1. Financial and Managerial Accounting
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John J. Wild
Third Edition
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Master Budgets and Performance Planning
Chapter 20
Master Budgets and Performance Planning
This chapter explains the importance of budgeting and describes the master budget and its preparation. It also discusses the value of the master budget to the planning of future business activities

3. Conceptual Learning Objectives
C1: Describe the importance and benefits of budgeting.
C2: Explain the process of budget administration.
C3: Describe a master budget and the process of preparing it.
In this chapter, you will learn the following conceptual objectives:
C1: Describe the importance and benefits of budgeting.
C2: Explain the process of budget administration.
C3: Describe a master budget and the process of preparing it.

4. Analytical Learning Objectives
A1: Analyze expense planning using activity-based budgeting.
In this chapter, you will learn the following analytical objectives:
A1: Analyze expense planning using activity-based budgeting.

5. Procedural Learning Objectives
P1: Prepare each component of a master budget and link each to the budgeting process.
P2: Link both operating and capital expenditures budgets to budgeted financial statements.
P3: Appendix 20A: Prepare production and manufacturing budgets.
In this chapter, you will learn the following procedural objectives:
P1: Prepare each component of a master budget and link each to the budgeting process.
P2: Link both operating and capital expenditures budgets to budgeted financial statements.
P3: Appendix 20A: Prepare production and manufacturing budgets.

6. Budget Process Advantages Defines goals and objectives
Communicates plans and instructions
Promotes analysis and a focus on the future
Advantages
There are many advantages to budgeting. The most important advantages are displayed on your screen. One of the advantages that we may not think of right away is that budgeting provides a way to communicate plans throughout the business. Most large companies have a standing budget committee that is responsible for budgeting policies and for coordinating the efforts of all participants in the budgeting process.
Coordinates
business activities
Motivates employees
Provides a basis for evaluating performance against past or expected results

7. Budget Timing The budget may be a twelve-month
C 2
Continuous or
Rolling Budget
2009
2010
2011
2012
The budget may be a twelve-month
budget that rolls forward one month
as the current month is completed.
In a participatory budgeting process, information flows upward from lower levels of the business to top management. Lower-level managers have more detailed knowledge because they are closer to the day-to-day activities and operations of the business.
Many companies use a continuous or rolling twelve-month budget that drops off the immediate past month and adds one future month as the year progresses. A rolling budget allows a company to continuously work with a full one-year budget in place.

8. Master Budget Components
Sales budget
Merchandise Purchases
Prepare financial budgets:
cash
income
balance sheet
Prepare capital expenditure budget
Prepare selling and general administrative budgets
A company’s budgeting process begins with a sales budget. The success of all subsequent steps in the process depends on an accurate sales forecast. This slide describes the components of the master budget for a merchandser. The final result of the budgeting process is a set of budgeted financial statements.

9. Sales Budget P1
The marketing department is usually responsible for developing the sales budget. Sales personnel forecast sales volume for the budget period by analyzing customer needs. Companies may also take a broader view by using economic forecasting models. To illustrate the budgeting process, we are going to prepare a detailed budget for Hockey Den, a retailer of youth hockey sticks. We will begin with the sales budget.
Hockey Den sold seven hundred hockey sticks at one hundred dollars each in September Using this pricing information and the forecasted unit sales for the colder months of the fall season, the sales budget for the remaining three months of the year can be prepared. The sales budget includes January 2010 because the purchasing department relies on estimated January sales to plan December 2009 inventory purchases.

10. Merchandise Purchases Budget
Hockey Den buys hockey sticks for $60.00 each and maintains an ending inventory equal to 90 percent of the next month’s budgeted sales hockey sticks are on hand on September 30.
Inventory
to be
purchased
Budgeted
ending
inventory
Budgeted
cost of sales for the period
Budgeted beginning
inventory = + –
Once we have completed the sales budget, we can prepare the merchandise purchases budget that will incorporate Hockey Den’s sales demand and inventory policy. To prevent potential stock-outs of inventory items, and to have a good selection of merchandise on hand for customers, Hockey Den always wants its ending inventory for a month to be equal to ninety percent of the next month’s sales. On September 30, nine hundred hockey sticks were on hand, an amount equal to ninety percent of the one thousand hockey sticks budgeted for October sales.
Let’s prepare the purchases budget for Hockey Den.

11. Merchandise Purchases Budget
We begin the purchases budget by computing the desired ending inventory for each of the three months. Recall that Hockey Den always wants its ending inventory for a month in units to be equal to ninety percent of the next month’s unit sales. The unit sales figures are from the sales budget.
Next we add the unit sales for each month to the desired ending inventory to get the total needs for each month.
Now, let’s complete the month of October. Total needs for October are one thousand seven hundred and twenty units. Hockey Den can partially meet these needs from the beginning inventory of nine hundred units. Subtracting nine hundred units from one thousand seven hundred and twenty units, we find that Hockey Den must purchase eight hundred twenty units in October. Multiplying the eight hundred twenty units by Hockey Den’s sixty dollars cost per unit converts the purchase amount to forty nine thousand two hundred dollars. Next, we will complete the purchases budget.
Here’s our completed purchases budget. Notice that the ending inventory for each month becomes the beginning inventory for the next month.

12. Selling Expense Budget
We use the sales budget to prepare a selling expense budget for Hockey Den. Sales commissions are variable, based on a percentage of sales revenue. In this case the commission is 10%. The sales manager’s salary is a fixed expense.
Using this information, we begin the selling expense budget with sales revenues amounts taken from the sales budget. Next, we compute sales commissions for each month by multiplying sales revenue for each month times ten percent. The sales manager’s salary of two thousand dollars per month is then added to sales commissions to get the total selling expense for each month.
From Hockey Den’s sales budget

13. General and Administrative Expense Budget
The general and administrative expense budget for each month is the sum of administrative salaries and equipment depreciation. In this case administrative salaries and the depreciation on the equipment are fixed costs. This means that the total amount is the same each month since both of these amounts are fixed expenses.

14. Budgeted Income Statement Budgeted Balance Sheet
Financial Budgets P2
Cash
Budget
(Expected Receipts &
Disbursements)
Budgeted Income Statement
Budgeted Balance Sheet
Now that we have completed the budgets for sales, material purchases, selling expenses, and general and administrative expenses, we are ready to prepare budgets for cash receipts and disbursements. Our ultimate objective is budgeted financial statements.

15. Budgeted Cash Receipts
40% of Hockey Den’s sales are for cash.
60% are credit sales (collected in full in the month following sale).
We use the sales budget to prepare the cash receipts budget. Forty percent of Hockey Den’s sales are for cash. The remaining sixty percent of sales are on account. None of the sales on account are collected in the month of sale, but all sales on account are collected in the month following sale.
Let’s prepare the cash receipts budget for Hockey Den.

16. Budgeted Cash Receipts
From Hockey Den’s sales budget
60 percent of September
sales are collected in October
We begin the cash receipts budget with sales revenues amounts taken from the sales budget. September sales revenue is included because sixty percent of September sales will be collected in October.
The accounts receivable balance at the end of each month is sixty percent of that month’s budgeted sales. Cash sales are forty percent of each month’s sales.
40% of sales
60% of sales

17. Budgeted Cash Receipts
The accounts receivable balance at the end of each month is collected in full during the next month. Cash sales are added to accounts receivable collections to get total cash receipts for the month.

18. Cash Disbursements for Purchases
Hockey Den’s purchases of merchandise are entirely on account.
Full payment is made in the month following purchase.
The September 30 balance of Accounts Payable is $58,200.
We’re now ready to budget cash disbursements. We will begin with cash disbursements for purchases. Hockey Den makes all purchases of merchandise on account and pays the entire balance of accounts payable in the month following purchase. We will need to refer to the merchandise purchases budget to complete the cash disbursements budget.
Let’s look at cash disbursements for purchases for Hockey Den.

19. Cash Disbursements for Purchases
The accounts payable balance at the end of September is fifty eight thousand, two hundred dollars and that amount is paid in October. Note that each month’s cash disbursement is the amount of the previous month’s purchase of merchandise.
From merchandise purchases budget

20. Cash Budget Hockey Den:P2
Hockey Den:
Will pay a cash dividend of $3,000 in November.
Will purchase $25,000 of equipment in December.
Has an income tax liability of $20,000 from the previous quarter that will be paid in October.
Has a September 30 cash balance of $20,000.
Has an agreement with its bank for loans at the end of each month to enable a minimum cash balance of $20,000.
Now that we have completed the cash receipts budget and the cash disbursements budget for merchandise purchases, we are ready to complete the cash budget. Some additional events affecting cash are displayed on your screen. You may need to make make a few notes from this information to keep from referring back to this screen as we use this information.
Continue

21. Let’s prepare the cash budget for Hockey Den.
Pays interest equal to one percent of the prior month’s ending loan balance.
Repays loans when the ending cash balance exceeds $20,000.
Owes $10,000 on this loan arrangement on September 30.
Has 40 percent income tax rate.
Will pay taxes for current quarter next year.
Here is the remainder of the information needed to complete Hockey Den’s cash budget. Again, you my find it helpful to take a few notes summarizing this information.
Let’s prepare the cash budget for Hockey Den.

22. From Cash Receipts Budget From Cash Disbursements for Purchases
Our first cash disbursements are for merchandise purchases. These amounts come from the cash disbursements for purchases budget.
From Cash Disbursements for Purchases

23. From Selling Expense Budget
Next, we enter the disbursement amounts from Hockey Den’s selling expense budget.
From Selling Expense Budget

24. Because Hockey Den maintains a minimum cash balance of $20,000,P2
Because Hockey Den maintains a minimum cash balance of $20,000,
the company must
borrow $12,800.
Next, we enter the administrative salaries from Hockey Den’s general and administrative budget. Equipment depreciation was included in the general and administrative budget, but we do not include in the cash budget because depreciation is a non-cash expense.
Now we are ready to use some of the additional information affecting cash. Hockey Den has a ten thousand dollars loan and pays interest at the rate of one percent per month. The preliminary cash balance for October is seven thousand, two hundred dollars. Hockey Den has an agreement with its bank for loans at the end of each month to provide a minimum cash balance of twenty thousand dollars. The minimum cash balance policy will require Hockey Den to borrow twelve thousand, eight hundred dollars.
.01 × $10,000

25. Ending cash balance for October is the beginning November balance.
Cash Budget Continued P2
After borrowing twelve thousand, eight hundred dollars, Hockey Den’s ending cash balance is twenty thousand dollars. The total loan amount is now the original ten thousand dollars plus the additional twelve thousand, eight hundred dollars for a total of twenty two thousand, eight hundred dollars.
Ending cash balance for October
is the beginning November balance.

26. Cash balance is sufficient to repay the $22,800 loan.
Here we see the completed cash budget for November. Hockey Den plans to pay a three thousand dollar cash dividend in November. The loan loan balance is twenty-two thousand dollars, resulting in an interest payment of two hundred twenty-eight dollars using the one percent per month interest rate. The preliminary cash balance for November is forty-five thousand, seventy two dollars which will allow Hockey Den to repay its twenty-two thousand, eight hundred dollar loan and still have an ending cash balance above its twenty thousand dollar minimum.
Cash balance is sufficient to repay the $22,800 loan.
.01 × $22,800

27. P2
The cash budget is completed with the December cash information. Hockey Den plans to pay twenty-five thousand dollars in December to purchase new equipment. This large cash disbursement will reduce the December preliminary cash balance to three hundred seventy-two dollars, requiring Hockey Den to borrow again to meet its twenty thousand dollar minimum cash balance policy.

28. Cash Budget Continued P2
Hockey Den will need to borrow nineteen thousand, six hundred twenty-eight dollars to increase it cash balance to twenty thousand dollars.

29. From the Merchandise Purchases Budget
From the Sales Budget P2
From the Merchandise Purchases Budget
Now that we have completed the cash budget, we are ready to prepare a budgeted income statement for the quarter.
Recall that Hockey Den plans to sell one thousand units in October, eight hundred units in November, and one thousand, four hundred units in December, for a total of three thousand, two hundred units for the quarter. The sales price is one hundred dollars per unit. Hockey Den pays sixty dollars per unit for its merchandise.

30. From the Selling Expense Budget
Sales commissions are ten percent of sales revenue. Sales salaries are two thousand dollars per month for the three months.
From the Selling Expense Budget

31. P2
Administrative salaries are four thousand, five hundred dollars per month and equipment depreciation is one thousand, five hundred dollars per month for the three months. Recall that even though depreciation does not result in a cash disbursement, it is an expense that is included in the income statement.
From the General and Administrative Expense Budget Depreciation is a non-cash expense.

32. P2
Hockey Den paid one hundred dollars in interest in October and two hundred twenty-eight dollars in November.
From the Cash Budget

33. P2
Hockey Den’s income tax rate is forty percent.
$71,672 × .40

34. Preparing a Budgeted Balance Sheet
Hockey Den reports the following account balances on September 30 prior to preparing its budgeted financial statements:
Equipment $200,000
Accumulated depreciation $ 36,000
Common stock $150,000
Retained earnings $ 41,800
Now that we have completed the income statement for the quarter, we can prepare the balance sheet.
At this point, we have almost all of the information we need to prepare the balance sheet. However, we do need the account balances on your screen from September 30 to complete our work.
Let’s prepare the budgeted balance sheet for Hockey Den.

35. P2
From the Cash Budget
Hockey Den ends the month of December with a cash balance of twenty thousand dollars. Recall that borrowing was necessary to increase the cash balance to twenty thousand dollars minimum desired amount.

36. From the Merchandise Purchases Budget
Hockey Den makes all purchases of merchandise on account and pays the entire balance of accounts payable in the month following purchase. Budgeted purchases of fifty seven thousand dollars in December will be paid in January.

37. From the Budgeted Income StatementP2
From the Budgeted Income Statement
Hockey Den’s income tax payable is forty percent of its pretax income for the quarter.

38. P2
From the Cash Budget
Hockey Den will borrow nineteen thousand, six hundred twenty-eight dollars in December to increase its cash balance to the twenty thousand dollar minimum.

39. P2
When we add the budgeted net income to the beginning balance for retained earnings, and deduct the budgeted dividend payment, we find Hockey Den’s ending retained earnings balance of eighty one thousand, eight hundred three dollars. The balance sheet is now complete.

40. Activity-Based Budgeting
Activity-based budgeting is based on activities rather than traditional items such as salaries, supplies, depreciation, and utilities.
Activity-based budgeting is based on expected activities instead of the traditional budget categories that we normally see. Activity-based budgets enable management to more easily plan resource consumption to match related changes in activity.

41. End of Chapter 20
Now that we have mastered some of the basic concepts and principles of flexible budgets, variance analysis, and standard costs, we are ready to move onto the next chapter.