BUDGETING AND THE MASTER

BUDGET

Alok Dixit
Indian Institute of Management, Lucknow
 BUDGET
 A detailed plan in monetary terms.

 Based on certain assumptions, a budget reflects target revenues

to be achieved and support (operating & Non-operating)
expenses to accomplish it, over a specified period (year/ quarter/
month).

 The budget numbers are based on the changes that are yet to be
implemented, rather than on current practices or methods.

(Horngren, 2010)
 BENEFITS OF BUDGETS
Presents an ‘integrated picture of core operations’ of a Business
to be achieved during a specific period.

Compel
managers
to think
ahead Provide an opportunity to
reevaluate existing activities
and evaluate new ones.

Aid managers in communicating

objectives and coordinating actions
across the organization.

Facilitates in spotting deviation (if any) on time & its control.

TYPES OF BUDGETS

Strategic plan

Master budget

Rolling / Continuous budget

MASTER BUDGET
MASTER BUDGET FOR MANUFACTURING FIRM

Source: Cost Accounting by Horngren

 MASTER BUDGET
A comprehensive planning document that incorporates several individual budgets.

broadly classified in terms of “Operating Budgets” and “Financial Budgets”.

Operating Budget
(Profit plan) Financial Budget
Focuses on the planned Focuses on the effects that
operations and their summary. the operating budget and
Budgeted Income Statement other plans will have on
and supporting schedules or cash balances & overall
budgeted expenses. financial health of the
company.
 TRADITIONAL VS. CONTINUOUS/
ROLLING BUDGET

Traditional Forecasts and Budgeting

 HYPOTHETICAL LIMITED
(AN EXAMPLE OF STATIC MASTER BUDGET;
STATIC REFERS TO BUDGETING PRACTICE
WHEREIN THE BUDGET IS PREPARED FOR
ONLY ONE LEVEL OF ACTIVITY, I.E.,
BUDGETED CAPACITY)
 MASTER BUDGET EXERCISE

Master Budget
 http://faculty.cbpp.uaa.alaska.edu/afrfb/acct202/pracexams/Ch
pt_09_pex.htm

Cashflow budget
 https://www.extension.iastate.edu/agdm/wholefarm/html/c3-15
.html
 CAPACITY TYPES
 Theoretical / Ideal/ Full capacity: The maximum capacity specified by the
manufacturer. Assumes no loss of time, i.e., we can run the machine at full
speed without any interruptions.

 Practical Capacity: The capacity after accounting for unavoidable operating

interruptions/ constrains, e.g., time lost in preventive maintenance, weekly
offs, set up time, etc.

 Normal Capacity: The average capacity most likely to be utilized by the

company (to cater to the customers’ demand) over sufficiently long-period of
time. It is chosen to cover whole economic cycle so that ‘seasonal’ and
‘cyclical’ fluctuations can be averaged out.

 Budgeted Capacity: The most likely/ expected level of activity to be utilized

by the company during the budgeted period (short-term, e.g., one year).
 USES OF MASTER BUDGET

 Controlling (provides targets to be achieved in near future,

e.g., a month; a quarter; a year or even longer).

 Guiding efforts, communicates objectives, constraints, and

expectations to the employees.

 Helps in financing expansions/ growth strategies

(Negotiating Finances/ Funds)
TIME COVERAGE OF BUDGETS

Budgets typically have a set time

period (month, quarter, year).

This period can be further broken

into sub periods.

The most frequently used budget

period is one year.

Businesses are increasingly using

rolling budgets.
 SOURCES OF UNCERTAINTIES

Estimated/ Budgeted Estimated/ budgeted Costs

Revenues

Uncertainties in budget
estimates
 TREATMENT IN FINANCIAL ACCOUNTS:
FIXED PRODUCTION OVERHEAD & NORMAL
CAPACITY
The allocation of fixed production overheads to the costs of conversion is based
on the normal capacity of the production facilities. Normal capacity is the
production expected to be achieved on average over a number of periods or
seasons under normal circumstances, taking into account the loss of capacity
resulting from planned maintenance. The actual level of production may be used
if it approximates normal capacity. The amount of fixed overhead allocated to
each unit of production is not increased as a consequence of low production or
idle plant. Unallocated overheads are recognised as an expense in the period in
which they are incurred. In periods of abnormally high production, the amount of
fixed overhead allocated to each unit of production is decreased so that
inventories are not measured above cost.
Ind AS 2 (Inventory Valuation)

Conclusion:
Normal or Actual capacity, whichever is higher, should be used for
determining fixed overhead per unit.
STEPS IN PREPARING THE MASTER
BUDGET

1. Basic data

2. Operating budget

3. Financial budget
OPERATING BUDGET

Sales Cash collections

budget from customers

Purchases Disbursements
budget for purchases

Operating expenses Disbursements for

budget operating expenses
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 (assuming to be collected in the following month).
 PURCHASES BUDGET

MERCHANDISING FIRMS (Walmart, Big Baazar, Pantaloon Retail, etc.)

Budgeted purchases
= Desired closing inventory of Finished Goods + Sales – Opening inventory
of Finished Goods

MANUFACTURING FIRMS (MarutiSuzuki, Bajaj Hindusthan Ltd., etc.)

Budgeted purchases
= Desired closing inventory of Raw Material
+ Raw Material Consumed (to achieve budgeted production level)
– Opening inventory of Raw Material
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.
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.
OPERATING EXPENSE BUDGET

Expenses driven by sales volume include sales commissions

and many delivery expenses.
 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 Depreciation

Insurance Salaries
 OPERATING EXPENSE DISBURSEMENTS

Disbursements for operating expenses are based on the

operating expense budget.
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.
 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.
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
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.
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.
CASH BUDGET

Disbursements for some costs and expenses

depend on contractual terms for installment
payments, mortgage payments, rents,
leases, and miscellaneous items.

Other disbursements include outlays for

fixed assets, long-term investments,
dividends, and the like.
CASH BUDGET

Management determines the minimum cash balance

desired depending on the nature of the business
and credit arrangements.
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.
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).
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.
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.
FACTORS TO CONSIDER WHEN
FORECASTING SALES

Past patterns of sales

Estimates made by the sales force

General economic conditions

Competitors’ actions
FACTORS TO CONSIDER WHEN
FORECASTING SALES

Changes in the firm’s prices

Changes in product mix

Market research studies

Advertising and sales promotion plans

 TEXTBOOK READINGS AND EXERCISES

Chapter 9
Pages 377 – 381

Exercise 9-23

Exercise 9-24 (Required 1 and 2)

Exercise 9-25 (Required 1)