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Managerial Accounting Unit 7: Budgeting and the Master Budget

The master budget turns a sales forecast into a full set of plans for production, purchases, labor, cash and financial statements. Students must be able to prepare each schedule in the right order.

Covers: Purposes of budgeting and behavioral issues, Sales and production budgets, Direct materials, labor and overhead budgets, Selling and administrative expense budget, Cash collections and disbursements, Cash budget and financing, Budgeted income statement and balance sheet

Study guide

A budget is a detailed plan for acquiring and using resources over a period. Budgets help managers plan, coordinate departments, communicate goals, allocate resources and evaluate performance. How a budget is set matters. In participative (self-imposed) budgeting, managers help prepare their own budgets, which improves accuracy and commitment but invites budgetary slack, the padding of costs or understating of revenue to make targets easier. Many firms use a continuous or rolling budget that always looks 12 months ahead. Zero-based budgeting requires every expense to be justified from scratch rather than adjusted from last year.

The master budget is a linked set of schedules. It begins with the sales budget: budgeted units × price. The production budget follows: required production = budgeted sales + desired ending finished goods - beginning finished goods. Next comes the direct materials budget: materials needed for production + desired ending materials - beginning materials = materials to purchase, then times cost per unit. The direct labor budget multiplies units produced by labor-hours per unit and the wage rate. The manufacturing overhead budget lists variable and fixed overhead, and the selling and administrative budget lists those period costs. Inventory targets are often a percentage of the next period's needs.

The cash budget gathers the cash effects of all the operating budgets. Cash receipts come mainly from collections of sales, which follow a pattern, such as 60% in the month of sale and 40% the next month. Cash disbursements include payments for materials (often lagging purchases), direct labor, overhead, selling and administrative costs, equipment, taxes and dividends. Non-cash expenses such as depreciation are excluded. The format is: beginning cash + receipts = cash available; minus disbursements = excess or deficiency; plus borrowing or minus repayments and interest = ending cash. Borrowing is set to keep the required minimum balance.

The last pieces are the budgeted income statement and budgeted balance sheet. The income statement uses budgeted sales, cost of goods sold (units sold × budgeted unit product cost), selling and administrative expenses and interest. The balance sheet uses ending balances from the schedules: ending cash from the cash budget, receivables from uncollected sales, inventories from the production and materials budgets, and payables from unpaid purchases. Because everything links back to the sales forecast, an error in sales flows through every schedule. A static master budget is set for one activity level, so it cannot be used alone to judge costs when actual activity differs.

Key ideas

• The sales budget comes first; every other budget depends on it.
• Required production = budgeted sales + desired ending FG - beginning FG.
• Materials purchases = production needs + desired ending materials - beginning materials.
• Cash collections and payments follow stated patterns and often lag sales and purchases.
• Depreciation is a non-cash expense and is excluded from cash disbursements.
• Borrowing in the cash budget is set to maintain a minimum cash balance.
• Participative budgeting improves buy-in but can create budgetary slack.

Formulas and rules

Common mistakes

• Basing ending inventory targets on the current month instead of the next month.
• Using sales units instead of production units in the materials and labor budgets.
• Including depreciation in cash disbursements.
• Mixing up which month's sales or purchases are collected or paid in a given month.
• Forgetting interest or rounding rules when computing borrowing and repayment.

Before the test, make sure you can

• Explain the purposes of budgeting and the risks of budgetary slack.
• Prepare a sales budget and a production budget.
• Prepare a direct materials purchases budget in units and dollars.
• Prepare direct labor and manufacturing overhead budgets, including cash paid for overhead.
• Prepare a schedule of cash collections and cash payments.
• Prepare a cash budget with borrowing, repayment and interest.
• Prepare a budgeted income statement and identify budgeted balance sheet amounts.

Words to know

Budget

A detailed plan, usually in dollars, for acquiring and using resources over a period.

Master budget

A linked set of budgets covering operations and finances for a period.

Sales budget

A schedule of expected sales in units and dollars; the starting point of the master budget.

Production budget

A schedule of units that must be produced to meet sales and inventory targets.

Direct materials budget

A schedule of materials needed and materials to purchase.

Direct labor budget

A schedule of labor-hours and labor cost needed for planned production.

Cash budget

A schedule of expected cash receipts, disbursements and financing.

Schedule of expected cash collections

A schedule showing when sales will be collected in cash.

Budgeted balance sheet

A projected balance sheet using ending balances from the other budgets.

Participative budget

A budget prepared with the input of the managers responsible for meeting it.

Budgetary slack

Padding in a budget from underestimating revenues or overestimating costs.

Continuous budget

A rolling budget that adds a new period as each period ends.

Zero-based budgeting

A method requiring every expense to be justified from zero each period.

Static budget

A budget prepared for one planned level of activity.

Minimum cash balance

The lowest cash balance a company wants to hold; it determines borrowing needs.

Sample practice questions

30 more questions like these, from level 1 to 5, are in the practice set.