Budgeting process

| October 22, 2018

Module 7: Budgeting – Part II
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Mod 7: For Your

Learning Outcomes
Identify the elements of the master
Prepare a master budget.

Mod 7: Readings

Chapter 6 in Managerial
Module 7: Budgeting – Part II

Table of Contents

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I. Compiling the Master Budget
The process of compiling the master budget includes every functional area of
the organization. Each manager that is responsible for a portion of the budget
must submit his or her budget to the controller of the organization who
assembles the budget components together and prepares the budgeted financial
As described above, the budget process begins with the strategic plan. The
strategic plan’s long term goals include metrics that are met through
implementing strategy and are measured in financial terms. The budget
communicates the strategic plan through the financial projections it presents.
The following exhibits present a master budget for a manufacturing
organization. The master budget process begins with the projected sales budget.
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Next the product cost budgets are prepared that will flow into the cost of
goods sold budget that will flow into the budgeted income statement.
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The figures from the sales budget are presented to justify the number of
units that will have to be manufactured. The desired ending inventory for the
first quarter (3000 units) becomes the desired beginning inventory for the
second quarter because the second quarter begins the day after the first
quarter, so the beginning inventory for the second quarter is the same as the
ending inventory for the first quarter.
The materials purchases budget is prepared next. Since the number of units
to be manufactured was established in the production budget, the amount of
material needed can be estimated. Notice that the total production units from
the production budget above flows into the materials budget below. For example,
the first quarter total production units is 12,000 above, the last figure in
the left column. Now looking below to the materials budget, we see that 12,000
units is our first figure in the first row. Standard costs are used to
calculate the dollar amount estimated to be spent on materials for each
quarter. These figures will flow into the budgeted cost of goods sold. They
will also be used to estimate the cash budget.
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The direct labor budget is prepared next. Notice that the figures from the
production schedule flow into the direct labor budget as well. For example, the
12,000 units projected for the first quarter are the first line item on the
labor budget. Standard rates and times are used to complete the direct labor
budget. The direct labor budget will flow into the cost of goods sold budget.
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If you remembered from a previous module that the three product costs are
materials, labor, and overhead, then you probably deduced that the next budget prepared
is the overhead budget. This overhead budget is prepared from prior year actual
costs. Most companies usually add a small percentage for price increases. The
overhead budget is used to calculate the applied overhead rate that we
discussed in a previous module.
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The selling and administrative expense budget is prepared similarly to the
overhead budget, from prior year actual expenses with a percentage increase to
the expenses expected to rise. The increases are based on economic factors and
actual information pertaining to the expense. For example, it may be known that
employee healthcare costs are going to increase and the company will be
absorbing a portion of the increase. The actual increase can then be added to
the budgeted amount.
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Preparing the cost of goods manufactured budget involves compiling the
information in the product cost budgets previously prepared.
The direct materials purchases shown on the budget below of $45,550 is taken
from the materials budget ending figure above. The direct labor figure on the
budget below of $54,300 is taken from the total direct labor cost calculated in
the labor budget above. The budgeted overhead of $169,225 is taken from the
ending figure on the overhead budget.
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Finally, all of the budgets prepared so far, flow into the budgeted income
statement. In the budgeted income statement below, we see the projected sales
figure from the first budget prepared, the sales budget, of $450,000. We see
the cost of goods sold budgeted figures and the selling and administrative
expense budget figure. As the operating budgets are compiled into a formal
income statement format, we are able to project a budgeted net income of
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The final three budgets in a master budget include the budgeted balance
sheet and two budgets that flow into the budgeted balance sheet, the cash
budget and the capital expenditures budget. The capital expenditures budget is
only prepared if the company expects to purchase capital equipment in the
coming year. Our example company, Framecraft is not making any capital
purchases in the budget period, so no capital expenditures budget is prepared.
If capital expenditures are budgeted, the figure flows into the property,
plant, and equipment total on the budgeted balance sheet. There may also be a
note payable associated with the capital expenditure that would be included in
liabilities on the budgeted balance sheet.
The cash budget is based on the cash inflows and outflows that result from
the operating budgets above. Recall that the operating budgets are prepared in
accrual based accounting terms, so the cash budget, showing the inflows and
outflows of cash, is different than the schedules and budgets illustrated
above. The cash budget must consider the timing of the cash inflows in relation
to the speed of customer payments and outflows in relation to the invoices
received and paid for product costs and selling and administrative expenses.
For example, recall that budgeted sales above were $450,000. Notice that cash
inflows (cash receipts) below are $430,000. The difference of $20,000 ($450,000
– $430,000) relates to the speed at which customers pay their bills. The ending
figure on the cash budget of $50,162 is the cash amount you will see on the
budgeted balance sheet, our final component of the master budget.
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The cash figure calculated in the cash budget flows to the budgeted balance
sheet. Some companies estimate the accounts receivable figure and the accounts
payable figure by multiplying a percentage of the prior year. Other companies
calculate these estimates based on the prior budgets prepared. Most figures on
the budgeted balance sheet are estimated and presented to support the operating
budgets previously presented. The most important aspect of the budgeted balance
sheet is that it ties into the operating budgets and the cash budget and that
it balances with total assets equaling total liabilities plus stockholders’
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Assignment 7:
Breakeven Analysis
Breakeven Analysis

Prepare breakeven analysis and a C-V-P analysis planning future sales using
the information below.

Breakeven Analysis and Planning Future Sales

Write Company has a maximum capacity of 200,000 units per year. Variable
manufacturing costs are $12 per unit. Fixed overhead is $600,000 per year.
Variable selling and administrative costs are $5 per unit, and fixed selling
and administrative costs are $300,000 per year. The current sales price is $23
per unit.

What is the breakeven point in (a)
sales units and (b) sales dollars?
How many units must Write Company
sell to earn a profit of $240,000 per year?
A strike at one of the company’s
major suppliers has caused a shortage of materials, so the current year’s
production and sales are limited to 160,000 units. To partially offset the
effect of the reduced sales on profit, management is planning to reduce fixed
costs to $841,000. Variable cost per unit is the same as last year. The company
has already sold 30,000 units at the regular selling price of $23 per unit.
a. What amount of fixed costs was
covered by the total contribution margin of the first 30,000 units sold?
b. What contribution margin per unit
will be needed on the remaining 130,000 units to cover the remaining fixed
costs and to earn a profit of $210,000 this year?

Required references
And use
excel sheet
calculations as side tips

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