Cost & Management Accounting – II Ch3: Master Budget Compiled By:

Yafet H..

CHAPTER TREE
MASTER BUDGET
Introduction
This chapter is about master budget which is an important management accounting tool for
planning future activities and controlling current operation in the organization.
Budgets are crucial to the ultimate financial success of any organization. Budgets are so
important, mainly because they serve as road map towards achieving organizational goals.
Budgets as a management accounting tool helps management in planning, controlling and
performance evaluation. In this unit you will study how budget is used in planning the operation
of an organization

2.1 Purposes of Budget

Budget is a formal business plan. A budget is a tool that helps managers in both
their planning and control functions. Interestingly, budget helps managers with their
control function not only by looking forward but also by looking backward. Budget
deals with what managers’ are planning for the future. Budget can be used as a
benchmark that allows managers to compare actual performance with estimated or
desired performance.

Budget prepared as a formal business plan is used by all managers at different functional areas
and managerial level. Further budget is used by all types of organizations, be it a business
organization, government organization or NGO. When administered wisely budget can provide
the following benefits:
I. Efficient Allocation of Resources
Resource available to meet the objective of any organization is generally limited; therefore
efficient allocation of resource is one of the prerequisite for successful attainment of
organizational goal. For example, an office of a city Administration must allocate its revenue
among basic societal service such as security and protection, heath, education, infrastructure etc.
In the case of business organizations, the well-designed business strategy hardly becomes
successful without availability and efficient allocation of resource. Therefore, adopting formal
budgetary process helps organization to identify the resource requirement of the planed activity
and allocate in accordance to the priority of each operation in achieving organizational objective.
II. Compel strategic planning and implementation of plans
The budgeting process forces managers to plan ahead. The development of budget triggers
managers to plan their operation ahead as well as to prepare on the ways of talking any change
during the implementation of the plan.
Budget enable the successful implementation of strategy that is why in most business
organization budget is considered as an integral part of strategic planning and implementation.
III.Facilitating coordination and communication
For any organization to be effective, each manager throughout the organization must be aware of
the plan made by other managers. In large and diverse organizations the problem of coordination
becomes critical. An important role of budgeting is to improve the coordination among the
various units of the organization. Planning or budgeting means establishing objectives in

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advance and identifying the steps by which the objectives are to be accomplished. The planning
process initiates coordination and clarification of sub-goals to achieve major enterprise goals.
The coordinated plan or budget provides a blue print for implementation and control.
A good budgeting process facilitates communication in all direction in the organization
and help coordinating the various resources, manpower and units of the organization so
that goal of the organization is achieved.
IV. Frame work for judging performance
Once plans are in Place, Company’s performance can be measured against the budget established
for those plans. Budget can overcome two limitations of using past performance as a bases of
judging actual results. One limitation is that past results incorporate past misuse and sub standard
performance and the other limitation of using past performance is that the future conditions may
be expect to differ from the past.
As a performance evaluation basis budgeted performance are better than actual results.
V. Motivating Managers and Employees
Research shows that budgets that are challenging improve performance. An inability to achieve
budget numbers is viewed as filer. Most individuals are motivated to work more intensely to
avoid failure than to achieve success. As individuals get closer to goal they work harder to
achieve it. For this reason many executives like to set challenging but achieve goal for their
subordinates .Creating attitude of anxiety improves performance, but overly ambitious and
unachievable budget increase anxiety without motivation that is because individuals see little
chance of avoiding.
2.2 Types of Budget and Budgeting Techniques
The type of budget used by different organization differs based upon the nature of their business
and the purpose of the budget; however, the general frame work is the same. In this section we
will try to see the different types of budget, their advantage and disadvantage and in what
circumstance organizations prefers to adopt a specific type of budget and budgeting techniques.
2.2.1 Types of budgets
1. Strategic Plan: The most forward looking budget is the strategic plan, which sets the
overall goals and objective of the organization. Some organization won’t classify the
strategic plan as an actual budget though because it does not deal with a specific time
frame and it does not produce forecasted financial statement. In any case, the strategic
plan leads to long range planning which produce forecasted financial statement for five or
ten years. The financial statements are estimates of what management would like to see
in the company’s future financial statement. Decisions made in long range planning
include addition or deletion of department, acquisition of a new equipment or building
and other long term commitment.
2. Capital Budget: Capital budget is a budget that details the planned expenditure for
facilities, equipment, new product, and other long-term investments.
3. Master budget: A master budget is a short-term, comprehensive plan to achieve the
financial and operational goals of an organization. Master budget comprises of the
organizations overall plan for the given period and the budget for the various functional
areas that make up the organization.
A master budget involves the development of a complete set of financial statement for the
budget period with supporting schedule.

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2.2.2 Types of budgeting techniques

Different organizations prepare budget using different techniques that may be grouped as
follows:
1. Incremental budgeting: is a budget set based on past year’s actual performance. In this
technique a budget for the coming year is simply this year budgeted or actual results plus
or minus some amount for expected change on planned operation or change in the market
price. This budgeting technique is easy and widely used, however it has its own draw
back. As the base is the current year performance or budget any anomaly in the current
year performance or budget may be incorporated in the budget.
2. Zero based budgeting: In a dynamic business it often makes sense to 'start afresh' when
developing a budget, rather than basing ideas too much on past performance. In this
technique each budget is therefore constructed without much reference to previous
budgets. Preparing a budget afresh is usually required in most business organizations,
where the business environment is volatile that require continues effort of incorporating
changes in budget thinking.
3. Rolling budgets: Given the speed of change and general uncertainty in the external
environment, shareholders seek quick results. US companies typically report to
shareholders every three months, compared with six months in the UK. Rolling budgets
involve evaluating the previous twelve months' performance on an ongoing basis, and
forecasting the next three months' performance.
4. Strategic budgeting: This involves identifying new, emerging opportunities, and then
building plans to take full advantage of them. This is closely related to zero based
budgeting and helps to concentrate on gaining competitive advantage.
5. Activity based budgeting: This examines individual activities and assesses the strength
of their contribution to company success. They can then be ranked and prioritized, and be
assigned appropriate budgets.
Master budget can be prepared as a standalone for one year or one operating cycle or in a
continuous basis. Continuous budget or rolling budget or revolving budget are a very common
form of a master budget that simply add a month in the future as the month just ended is
dropped. Budgeting thus becomes an ongoing instead of periodic process. Continuous budgets
for managers to allow think about the next twelve months not just the remaining month in fixed
budgeting cycle. As they added a new twelfth month to continuous budget, managers may update
the other month as well. They can compare actual monthly result with both the organization plan
and the most recent revised plan. Continuous budgeting approach in preparing master budget is
adapted mostly when the business environment is volatile to coup up with the change.
2.3 Budgeting in Business Organization

2.3.1 Responsibility for developing master budget

The type of budget and the extent of the budgeting activity vary considerably from organization
to organization. In smaller business organization, there may only be a sales forecast, a production
budget or a cash budget, larger organization generally prepare a master budget or a
comprehensive budget.

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The primary responsibility for developing a master budget is given to the controller and her or
his staff. In large organization, a special budget committee will be formed.
The budget committee is usually composed of several key executive from various segment of the
organization. People from finance, sales, purchasing, production, engineering and accounting are
usually represented.

The procedure followed by this committee in developing the budget is largely determined:
 By the authority it has over the finance budget
 By the amount of participation it allows from others within the organization.
The authority of the budget committee is determined by top management philosophy; top
management may have a predetermined profit objective in mind and will look to the budget as a
means to accomplish it. This objective may be stated in variety of ways, such as rate of return on
net asset, earning per share, or a specific amount of net income. It may be based on operating
results of previous years adjusted for expectations about the coming year or some desired level
of profitability. When top management has a predetermined profit objective, the budget
committee must recognize it and develop a budget that will achieve it.
If top management has no specific profit level in mind, the budget committee must first develop
some notion about what is fair and reasonable expectation for the budget period without this, the
budget process often turn in to “game” and much of the benefit is lost.
The budget committee may or may not invite other members in the organization to participate in
developing the budget. In estimating sales for the coming period, for example, sales people may
be asked to project the number of units of each product they expect to sell in their territories.
The sales representative on the budget committee would use these as a basis for developing the
sales forecast for the entire company. Participation could be carried to the extreme, and every
person in the organization could be asked to estimate productivity in her or his individual area.
On the other extreme, the budget committee may allow no participation. It merely may develop a
budget that will achieve the desired profit and pass it on as the standard of performance for the
budget period.

2.3.2 Process of developing a master Budget

Although each organization is unique in the way it puts together its budget, all budgeting process
share some common elements. After organizational goals, strategies, and long range plans have
been developed, work begins on the master budget, a detailed budget for the coming fiscal year
with some detail.
The master budget is a comprehensive financial plan for a business. It is made up of the
Operating and Financial budgets, which are in turn made up of supporting schedules (budgets).

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To envision the master budget process, picture the financial statements most commonly prepared
by companies: The income statement, the balance sheet, the cash flow statement. Then imagine
the preparation of these statements before the fiscal period operational period.

2.4. Components of a Master Budget

As explained earlier, the master budget is the principal output of a budgeting
system that shows a comprehensive operating and financial plans of management.
This budget ties together all phases of an organization’s operations and is
comprised of many separate budgets and schedules that are interdependent. The
terms used to describe assorted budget schedules vary from organization to
organization, though most master budgets have common elements.

The usual master budget for a non-manufacturing company, for instance,

merchandising firm has the following components:
 Operating budget refers to the budgeted income statement and the supporting budget
schedules for various business functions in the value chain. The operating budget
basically shows the expected operating result of the organization in the upcoming
operational period.
 The financial budget is part of the master budget made up of the capital expenditures
budget, the cash budget, the budgeted balance sheet, and the budgeted statement of cash
flow.
2.4.1. Operating Budget for merchandising business
The operating budget focuses on the income statement and its supporting
schedules. Although the operating budget is sometimes called the profit plan, an
operating budget may show a budgeted loss, or even be used to budget expenses
in an organization or agency with no sales revenue. The budgeting process normally
begins with the preparation of the operating budgets. An operating budget is
prepared by individual sections within a company and becomes part of the
company’s master budget. The number of operating budgets depends on the
nature of the business entity. For instance, some operating budgets prepared
for manufacturing companies may not be required for merchandising concerns.

2.4.1.1 Sales Budget

The sales budget is the starting point for budgeting because the inventory levels,
purchases, and operating expenses are geared to the rate of sales activities and
other cost drivers. A sales budget is a detailed schedule showing the expected sales
for the budget period. The sales budget typically is expressed in both sales birr and
units of product. An accurate sales budget is the key to the entire budgeting
process. All of the other parts of the master budget are dependent on the sales
budget in some way. Thus, if the sales budget is done sloppily or messily, then the
rest of the budgeting process is largely a waste of time. The sales budget for a
hypothetical company used in this Duty called ABC Company appears in table below

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shows the total budgeted sales and the composition of cash and credit sales
respectively.

ABC Company
Sales Budget
For the Quarter Ended December 31, 20XX
Months
Quarter’s
January February March
Budgeted cash
Birr XX Birr XX Birr XX XXXX
sales
Budgeted credit
Birr XX Birr XX Birr XX Birr X
sales
Total Budgeted Birr Birr Birr Birr
sales XXXX XXXX XXXX XXXX

Notice that, to prepare the sales budget, budgeted cash sales and budgeted credit
sales information of the original data are used and that this information can be
obtained from the marketing department or any other sales forecast related units.

2.4.1.2 Cash Collection Budget

The schedule of expected cash collection is prepared at the same time of preparing
the sales budget. Thus, after the sales budget is prepared, the schedule of expected
cash collections is prepared to show how much cash is expected to be received
from customers. The cash collections include to current month’s cash sales plus the
previous month’s credit sales expected to be collected in the current month. In
brief, the cash collections consist of collections on sales made to customers in prior
periods plus collections on sales made in the current budget period. To prepare this
schedule, you have to look at the sales budget prepared above and the data given
in the illustration on the mode of collecting credit sale. The schedule of expected
cash collections for ABC Company appears in table below, which will be later
needed to prepare the cash budget.

ABC Company
Cash Collection Budget
For the Quarter Ended December 31, 20XX
Months
Quarter’
Februar
January March s
y
Accounts Receivable-beginning
Birr XX - - Birr XX
balance
January sales Birr XX Birr XX - Birr XX
February sales - Birr XX Birr XX Birr XX
March sales - - Birr XX Birr XX

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Birr Birr
Total expected cash collections Birr XXX Birr XXX
XXX XXX

2.4.1.3 Purchases Budget

This budget is prepared to show the amount of goods to be purchased from
suppliers during the period. Merchandising firms would prepare an inventory
purchases budget for each item carried in stock. Some large retail organizations
make such computations on a frequent basis to ensure that adequate stocks are on
hand to meet customer needs. In brief, after the sales budget is prepared, the
inventory purchases budget is prepared to show the amount of inventory that will
be needed to satisfy the amount of projected sales. Meeting the sales demand
requires having enough inventories to cover expected sales and future sales
between reorder points. Accordingly, the total amount of inventory needed for each
month equals the amount needed to fulfill budgeted sales demand plus the desired
ending inventory. The total amount of inventory needed can be obtained from two
sources. These are the company can use existing stock, or simply beginning
inventory, and the company’s planned purchases. The schedule of inventory
purchases for ABC Company appears in table below.

ABC Company
Inventory Purchases Budget
For the Quarter Ended December 31, 20XX
Months
Quarter’s
January February March
Budgeted costs of goods
Birr XX Birr XX Birr XX Birr XX
sold
Add: Desired ending Birr XX Birr XX Birr XX
Birr XX
inventory
Total inventory needed Birr XX Birr XX Birr XX Birr XX
Less: Beginning inventory Birr XX Birr XX Birr XX Birr XX
Birr Birr Birr Birr
Required purchases
XXXX XXXX XXXX XXXX

2.4.1.4 Disbursement for Purchase Budget

This schedule is based on the purchases budget. This schedule is later needed to prepare the overall
cash budget. Disbursements for inventory purchases consist of payments for purchases on account
made in prior periods plus any payment for inventory purchases made in the current budget period. The
schedule of expected disbursements for purchases for ABC Company appears in table below.
ABC Company
Expected Cash Disbursements for Purchases Budget
For the Quarter Ended December 31, 20XX
Months Quarter’
January February March s

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Accounts payable-beginning Birr XX - - Birr XX

balance
January purchases Birr XX Birr XX - Birr XX
February purchases - Birr XX Birr XX Birr XX
March purchases - - Birr XX Birr XX
Total disbursements for Birr Birr Birr Birr
purchases XXXX XXXX XXXX XXXX

2.4.1.5 Operating Expenses Budget

This budget lists the budgeted operating expenses for the budget period. All
budgeted selling and administrative expenses would be compiled and listed down.
In large organizations, this budget would be a compilation of many smaller,
individual budgets submitted by department heads and other persons responsible
for selling and administrative expenses. For example, the marketing manager in a
large organization would submit a budget detailing the advertising expenses for
each budget period.

The budgeting of operating expenses depends on various factors. Month-to-month

fluctuations in sales volume and other cost-driver activities directly influence many
operating expenses. Examples of expenses driven by sales volume include sales
commissions and many delivery expenses. Other expenses are not influenced by
sales or other cost-driver activity, and such expenses include rent, insurance,
depreciation, and salaries within appropriate relevant ranges and are regarded as
fixed. The operating expenses budget does not contain a provision for interest
expense, because the amount of interest expense cannot be determined until the
amount of expected borrowing has been established through the preparation of the
cash budget. Accordingly, the interest component will be determined at a later point
in the budgeting process. The operating expense budget, in any case, will be later
needed to prepare the budgeted income statement. The schedule of operating
expense budget for ABC Company appears in table below.

ABC Company
Operating Expense Budget
For the Quarter Ended December 31, 20XX
Months
Quarter’s
January February March
Salaries and wages Birr XX Birr XX Birr XX Birr XX
Advertising Birr XX Birr XX Birr XX Birr XX
Shipping Birr XX Birr XX Birr XX Birr XX
Depreciation Birr XX Birr XX Birr XX Birr XX
Other expenses Birr XX Birr XX Birr XX Birr XX
Total budgeted operating Birr Birr Birr Birr
expenses XXXX XXXX XXXX XXXX

2.4.1.6 Disbursements For Operating Expenses Budget

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This schedule is based on the operating expenses budget. For example, if the
information available states that cash expenses are paid as incurred it means that
all cash expenses incurred in first month will be paid in that month, and so on. In
practice, differences between expense recognition and cash flow are present
because of several conditions. Thus, expenses recognized in one period may not
affect the cash flow of that period if they will be paid in later periods. Notice that
depreciation expense is not included in the cash disbursements for operating
expenses, because depreciation is a non-cash expense. Cash outflow for
investments in plant assets is shown as an investing activity at the time cash is paid
to purchase plant assets. At this time, the investing activity will be shown on a
separate line on the cash budget. At later times, depreciation is recognized as an
expense by rationally and systematically allocating the cost of plant assets over
their useful life. Such an allocation, however, does not represent an expense that
calls for the payment of cash.

The schedule of expected cash disbursements for operating expenses for ABC
Company appears in table below.

ABC Company
Cash Disbursements for Operating Expense Budget
For the Quarter Ended December 31, 20XX
Months Quarter’
January February March s
Salaries and wages Birr XX Birr XX Birr XX Birr XX
Advertising Birr XX Birr XX Birr XX Birr XX
Shipping Birr XX Birr XX Birr XX Birr XX
Other expenses Birr XX Birr XX Birr XX Birr XX
Disbursements for operating Birr Birr Birr Birr
expenses XXXX XXXX XXXX XXXX

Notice from the operating expense disbursement schedule that depreciation

expense is excluded for reasons explained earlier. This schedule will later be
needed when the cash budget is prepared.

2.4.1.7 Budgeted Income Statement

The budgeted income statement from operations can be prepared from the data
developed in all tables shown above. The budgeted income statement is one of the
key schedules in the budget process. It shows the company’s planned profit for the
upcoming budget period, and it stands as a benchmark against which subsequent
company performance can be measured. The income statement will be complete
after addition of the interest expense, which is computed after the cash budget,
has been prepared.

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If expected profitability is unsatisfactory, management may take actions, including

abandoning the project for which the budget is prepared or altering planned
activity. Management perhaps may convince employees to accept lower pay or take
actions to reduce the number of employees, which is of course is not a corrective
action. Likewise, the pricing strategy could be scrutinized or examined for possible
changes. Indeed, budgets are usually prepared on spreadsheets or computerized
mathematical models that enable managers to easily perform “what-if” analysis.
Managers change some variables on the spreadsheet, and the software instantly
presents revised set of budgets. Although computer technology can provide instant
access to a wide array of budgeted data, the manager remains responsible for data
analysis and decision-making. The proper interpretation of budgeted data requires
an understanding of the origins and limitations of the budget amounts. For this
reason, you are advised to retrace the data in the budgeted income statement, and
other Performa financial statements for that matter, back to the source data.

The budgeted income statement for ABC Company appears in table below, which is
referenced by the source data for its preparation. Notice that income taxes are
ignored in this illustration.

ABC Company
Budgeted Income Statement
For the Quarter Ended December 31, 20XX
Sales Birr XX
Less cost of goods sold Birr XX
Gross margin Birr XX
Less operating expenses:
Salaries and wages Birr XX
Advertising Birr XX
Shipping Birr XX
Depreciation Birr XX
Other expenses Birr XX
Total operating expenses Birr XX
Net operating income Birr XX
Less interest expense Birr XX
Net income Birr XX

The interest expense will be computed later when the cash budget is prepared.
The main reason why the budgeted income statement is prepared before the cash
budget is to show that the ultimate output of the operating budgets is Performa or
budgeted income statement.

2.4.2. Operating budget for Manufacturing Companies

Steps in preparing an operating budget for Manufacturing Companies
Step1. Revenue budget:

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 It is the usual starting point for budgeting, because production and hence costs
and inventor level generally depend on the forecasted level of revenue.
Budgeted Revenue = Budgeted quantity x unit selling price

Step2. Production Budget (unit):

 After revenue is budgeted, the production budget can be prepared. The total
finished goods units to be produced depend on planned sales and expected
changes in inventory level.
Budgeted Production (unit) = Budgeted sales + Target ending FG -–
Beginning FG
Inventory (unit)
Inventory (unit)

Step3. Direct Material Purchase & Usage Budget

 The decision on the number of units to be produced is the key to computing
the usage of direct material in quantities and currency.
 Direct Material Usage Budget in Units and Currency
Direct Material Usage = Budgeted production X Quantity of material required
per unit
Budget (unit)

Direct Material Usage in Currency = quantity of material used X rate per unit

 Direct Material Purchase Budget

DMPB (unit) = Production Usage + Target EI of Material in Unit - Beginning Inventory of RM in Units

DMPB in Currency= purchase quantity X rate per unit

Step4. Direct Manufacturing Labour Budget

 These costs depends on wage rates, production methods and hiring plans
 Budgeted Labour Hours = budgeted Production X Time Required per
Unit
 Budgeted Labour Cost = Budgeted Labour Hours X Labour Cost per Unit

Step5. Manufacturing overhead budget:

 The total of these costs depends on hours individual over head costs vary with
the assumed cost driver, direct manufacturing labour hours

Step6. Ending inventory budget

RM ending Budget = Unit cost of RM X Quantity of Ending Inventory
FG good Ending inventory = Unit Cost of Production X Quantity of Ending Inventory

Step7. Cost of goods sold budget

Beginning FG inventory XXX
Beginning work in process XX

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Direct Material used XX

Direct Manufacturing Labour XX
Manufacturing overhead XX
Manufacturing cost during the year XX
Total Work in Process Inventory during the year XX
Less: Ending Work in Process (XX)
Cost of goods manufactured
XX
Cost of Goods Available for Sale
XXX
Less: Ending Finished Goods Inventory
(XX)
Cost of Goods Sold
XXX

Step8. Budgeted Income Statement

Revenue
XXX
Less Cost of Goods Sold
(XX)
Gross Margin
XXX
Less: Operating Costs:
Research & Development Costs XX
Marketing Costs XX
Distribution Costs XX
Customer service Cost XX
Administrative Costs XX
XX
Operating Income
XXX

2.4.3 Financial Budget

The second major part of the master budget is the financial budget, which consists
of the capital budget, cash budget, budgeted balance sheet, & budgeted
statement of cash flows. The capital expenditure budget or capital budget is a
very important budget as it throws light on a firm’s outlay and expansion and
diversification program. This budget may not be restricted to a single year and may
be prepared to cover a long period of years. While preparing this budget, factors
such as sales potential for the increased production, possibility of price reduction,

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and increased selling and administrative costs are to be considered. The capital
expenditure budget enables a firm to establish a system of priorities, and serves as
a tool for controlling expenditure. It also facilitates cost reduction program
particularly when modernization and renovation is covered by this budget. However,
the capital expenditure budget will not be discussed in this section. This section,
therefore, focuses on the cash budget, budgeted balance sheet, and budgeted
statement of cash flows. The financial budget focuses on the effects that the
operating budget and other plans (such as capital budgeting and repayment of
debt) will have on cash. The financial budget consists of the capital budget, cash
budget, budgeted balance sheet, and budgeted statement of cash flows.

2.4.3.1 Capital Budget

The capital budget is prepared for additions to property and equipment. This
budget is used to describe a company’s long-term plans regarding investment in
facilities, equipment, new products, store outlets, and lines of business.

2.4.3.2 Cash Budget

The cash budget is used, as you shall see later in this section, to ensure that cash
will be available throughout the budget year. Once the operating budgets have
been established, the cash budget and other financial budgets can be prepared. A
cash budget is a detailed plan showing how cash resources will be acquired and
used over some specified time period. All of the operating budgets have an impact
on the cash budget. In the case of the sales budget, the impact comes from planned
cash receipts to be collected from sales to customers. In the case of the other
budgets, the impact comes from the planned cash expenditures within the budgets
themselves.

The cash budget is a statement of planned cash receipts and disbursements and
pulls together much of the data developed in the preceding steps. Most of the raw
data needed to prepare the cash budget are included in the cash receipts and
disbursements schedules that were discussed earlier. However, further refinements
of these data are sometimes necessary. The cash budget is composed of four major
sections listed below:

1. The Receipts Section. This section consists of a listing of all of the cash
inflows, except for financing, expected during the budget period. Generally,
the major source of receipts will be from sales.

2. The Disbursements Section. This section consists of all cash payments that
are planned for the budget period. These payments will include raw materials
purchases, direct labor payments, manufacturing overhead costs, operating
expenses, and so on, as contained in their respective budgets. In addition, other
cash disbursements such as equipment purchases, dividends, and other cash

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withdrawals by owners are listed. This is additional information that does not
appear on any of the earlier schedules.

3. The Cash Excess or Deficiency Section. The cash excess or deficiency is

computed as follows:
Cash Balance, Beginning Birr XX
Add Cash Received Birr XX
Total cash available before financing Birr XX
Less disbursement Birr XX
Excess (deficiency) of cash Birr XX

If there is a cash deficiency during any budget period, the company will need to
borrow funds. If there is cash excess during any budget period, funds borrowed in
previous periods can be repair or the idle funds can be placed in short-term or other
investments.

4. The Financing Section. This section provides a detailed account of the

borrowings and repayments projected to take place during the budget period.
It also includes a detail of interest payments that will be due on money
borrowed.

The following points are worth mentioning about the cash budget shown for ABC
Company in table below:
(a) Cash balance, beginning. It is taken from the original information given or
available, that is, a cash balance on December 31, 20XX in the case of ABC
Company. Thus, remember that the ending cash balance of December
becomes the beginning cash balance of January. Moreover, the beginning
cash balance for the quarter means the same as the beginning cash
balance for January. This is so because the quarter begins on January 1.
(b) Collections from customers. The collections from customers are brought from
the schedule of expected cash collections.
(c) Purchases of inventory. The figures for purchases of inventory are taken
from the schedule of expected cash disbursements for purchases.
(d) Operating expenses. The figures for operating expenses are taken from the
schedule of expected cash disbursements for operating expenses.
(e) Purchases of equipment and cash dividends. While the figures for purchases
of equipment are taken from information given or available and the figure for
cash dividends.
(f) Financing.

ABC Company
Cash Budget
For the Quarter Ended December 31, 20XX
Months Quarter

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Yafet H..

January February March s

Cash balance, beginning Birr XX Birr XX Birr XX Birr XX

Add Cash Received:

Collection from customers Birr XX Birr XX Birr XX Birr XX
Total cash available for needs
Birr XX Birr XX Birr XX Birr XX
[a]

Less Cash disbursements:

Purchases of inventory Birr XX Birr XX Birr XX Birr XX
Operating expenses Birr XX Birr XX Birr XX Birr XX
Purchases of equipment - Birr XX Birr XX Birr XX
Cash dividends Birr XX - - Birr XX
Total Cash disbursements [b] Birr XX
Birr XX Birr XX Birr XX
Minimum Cash Balance Desired Birr XX
[c] Birr XX Birr XX Birr XX Birr XX
Total Cash Needed [d]=[b]+[c] Birr XX Birr XX Birr XX

Excess (deficiency) of cash [e] = [a] Birr XX Birr XX Birr XX Birr XX

- [d]
Financing:
Borrowings (at beginning) Birr XX - - Birr XX
Repayments (at ending) - - Birr XX Birr XX
Interest - - Birr XX Birr XX
Total financing [f] Birr XX - Birr XX Birr XX
Cash balance, ending [g]=[c] + Birr XXX Birr
Birr XXX Birr XXX
[e]+[f] XXX

2.4.3.3 Budgeted Balance Sheet

Financial budgets are concerned with the inflows and outflow of cash, which may be
detailed in cash budget and showing expected financial position at the end of the
budget period in a pro forma or budgeted balance sheet. The preparation of the
operating budget should precede the preparation of the financial budget because
many of the financing activities are not known until the operating budgets are
known.

The budgeted or pro forma balance sheet projects each balance sheet item in
accordance with the business plan as expressed in the previous schedules. To
construct the budgeted balance sheet, we start with the general ledger account
balances as of December 31,20XX given or available data in the case of ABC

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 Cost & Management Accounting – II Ch3: Master Budget Compiled By:
Yafet H..

Company and adjust each balance sheet account balance for the changes expected
to take place during 20XX. The budgeted balance sheet for ABC Company is shown
in table below.

ABC Company
Budgeted Balance Sheet
December 31, 20XX
Assets
Current assets:
Cash Birr XX
Accounts receivable Birr XX
Inventory Birr XX
Total current assets Birr XX
Plant assets:
Building and equipment (net) Birr XX
Total Assets Birr XX
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable Birr XX
Stockholders’ equity:
Capital stock Birr XX
Retained earnings Birr XX
Total stockholders’’ equity Birr XX
Total Liabilities and Stockholders’’ Equity Birr XXX

Carefully observe the following explanations about the figures contained in the
budgeted balance sheet shown in table above.

(a) Cash: The figure for cash is brought from the cash budget prepared before
and shows the ending cash balance for the month of March or for the
quarter in general.

(b) Accounts Receivable: The figure for accounts receivable represents the
credit sales expected to be made in March. You are encouraged to look back
at the explanation given below the schedule of expected cash collections
that appears in schedule.

(c) Inventory: The figure for inventory is brought from the inventory purchases
budget in schedule 1(c) and shows the desired ending inventory for the
month of March or for the quarter in general.

(d) Plant assets (net): The figure for plant assets (net) is computed from the
acquisition cost of the plant assets and its accumulated depreciation.

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 Cost & Management Accounting – II Ch3: Master Budget Compiled By:
Yafet H..

(e) Accounts payable: The figure for accounts payable represents the amount
of the inventory purchases and other items acquired on account in March.
You are encouraged to look back at the explanation given below the
schedule of purchases & expected cash disbursements for inventory
purchases budget.

(f) Capital stock: The figure for capital stock is taken as it is directly from
information given on the general ledger account balances as of the date of
incorporation and any other paid in capital in excess of par value.

(g) Retained earnings: The figure for retained earnings is computed projected
retained earnings and adding it to the net income projected and deducting
the dividends to paid.

EXERCISE 2.1(Master budget of Merchandising Business)

To illustrate the budget process for merchandising firms, a hypothetical
office supplies specialty store in Addis Ababa called ANC Company will be
considered. The company prepares its master budget on a quarterly basis.
The following data have been assembled to assist in the preparation of the
master budget for the first quarter of 2005:

(a) As of December 31, 2004, the company’s general ledger showed the following
account balances:
Debit Credit
Cash Birr 48,000
Accounts receivable 224,000
Inventory 60,000
Building and equipment (net) 370,000
Accounts payable Birr 93,000
Capital stock 500,000
Retained earnings 109,000
Total Birr 702,000 Birr
702,000

(b)Actual sales for December 2004 and budgeted sales for the next four months of 2005 are as follows:
December (actual) Birr 280,000
Budgeted sales of 2005:
January 400,000
February 600,000
March 300,000
April 200,000

(c) Sales are 20% for cash and 80% on credit. All payments on credit sales are
collected in the month following sale. The accounts receivable at December
31, 2004 are a result of December credit sales.

(d) The company’s gross profit rate is 40% of sales.

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 Cost & Management Accounting – II Ch3: Master Budget Compiled By:
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(e)Monthly expenses are budgeted as follows:

Salaries and wages Birr 27,000 per
month
Advertising Birr 70,000 per
month
Shipping 5% of sales
Depreciation Birr 14,000 per
month
Other expenses 3% of sales
Note that cash expenses are paid as incurred.

(f) At the end of each month, inventory is to be on hand (minimum required or

desired inventory level) equal to 25% of the following month’s sales needs,
stated at cost.

(g) One-half of a month’s inventory purchases are paid for in the month of
purchase, the other half is paid for in the following month.

(h) During February, the company will purchase a new copy machine for Birr 1,700
cash. During March, other equipment will be purchased for cash at a cost of Birr
84,500.

(i) During January, the company will declare and pay Birr 45,000 in cash dividends.

(j) The company must maintain a minimum cash balance of Birr 30,000 each
month. An open line of credit is available at a local bank for any borrowing that
may be needed during the quarter. All borrowing is done at the beginning of a
month, and all repayments are made at the end of a month. Borrowings and
repayments of principal must be in multiples of Birr 1,000. Interest is paid only
at the time of payment of principal. The annual interest rate is 12%.

The end of chapter 2!

Have a Nice Study!

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