurance Depreciation Salaries

24. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 23 Operating Expense Disbursements Disbursements for operating expenses are based on the operating expense budget.

25. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 24 Operating Expense Disbursements For example, 50% of last month’s and this month’s wages and commissions plus miscellaneous and rent expenses may be included. The total of these disbursements is then used in preparing the cash budget.

26. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 25 Budgeted Income Statement 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.

27. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 26 Objective 4 Prepare the financial budget.

28. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 27 Cash Budget The cash budget has the following major sections:  available cash balance  cash receipts disbursements  cash needed from (or used for) financing  ending cash balance

29. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 28 Cash Budget 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.

30. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 29 Cash Budget 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.

31. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 30 Cash Budget Other disbursements include outlays for fixed assets, long-term investments, dividends, and the like. Disbursements for some costs and expenses depend on contractual terms for installment payments, mortgage payments, rents, leases, and miscellaneous items.

32. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 31 Cash Budget Management determines the minimum cash balance desired depending on the nature of the business and credit arrangements.

33. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 32 Cash Budget 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.

34. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 33 Cash Budget Ending cash balance = Beginning cash balance + Receipts – Disbursements + Cash from financing The cash from financing can be either positive (borrowing) or negative (repayment).

35. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 34 Budgeted Balance Sheet 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.

36. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 35 Objective 5 Explain the difficulties of sales forecasting.

37. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 36 Sales Forecast 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.

38. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 37 Factors to Consider When Forecasting Sales Competitors’ actions Past patterns of sales Estimates made by the sales force General economic conditions

39. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 38 Factors to Consider When Forecasting Sales Advertising and sales promotion plans Changes in the firm’s prices Changes in product mix Market research studies

40. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 39 Objective 6 Anticipate possible human relations problems caused by budgets.

41. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 40 Getting Employees to Accept the Budget To fully benefit from budgets, an organization needs the support of all the firm’s employees. The attitude of top management will heavily influence lower-level workers’ and managers’ attitudes.

42. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 41 Getting Employees to Accept the Budget Another problem that can negate the benefits of budgeting arises if budgets stress one set of performance goals, but employees and managers are rewarded for different performance measures.

43. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 42 Participative Budgeting Budgets created with the active participation of all affected employees are generally more effective than budgets imposed on subordinates.

44. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 43 Functional Budgeting The budgeting focus is on preparing budgets for various functions such as production, selling, and administrative support.

45. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 44 Activity-Based Master Budgets This budgetary system emphasizes the planning and control purpose of cost management.

46. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 45 Objective 7 Use a spreadsheet to develop a budget. (Appendix 7)

47. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 46 Spreadsheets Spreadsheet software for personal computers is a powerful and flexible tool for budgeting. Arithmetic errors are virtually nonexistent. Spreadsheets can be used to make a mathematical model of the organization.

48. ©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 7 - 47 End of Chapter 7