Master Budgeting Lesson

1

Horngren’s Financial & Managerial
Accounting

Eighth Edition

Chapter 7

Master Budgets

2

Learning Objectives (1 of 3)

7.1 Describe budgeting
objectives, benefits, and
procedures and how
human behavior
influences budgeting

7.2 Define budget types
and the components of
the master budget

3

Learning Objectives (2 of 3)

7.3 Prepare an operating
budget for a manufacturing
company

7.4 Prepare a financial budget
for a manufacturing company

7.5 Prepare an operating
budget for a merchandising
company

4

Learning Objectives (3 of 3)

7.6 Prepare a financial
budget for a
merchandising company

7.7 Describe how
information technology
can be used in the
budgeting process

5

Learning Objective 7.1

Describe budgeting
objectives, benefits, and
procedures and how
human behavior
influences budgeting

6

Why Do Managers Use Budgets?

• A budget is a financial plan that managers use to

coordinate a business’s activities.

• Managers use budgets to:

– Develop strategies
– Plan and budget for specific actions to achieve goals
– Implement plans
– Take corrective action

7

Exhibit M:7-1 Budgeting Objectives

8

Budgeting Benefits (1 of 2)

• Budgeting requires managers to plan for the company’s

future.

• A budget coordinates a company’s activities.

• A budget provides a benchmark that motivates employees

and helps managers evaluate performance.

9

Multiple Choice

You are placed in charge of your household budget for the month. What is one of the first things you should examine as you plan the budget?

1

The number of visitors you will have in the next month

2

The average income for your neighborhood

3

The number of chores each person has

4

The income for the household

10

Budgeting Benefits (2 of 2)

• Budgeting requires managers to plan for the company’s

future.

– Decisions are based on this formalized plan

• Creating a budget facilitates coordination and

communication.

• Budgets provide a benchmark that motivates employees

and helps managers evaluate performance.

– Benchmarking is the practice of comparing a

company with its prior performance or with best
practices from other companies.

11

Budgeting Procedures

• To achieve the benefit of motivating employees, the budget

should include input from all levels of the company.

• A participative budget is a budgeting process where those

individuals who are directly impacted by a budget are
involved in the development of the budget.

– These budgets tend to be achievable because those

directly impacted by the budget help to create the plan.

12

13

Multiple Choice

Spending plans will..

1

change at times

2

never change

3

should always be the same

14

Budgeting and Human Behavior

• Managers must:

– Support the budget
– Show employees how budgets can help them achieve

better results

– Require that employees participate in developing the

budget

• Budgetary games:

– Budgetary slack occurs when managers intentionally

understate expected revenues or overstate expected
expenses.

– Another game is “spend it or lose it.”

15

What Are the Different Types of
Budgets? (1 of 2)

• Some companies will use the previous year’s results to

create a budget and modify for expected changes.

– Managers must only justify changes to budget from

the previous year’s actual results.

• Budgets can also be developed using a zero-based

budget where all revenues and expenses must be
justified for each new period.

– The previous year’s actual results are ignored under

this approach.

16

Learning Objective 7.2

Define budget types and
the components of the
master budget

17

What Are the Different Types of
Budgets? (2 of 2)

18

Strategic and Operational Budgets

• A strategic budget is a long-term financial plan used to

coordinate the activities needed to achieve the long-term
goals of the company.

• An operational budget is a short-term financial plan used

to coordinate the activities needed to achieve the short-
term goals of the company.

• A continuous budget is a type of operational budget that

involves continuously adding one additional month as each
month goes by.

19

Multiple Choice

What is the difference between fixed and variable expenses?

1

Fixed expenses are always higher than variable expenses.

2

Fixed expenses are only applicable to businesses, while variable expenses are for individuals.

3

Fixed expenses remain the same, while variable expenses can change.

4

Fixed expenses are one-time payments, while variable expenses are recurring.

20

Multiple Choice

What are some potential consequences of not budgeting and overspending?

1

Lack of financial freedom, strained relationships, and limited access to credit.

2

Accumulating debt, financial stress, inability to save for emergencies or future goals, and difficulty in achieving financial stability.

3

Decreased quality of life, missed opportunities, and increased stress levels.

4

Difficulty in obtaining loans, damaged credit score, and limited financial resources.

21

Static and Flexible Budgets

• A static budget is a budget prepared for only one level of

sales volume.

• A flexible budget is a budget prepared for various levels

of sales volume.

22

Multiple Choice

Bottom-up budgeting is know as:

1

Control budgeting

2

Simple budgeting

3

Authoritative budgeting

4

Participative budgeting

23

Master Budgets (1 of 2)

A master budget is a set of budgeted financial statements
and supporting schedules for an entire organization. It
includes three types of budgets:

1. The operating budget

2. The capital expenditures budget

3. The financial budget

24

Exhibit M:7-2 Master Budget Components—
Manufacturing Company

25

Master Budgets (2 of 2)

• An operating budget is a set of budgets that projects

sales revenue, cost of goods sold, and selling and
administrative expenses, all of which feed into the cash
budget and then the budgeted financial statements.

• A capital expenditures budget presents a company’s

plan for purchasing long-term assets.

• A financial budget includes the cash budget and the

budgeted financial statements.

• The cash budget details how the business expects to go

from the beginning cash balance to the desired ending
cash balances.

26

Multiple Choice

Operating budgets and financial budgets:

1

combined form the master budget

2

are prepared before the master budget

3

are prepared after the master budget

4

have nothing to do with the master budget

27

Multiple Choice

The two classes of budgets are:

1

Operating & Financial

2

Variable & Fixed

3

Sales & Product

4

Direct materials & Direct labor

28

Multiple Choice

This budget shows both the quantity and cost of direct materials to be purchased.

1

Production

2

Direct materials

3

Indirect materials

4

Materials

29

Learning Objective 7.3

Prepare an operating budget
for a manufacturing company

30

How Are Operating Budgets Prepared
for a Manufacturing Company?

The master budget includes the following budgets:

• Sales budget

• Production budget

• Direct materials budget

• Direct labor budget

• Manufacturing overhead budget

• Cost of goods sold budget

• Selling and administrative expense budget

31

Exhibit M:7-3 Balance Sheet

32

Sales Budget

The forecast of sales revenue is the cornerstone of the
master budget.

Exhibit M:7-4 Sales Budget

33

Production Budget (1 of 2)

The production budget is the basis for product costs
budgets: direct materials budget, direct labor budgets, and
manufacturing overhead budgets.

34

Production Budget (2 of 2)

Smart Touch Learning desires to have an ending inventory
each quarter equal to 20% of the next quarter’s sales.



=



=



=



=

First Quarter: Second quarter's sales

20%

Desired ending inventory

550 tablets

20%

110 tablets

Second Quarter: Third quarter's sales

20

Desired ending inventory

600 tablets

20

120 tablets

Third Quarter: F



=



=



=



=

ourth quarter's sales

20%

Desired ending inventory

650 tablets

20%

130 tablets

Fourth Quarter: First quarter's sales (2028)

20%

Desired ending inventory

700 tablets

20%

140 tablets

35

Exhibit M:7-5 Production Budget

36

Direct Materials Budget (1 of 2)

• After completing the production budget, Smart Touch Learning

needs to determine the product costs for the tablets.

• The direct materials budget estimates the amount of materials

to purchase to meet the company’s production needs.

37

Direct Materials Budget (2 of 2)

The company desires the ending balance in Raw Materials
Inventory to be 40% of the next quarter’s budgeted direct
materials needed for production.



=



=



=

First Quarter: 2nd quarter's production

3 pounds per tablet

40%

Desired ending inventory

560 tablets

3 pounds per tablet

40%

672 pounds

Second Quarter: 3rd quarter's production

3 pounds per tablet

40%

De



=



=



=

sired ending inventory

610 tablets

3 pounds per tablet

40%

732 pounds

Third Quarter: 4th quarter's production

3 pounds per tablet

40%

Desired ending inventory

660 tablets

3 pounds per tablet

40%

792 pounds

Fourth Quarter: Amount given

Desired ending inventory 852 pounds

38

Exhibit M:7-6 Direct Materials Budget

39

Direct Labor Budget

The direct labor budget estimates the direct labor hours and
related cost needed to support the production budget.

Exhibit M:7-7 Direct Labor Budget

40

Manufacturing Overhead Budget

• The manufacturing overhead budget estimates the

variable and fixed manufacturing overhead needed to meet
the company’s production needs.

• The predetermined overhead allocation rate is used to

allocate the indirect overhead costs to the tablets produced
by Smart Touch Learning.

Total estimated overhead costs
Predetermined Overhead Allocation Rate
Total estimated quantity of the overhead allocation base
=

41

Exhibit M:7-8 Manufacturing Overhead
Budget

42

Cost of Goods Sold Budget

• The cost of goods sold budget estimates the cost of

goods sold based on the company’s projected sales.

• The cost of goods sold budget starts by calculating the

projected cost to produce each tablet in 2028.

43

Exhibit M:7-9 Cost of Goods Sold
Budget

44

Selling and Administrative Expense
Budget (1 of 2)

• The cost accountant works with the office and sales

managers to develop the selling and administrative
expense budget.

• The selling and administrative expense budget

estimates the selling and administrative expenses needed
to meet the company’s projected sales.

• Cost behavior is also considered for this budget, with costs

designated as variable or fixed.

45

Selling and Administrative Expense
Budget (2 of 2)

Smart Touch Learning projects the following selling and
administrative costs for 2028:

Salaries Expense, fixed

$ 30,000 per quarter

Rent Expense, fixed

25,000 per quarter

Insurance Expense, fixed

2,500 per quarter

Depreciation Expense, fixed

1,500 per quarter

Supplies Expense, variable

1% of Sales Revenue

Quarter

Sales Revenue

Supplies Expense

First

$ 250,000

$ 2,500

Second

275,000

2,750

Third

300,000

3,000

Fourth

325,000

3,250

46

Exhibit M:7-10 Selling and Administrative
Expense Budget

47

Learning Objective 7.4

Prepare a financial budget
for a manufacturing
company

48

How Are Financial Budgets Prepared
for a Manufacturing Company?

The financial budgets include the cash budget and the
budgeted financial statements:

• Budgeted income statement

• Budgeted balance sheet

• Budgeted statement of cash flows

49

Capital Expenditures Budget

• The purchase of long-term assets is part of a strategic

plan.

• Capital expenditures are purchases of long-term assets,

such as:

– Delivery trucks
– Computer systems
– Office furniture
– Manufacturing equipment

50

Cash Budget

• The cash budget pulls information from the other budgets

previously prepared.

• The cash budget has three sections:

– Cash receipts
– Cash payments
– Short-term financing

51

Exhibit M:7-11 Schedule of Cash Receipts from
Customers

52

Cash Payments (1 of 2)

• Capital expenditures

• Product costs:

– Direct materials purchases
– Direct labor costs
– Manufacturing overhead costs

• Selling and administrative expenses

53

Exhibit M:7-12 Schedule of Cash
Payments

54

Exhibit M:7-13 Cash Budget—First Quarter,
Before Short-Term Financing Calculations

55

Exhibit M:7-14 Cash Budget—Second Quarter,
Before Short-Term Financing Calculations

56

Exhibit M:7-15 Cash Budget—Third Quarter,
Before Short-Term Financing Calculations

57

Exhibit M:7-16 Completed Cash Budget

58

Budgeted Income Statement (1 of 2)

The following is a summary of the sources used to calculate
the budgeted income statement:

59

Budgeted Income Statement (2 of 2)

Exhibit M:7-17 Budgeted Income Statement

60

Budgeted Balance Sheet (1 of 2)

Account

Source

Exhibit

Amount

Cash

Cash budget

M:7-16

$ 54,480

Accounts Receivable

Schedule of cash receipts from customers

M:7-11

91,000

Raw Materials Inventory

Direct materials budget

M:7-6

42,600

Finished Goods Inventory

Production budget

M:7-5

140 units

Finished Goods Inventory
Cost of goods sold budget

M:7-9

$ 294 per unit

Equipment

2026 balance sheet

M:7-3

210,340

Equipment
Capital expenditures budget

Blank
160,000

Accumulated Depreciation

2026 balance sheet

M:7-3

12,000

Accumulated Depreciation
Manufacturing overhead budget

M:7-8

48,000

Accumulated Depreciation
S&A expense budget

M:7-10

6,000

Accounts Payable

Schedule of cash payments

M:7-12

25,500

Common Stock

2026 balance sheet

M:7-3

300,000

Retained Earnings

2026 balance sheet

M:7-3

48,340

Retained Earnings
Budgeted income statement

M:7-17

159,740

61

Exhibit M:7-18 Budgeted Balance Sheet

62

Learning Objective 7.5

Prepare an operating
budget for a
merchandising
company

63

How Are Operating Budgets Prepared
for a Merchandising Company?

Exhibit M:7-19 Master Budget Components—Merchandising Company

64

Exhibit M:7-20 Balance Sheet

65

Sales Budget (1 of 2)

• The forecast of sales revenue is the cornerstone of the

master budget.

• For Greg’s Games, sales in March were $40,000.

• The sales manager projects the following monthly sales:

April

$ 50,000

May

80,000

June

60,000

July

50,000

August

40,000

66

Sales Budget (2 of 2)

The sales budget is prepared assuming sales are 60% cash
and 40% on account:

Exhibit M:7-21 Sales Budget

67

Inventory, Purchases, and Cost of
Goods Sold Budget

• The cost of goods sold computation shows the relationship

between inventory, purchases, and ending inventory:

Beginning merchandise inventory

Purchases

Ending merchandise inventory

Cost of goods sold

+

−

=

• The equation can be rearranged to find the amount of

purchases required:

Purchases

Cost of goods sold

Desired ending merchandise inventory

Beginning merchandise inventory

=

+

−

68

Exhibit M:7-22 Inventory, Purchases,
and Cost of Goods Sold Budget

69

Selling and Administrative Expense
Budget

• The next budget estimates the selling and administrative

expenses needed to meet the company’s projected sales.

• The monthly payroll for Greg’s Games is salaries of $2,500

plus sales commissions equal to 15% of sales. This is a
mixed cost with both a fixed and a variable component.

• Other monthly expenses are as follows:

Rent Expense, fixed

$ 2,000 per month

Depreciation Expense, fixed

$ 500 per month

Insurance Expense, fixed

$ 200 per month

Miscellaneous Expense, variable

5% of sales

70

Exhibit M:7-23 Selling and Administrative
Expense Budget

71

Learning Objective 7.6

Prepare a financial budget for
a merchandising company

72

How Are Financial Budgets Prepared
for a Merchandising Company?

The budgets for a merchandising company include:

• Capital expenditures budget

• Cash budget

• Budgeted income statement

• Budgeted balance sheet

73

Cash Receipts

• April’s budgeted cash collections consist of (1) April’s cash sales

from the sales budget and (2) collections of March’s credit sales

• This process is repeated for all four months.

Exhibit M:7-24 Schedule of Cash Receipts from Customers

74

Cash Payments (2 of 2)

• April’s cash payments consist of (1) 50% of March’s

purchases and (2) 50% of April’s purchases.

• This process is repeated for all four months.

Exhibit M:7-25 Schedule of Cash Payments for Purchases

75

Exhibit M:7-26 Schedule of Cash Payments for
Selling and Administrative Expenses

76

Short-Term Financing

• Companies often borrow funds to maintain a minimum

cash balance.

• For example, Greg’s Games borrows cash in $1,000

increments at an annual interest rate of 12%.

77

Exhibit M:7-27 Cash Budget

78

Exhibit M:7-28 Completed Cash Budget

79

Budgeted Income Statement

Summary of the sources for the budgeted income statement:

Account

Budget

Exhibit

Amount

Sales Revenue

Sales

M:7-21

$ 240,000

Cost of Goods Sold

Inventory, Purchases, and Cost of
Goods Sold

M:7-22

168,000

S&A Expenses

Selling and Administrative Expense

M:7-23

68,800

Interest Expense

Cash

M:7-28

210

80

Exhibit M:7-29 Budgeted Income Statement

81

Budgeted Balance Sheet (2 of 2)

Summary of the sources for the budgeted balance sheet:

Account

Source

Exhibit

Amount

Cash

Cash budget

M:7-28

$ 24,440

Accounts Receivable

Schedule of cash receipts from customers

M:7-24

20,000

Merchandise Inventory

Inventory, purchases, and COGS budget

M:7-22

42,400

Prepaid Insurance

March 31balance sheet

M:7-20

1,800

Prepaid Insurance

S&A expense budget

M:7-23

800

Equipment and Fixtures

March 31 balance sheet

M:7-20

32,000

Equipment and Fixtures

Capital expenditures budget

Blank

3,000

Accumulated Depreciation

March 31 balance sheet

M:7-20

12,800

Accumulated Depreciation

S&A expense budget

M:7-23

2,000

Accounts Payable

Schedule of cash payments for purchases

M:7-25

14,700

Salaries and Commissions Payable

Schedule of cash payments for S&A expenses

M:7-26

5,000

Notes Payable

Cash budget

M:7-28

5,000

Common Stock

March 31 balance sheet

M:7-20

20,000

Retained Earnings

March 31 balance sheet

M:7-20

60,350

Retained Earnings

Budgeted income statement

M:7-29

2,990

82

Exhibit M:7-30 Budgeted Balance Sheet

83

Learning Objective 7.7

Describe how information
technology can be used in
the budgeting process

84

Sensitivity Analysis

• Technology can make it more cost effective to conduct

sensitivity analysis.

• Sensitivity analysis as a what if technique that asks what a

result will be if a predicted amount is not achieved or if an
underlying assumption changes.

• Sensitivity analysis provides a better understanding of how

changes in sales and costs are likely to affect the
company’s bottom line.

85

Data Analytics in Accounting

• The use of technology and data analytics can be an

important part of a company’s budgeting process.

• For example, Anheuser-Busch uses data analytics to:

– Help with sales forecasting and financial planning
– Drive growth and operational efficiency
– Establish budgets and monitor them against actual

results

86

Budgeting Software

• Technology can make it more cost effective to combine

individual unit budgets to create the companywide master
budget.

• Companies use budget-management software to combine

the budget data from multiple segments for financial
statements.

• Managers spend less time compiling and summarizing

data and more time analyzing and making decisions to
ensure that the budget leads the company to achieve its
key strategic goals.

87

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Master Budgeting

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