CH 12 Master Budget CHAPTER TWO THE MASTER BUDGET 2 Overview of Budgeting Developing a budget is

production budget

There are various strategies companies use in adjusting the budget amounts and planning for the future. For example, budgets can be derived from a top-down approach or from a bottom-up approach. Shows the general difference between the top-down approach and the bottom-up approach. The top-down approach typically begins with senior management.

Which one of the following is not a benefit of budgeting? Entry field with correct answer It provides definite objectives for evaluating performance. It provides assurance that the company will achieve its objectives. It facilitates the coordination of activities. It requires all levels of management to plan ahead on a recurring basis.

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It should be noted that the budget should be prepared with the utmost caution as it affects the operational performance of the entire organization. A master budget is a comprehensive budget created from a series of smaller, specialized business budgets. The master budget process has two parts — an operating budget and a financial budget — that are themselves made up of a series of smaller budgets.

interrelated financial budgets and operating budgets.

Unlike a manufacturing company, a merchandiser must prepare a merchandise purchases budget rather than a production budget. In addition, a merchandiser does not prepare direct materials, direct labor, or factory overhead budgets. Let’s look at the merchandise purchases budget for Hockey Den , a retailer of hockey sticks. A master budget is a formal, comprehensive plan that contains several interconnected budgets. Exhibit 20.2 summarizes the master budgeting process. The master budgeting process begins with the sales budget.

  • The central aspect to remember about this budget is the sum of all the individual budgets made within separate departments, thus providing a vital link between sales, production, and costs.
  • Every company has set targets and goals for each year, and it is through these budgets the company prepares the plan of action to achieve them.
  • If you’re not manufacturing items, you can skip the production budget and focus on the materials budget instead.
  • The Master Budget contains the Operating and Financial budgets.

Cash budgets have a beginning balance while operating budgets do not. A budget is a quantum expression for a set of periods of a plan of action by the management. It involves both financial as well as non-financial plans for the organization. The selling and administrative expense budget deal with non-manufacturing costs such as freight or supplies.

The financing section of a cash budget is needed if there is a cash deficiency or if the ending cash balance is less than Entry field with correct answer management’s minimum required balance. The amount needed to avoid a service charge at the bank. The cash budget helps managers determine whether or not the company requires financing in a given month. The sales budget is derived from the production budget.

Preparing the Master Budget: Step-by-Step Guide

Further, since business environments are constantly changing, budgets are often criticized as too rigid to adhere to. There are two main components in the master budget, namely operational budget, and financial budget. A business’s capital budget lays out the cost of the asset, the expected payback period, and the asset’s potential return on investment. Your capital budget can tell you whether or not the purchase would be a good investment. Keep a close eye on your production budget. If sales and demand increase or decrease, adjust your production budget accordingly.

budgeting process

Direct labor, manufacturing overhead, and selling and administrative costs are paid in the quarter incurred. Income tax expense is projected at $3,500 per quarter and is paid in the quarter incurred. A financial budget consists of the cash budget, the budgeted balance sheet, and the budget for capital expenses. Similar to the individual budgets that make up the operating budgets, the financial budgets serve to assist with planning and monitoring the financing / cash requirements of the business. High profits may not always mean high levels of cash in the business’s bank accounts. Management must plan carefully how much cash is anticipated to come in from sales and customers each month, and what cash may be paid out.

Summary – Master Budget vs Cash Budget

The bottom-up approach requires involvement of prepaid rent throughout the organization, not just upper management, to create the operating budget. Successful companies use this approach because lower-level employees tend to know more about their functional areas than upper management, providing for more accurate budget information. Also, employee involvement in the budget process increases the likelihood employees will accept the budget. Creating a direct labor budget is a necessary step for businesses involved in production. If you purchase goods for resale, you can skip this step.

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A cash budget shows budgeted cash receipts and cash payments during the budget period. Managing cash flows is vital and a cash budget helps with that task. Most companies set a minimum cash balance to have available.

In a rolling budget, a company revises its entire set of budgets by adding a new quarterly budget to replace the quarter that just elapsed. Thus, at any point in time, monthly or quarterly budgets are available for the next 12 months or four quarters. The central aspect to remember about this budget is the sum of all the individual budgets made within separate departments, thus providing a vital link between sales, production, and costs. It helps to ensure that all the departments work together to achieve the common objective of the overall business. Sarah Edwards, division manager for Pillows Plus, is speaking to the controller, Diana Rothman, about the budgeting process. Sarah states, “I’m not an accountant, so can you explain the three main parts of the master budget to me and tell me their purpose?

Whereas the production budget shows units to be produced, the direct materials budget translates the units to be produced into budgeted costs. A business prepares various budgets to plan for its future operations. Such budgets plan the finances of the entire company and allow the business to coordinate the various facets of its operations. The sales budget and the production budget both contribute significantly in the preparation of the business’s master budget. A comprehensive—master—budget is a formal statement of management’s expectation regarding sales, expenses, volume, and other financial transactions for the coming period. It consists basically of a pro forma income statement, pro forma balance sheet, and cash budget.

From Exhibit 20.3, this is $18,000 per year [($200,000 – $20,000)∕10 years], or $1,500 per month ($18,000∕12 months). 2 Enter labor hours required per unit. We then compute direct labor hours needed.


The budget begins by predicting the sales volume of the company over a future period of time. The company may arrive at this estimated figure by analyzing its sales history, its competitors and the economic conditions. The sales budget then calculates the amount of income it will earn from sales activities over the coming time period. The production budget uses the data from the sales budget to calculate the number of products the company has to produce over the period of time.

A master budget is developed at the estimated level of activity. In many companies, responsibility for coordinating the preparation of the budget is assigned to Entry field with correct answer the company’s independent certified public accountants. The company’s board of directors. An unrealistic budget is more likely to result when it Entry field with correct answer has been developed by all levels of management. Is developed with performance appraisal usages in mind.

Master budgets provide an overview of the performance of different departments within the company and can help pinpoint areas for improvement or streamlining. A master budget is a combination of all of your business’s individual budgets. Your master budget gives you a complete financial picture of your company. And, it can show you where certain income and expenses fit in overall in the business. If you have employees or plan on hiring employees, consider creating a labor budget. Use a labor budget to determine how many employees you need to achieve a certain level of production.

However, while any Annual Report looks into the past and depicts the firm’s historical performance, the Master Budget is all about the future of an organization. What does a master budget consists of? Interrelated financial budgets and operating budgets…. This step will help you account for both fixed and variable costs in production, while excluding direct materials and direct labor, since each of those has its own budget.

  • The October 31 preliminary cash balance is $25,635 .
  • Consists of a projected income statement and a projected balance sheet showing the organization’s objectives and proposed ways of attaining them.
  • Shouldn’t that amount be based on the units produced?
  • In a perfect world, your actual totals would match up nicely with your budgeted figures.

These are the most often used elements within the master budget. Business owners love Patriot’s accounting software. Unlock every step-by-step explanation, download literature note PDFs, plus more. Employees affected by a budget should help prepare it . Because learning changes everything. ® Chapter 20 Master Budgets and Planning Wild and Shaw Financial and Managerial Accounting 9th Edition Copyright 2022 © McGraw Hill LLC. All rights reserved.

Exhibit 20.10 summarizes the product cost per unit calculation for TSC. The cost of direct materials is from Exhibit 20.7 and cost of direct labor is from Exhibit 20.8. The predetermined variable overhead rate is from Exhibit 20.9. To compute product cost per unit for fixed overhead, we note that TSC expects to produce, on average, 1,000 units per month, which means its fixed overhead per unit is $1.50 ($1,500/1,000 units). Total product cost per unit is $17.00.

cash flow

A flexible budget, on the other hand, separates fixed and variable costs and can adjust based on different production outputs. The difference between master budget and cash budget mainly depends on the purpose that they are prepared for. The budget prepared by amalgamating all the sub-budgets is referred to as the master budget whereas the budget that includes forecasts of cash inflows and outflows is referred to as the cash budget. If budgets are used effectively, they can enable a wider range of benefits including revenue growth and effective cost control. The direct labor budget shows the budgeted costs for the direct labor needed for the budgeted production for the period. Manufacturers often set a safety stock, a quantity of inventory that helps protect against lost sales caused by unfulfilled demands from customers or delays in shipments from suppliers.


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