Horngren’s Cost Accounting: A Managerial

Emphasis

Chapter 6
Master Budget and
Responsibility Accounting

Copyright © 2019 Pearson Canada Inc. 5-1

Learning Objectives
1. Distinguish the long-term from the short-term
benefits of budgets (pro forma financial statements).
2. Prepare a master operating budget and all
supporting budgets or schedules.
3. Prepare a cash budget.
4. Contrast responsibility against controllability.
Budgets

 A quantitative expression of a proposed (future) plan of action by

management for a for a set time period

 An aid to coordinating what needs to be done to implement that plan

 Master budget summarizes all financial and non-financial plans into a

single document

 Reported according to ASPE/IFRS standards and supported by non-

financial schedules
Budgeting Cycle – 4 Steps

1. Manager and accountants plan the performance of the organization

and sub-units

2. Provide a frame of reference against which results can be compared

3. Investigate variations and implement corrective actions as

necessary

4. Plan again, based on feedback from changed conditions and actual

performance
Advantages of Budgets
Advantages of Budgets

 Compel planning and monitoring of the implementation of plans.

 Provide reliable performance assessment criteria.

 Promote communication and coordination within the organization.

Organization Alignment
Five-Step Decision-Making Process

 Managers often use some variation of the five-step decision-making

process
Approaches to Budgets

 Traditional (historic) incremental approach

 Priority approach

 Zero-based budgeting

 Activity-based budgeting
Operating & Strategic Performance
Assessment
Master Operating Budget

 Time Coverage of budget is guided by the purpose for the budget

 Most frequently used period is one year

 A rolling budget may be prepared

 A budget that is always available for a specified future period by adding a
month, quarter or year in the future as the current month, quarter or year is
completed
Components of Master Budgets (1 of 2)

 Operating Budget
 The set of budgets in the value chain business functions
 Excludes financing and taxes
 Leads to the pro-forma (budgeted) income statement

 Financial Budget
 The set of budgets that comprise the capital budget, cash budget, budgeted
balance sheet and the budgeted cash flow statement
Components of Master Budgets (2 of 2)

 Cash Budget
 Schedule of expected cash receipts and disbursements
 Includes financing requirements – timing of borrowings and repayments,
interest expense
 Predicts cash position for specific level of activity
 Provides information (inputs) to the pro-forma income statement and
balance sheet
Overview of the Master Budget
Basic Operating Budget Steps (1 of 2)

1. Prepare the revenue/sales budget.

2. Prepare the production budget (in units).

3. Prepare the direct materials usage budget and direct materials

purchases budget.

4. Prepare the direct manufacturing labour budget.

Basic Operating Budget Steps (2 of 2)

5. Prepare the manufacturing overhead costs budget.

6. Prepare the ending inventories budget.

7. Prepare the cost of goods sold budget.

8. Prepare the operating expense (period cost) budget.

9. Prepare the budgeted income statement.

- Pro forma Income Statement
Pro Forma Financial Statements

• Pro forma, Latin for “as a matter of form” or “for the sake of form”, is a
method of calculating financial results using certain projections or
presumptions.

• Pro forma financials may not be GAAP compliant but can be issued to the
public to highlight certain items for potential investors.

• They can also be used internally by management for aiding in business

decisions.

• It's illegal for publicly traded companies to mislead investors with pro forma
financial results that do not use the most conservative possible estimates of
revenue and expense.
Sales Budget
 The sales budget is the starting point of preparing the master budget

 It represents management's best estimate of sales revenue for the budget period
 Units and Price

 Each of the other budgets depends on the sales forecast

 Sales forecasting involves a consideration of various factors such as:

 General economic & political conditions
 Industry trends
 Market Research studies
 The impact of anticipated advertising & promotion
 Previous market share
 Changes in Prices
Sales Budget
Production Budget

 The production budget shows the number of units that must be produced to meet
the anticipated sales

 It is derived from the budgeted sales units plus the desired ending finished goods
units less the beginning finished goods units.
Production Budget
Direct Materials Budget

 The direct materials budget shows both the quantity and cost of direct
materials to be purchased

 It is derived from the direct materials units required for production plus the
desired ending direct materials units less the beginning direct materials units
Direct Materials Budget
Practice

 The Russell Company expects 2019 sales of 135,000

units of serving trays. Russell’s beginning inventory
for 2019 is 9,700 trays; target ending inventory: 16,300
trays.
 Compute the number of trays budgeted for production
in 2019.
Direct Labour Budget
• The direct labor budget shows the quantity (hours) and cost
of direct labor necessary to meet production requirements
• To prepare the direct labor budget, a company would use its
production budget
• The direct labor budget enables the personnel department to plan for
hiring and repositioning of employees
• A good labor budget helps the firm to avoid emergency hiring,
prevent labor shortages, and reduce or eliminate the need to lay off
workers
Direct Labour Budget
Manufacturing Overhead Budget

 A factoryoverhead budget often includes all production costs

other than direct materials and direct labor

 Unlike direct materials and direct labor, manufacturing

overhead costs include costs that vary in direct proportion with
the units manufactured as well as costs that vary with either the
kind of facilities the firm has or the way in which the firm
carries out it operations
 ie. Fixed Costs
Manufacturing Overhead Budget

* The annual
depreciation expense
becomes part of
COGS

MOH Rate
= 1,001,689/30,000
= $33.39/DMLH
Ending Finished Goods Inventory
Budget

 The cost of goods manufactured production cost and the cost of

goods sold budget reports the total budgeted cost of units sold for
a period
 The income statement budget uses the cost of goods sold to
determine the gross margin of the period, and the balance sheets
includes the finished goods ending inventory it total assets
Ending Finished Goods Inventory Budget
Ending Finished Goods Inventory Budget
Cost of Goods Sold Budget

 Depreciation expense is included in the Cost of Goods Sold

(COGS) budget and is allocated to each unit of output. The
remaining depreciation, if any, of nonproduction long-term assets
is included in fixed non-inventoriable or period costs, a separate
schedule.
Cost of Goods Sold Budget
Selling and Administrative Expense
Budget/Non Production Cost Budget
 A sellingand general administrative expense
budget delineates plans for all non-manufacturing
expenses
 Thisbudget serves as a guideline for selling and
administrative activities during the budget period
 Many selling and general administrative
expenditures are discretionary
Selling and Administrative Expense
Budget/Non Production Cost Budget
Budgeted Income Statement

 The budgeted income statement is the important end-

product in preparing operating budgets. This budget
indicates the expected profitability of operations, and it
provides a basis for evaluating company performance
 Thebudget is prepared from the budgets described
previously
 For example, to find cost of goods sold, it is necessary to determine the
total unit cost of a finished product using the direct materials, direct labor,
and manufacturing overhead budgets
Budgeted Income Statement
 39

Top Hat Check

Example: Tiny Toons Budget

 TinyToons was established on January 1, 2023,

producing miniature, plastic cartoon characters and
capitalized through the issuance of common shares for
$85,000
 2023sales are estimated to be 10,000 units at a price of
$20 per unit
 30% of sales are cash; 70% are credit card
 90% of credit card sales are collected in the current
period; 10% are collected in the following period.
Example: Tiny Toons Budget
Operating Budgets Blank
Sales Budget Blank
Unit sales 10,000
Price per unit $20
Total sales $200,000

Operating Budgets blank

As the company began in Production Budget (units) Blank

2023, there are no
Unit sales 10,000
beginning inventories.
Desired ending inventory 2,000
Desired ending finished
goods inventory is 2,000 Required 12,000
units. Beginning inventory -
Production 12,000
Example: Tiny Toons Budget
blank
Production Budgets blank
Blank
Raw Material Budget (kg) Blank
Blank
Production (units) 12,000
Raw material required per unit 0.04 kg
Raw material required in production 480 kg
Desired ending raw material inventory 12 kg
Required 492 kg
Beginning raw material inventory 0 kg
Purchases 492 kg
Blank
Cost per kg $8
Blank
Purchases ($) $3,936
blank
Cost of raw material used $3,840
Example: Tiny Toons Budget
Operating Budgets Blank
Direct Manufacturing Labour (DML) Budget Blank
Production (units) 12000
DML hours to produce one unit 0.5
Total DML hours 6000
DML rate per hr $12
Direct manufacturing labour cost $72,000
Blank blank
Manufacturing Overhead Budget Blank
Total DML hours 6000
OH rate/DML hour $9
Manufacturing overhead cost $54,000
Example: Tiny Toons Budget

 80% of material purchases are paid for during the period of purchase;
20% are paid during the following period

 Direct labour costs are paid in the period incurred

 Manufacturing equipment cost $35,000, estimated salvage value of

$5,000 and useful life of 5 years

 All overhead costs (excluding depreciation) are paid in the period

incurred
Example: Tiny Toons Budget
Operating Budgets Blank
Cost of Goods Manufactured Budget Blank
Direct material used $3,840
Direct labour 72,000
Manufacturing overhead 54,000
Cost of goods manufactured $129,840
Units produced 12,000
Cost per unit $10.82
Units sold 10,000
Cost of goods sold $108,200
Blank blank
Example: Tiny Toons Budget

Operating Budgets Blank

Selling, General and Administrative Expense Budget Blank
Salary expense $ 20,000
Sales commissions 16,000
Sales supplies 8,000
Rent 14,400
Miscellaneous 2,000
Total S, G & A expenses $ 60,400
Blank Blank
Example: Tiny Toons Budget

Proforma Income Statement blank

Sales $ 200,000.00
Cost of goods sold 108,200.00
Gross margin $ 91,800.00
S,G & A expenses 60,400.00
Credit card fees 4,200.00
Interest on borrowing 60.00
Operating income $ 27,140.00
Basic Financial Budget Steps

Based on the operating budgets:

1. Prepare the capital expenditures budget.

2. Prepare the cash budget.

3. Prepare the budgeted balance sheet.

4. Prepare the budgeted statement of cash flows.

Example: Tiny Toons Budget
Operating Budgets Blank
Sales Budget Blank
Unit sales 10,000
Price per unit $20
Total sales $200,000
Blank Blank
Cash Budgets Blank
Cash Receipts Schedule Blank
Cash sales $60,000
Credit card sales $126,000
Credit card fees ($3,780)
Total cash receipts $182,220
Blank Blank
ProForma Data blank
Credit card receivable, December 31 $13,580
Example: Tiny Toons Budget
blank
Production Budgets blank
Blank
Raw Material Budget (kg) Blank
Blank
Production (units) 12,000
Raw material required per unit 0.04 kg
Raw material required in production 480 kg
Desired ending raw material inventory 12 kg
Required 492 kg
Beginning raw material inventory 0 kg
Purchases 492 kg
Blank
Cost per kg $8
Blank
Purchases ($) $3,936
blank
Cost of raw material used $3,840
Example: Tiny Toons Budget
Operating Budgets Blank
Direct Manufacturing Labour (DML) Budget Blank
Production (units) 12000
DML hours to produce one unit 0.5
Total DML hours 6000
DML rate per hr $12
Direct manufacturing labour cost $72,000
Blank blank
Manufacturing Overhead Budget Blank
Total DML hours 6000
OH rate/DML hour $9
Manufacturing overhead cost $54,000
Example: Tiny Toons Budget

Cash Budgets Blank

Cash payments for purchases $ 3,148.80

Cash payments for direct labour $ 72,000.00
Cash payments for MOH $ 48,000.00
Blank blank
Proforma Data Blank

A/P for purchases, Dec. 31 $ 787.20

Raw material inventory, Dec. 31 $ 96.00
Accumulated Depreciation $ 6,000.00
Example: Tiny Toons Budget
Operating Budgets Blank
Cost of Goods Manufactured Budget Blank
Direct material used $3,840
Direct labour 72,000
Manufacturing overhead 54,000
Cost of goods manufactured $129,840
Units produced 12,000
Cost per unit $10.82
Units sold 10,000
Cost of goods sold $108,200
Blank blank
Proforma Data blank
Finished goods inventory, Dec. 31 $21,640
Cost of goods sold $108,200
Example: Tiny Toons Budget
Operating Budgets Blank
Selling, General and Administrative Expense Budget Blank
Salary expense $ 20,000
Sales commissions 16,000
Sales supplies 8,000
Rent 14,400
Miscellaneous 2,000
Total S, G & A expenses $ 60,400
Blank Blank
Cash Budgets blank
Cash payments for S, G & A expenses $ 60,400
Example: Tiny Toons Budget

Proforma Income Statement blank

Sales $ 200,000.00
Cost of goods sold 108,200.00
Gross margin $ 91,800.00
S,G & A expenses 60,400.00
Credit card fees 4,200.00
Interest on borrowing 60.00
Operating income $ 27,140.00
 Example: Tiny Toons Cash Budget
Cash Budget Blank
 Tiny Toons
Cash, Jan. 1 $ -
requires a cash
Cash receipts from sales 182,220.00
“cushion” of
Issuance of common shares 85,000.00
$50,000
Cash available $ 267,220.00
Cash Payments: Blank  A line-of-credit
Purchase of equipment $ 35,000.00
loan is
For purchases of material 3,148.80
available;
For direct labour 72,000.00
interest rate 3%
For MOH 48,000.00
per annum
For S, G & A 60,400.00
$  All borrowing
Total cash payments 218,548.80
and repayment
Cash Surplus $ 48,671.20
occurs on the
Desired Cash Balance 50,000.00
first day of the
Line of Credit Borrowing 2,000.00
period
Interest on Borrowing 60.00
Cash, Dec. 31 $ 50,611.20
Example: Tiny Toons Budget
Proforma Balance Sheet blank
Assets: Blank
Cash $ 50,611.20
Credit card receivable 13,580.00
Raw material inventory, Dec. 3196.00
Finished goods inventory, Dec. 31 21,640.00
Equipment 35,000.00
Accumulated depreciation (6,000.00)
Total Assets $
114,927.20
Blank Blank
Liabilities: Blank
A/P for purchases, Dec. 31 $ 787.20
Line of credit payable 2,000.00
Total Liabilities $ 2,787.20
Example: Tiny Toons Budget

Shareholder’s Equity: Blank

Common shares $
85,000.00
Retained earnings 27,140.00
Total Shareholder’s Equity $ 112,140.00
Blank Blank
Total Liabilities and Shareholder’s Equity $
114,927.20
Budgets and Feedback

 Budgets offer feedback in the form of variances: actual results deviate

from budgeted targets.

 Variances provide managers with:

 Early warning of problems
 A basis for performance evaluation
 A basis for strategy evaluation
Responsibility Versus Controllability

 Responsibility accounting
 Focuses on information sharing, not in laying blame on a particular
manager
 Measures the plans (budgets) and actions (actual results) of each
responsibility centre

 Controllability
 The degree of authority that a manager has over costs, revenues, or other
items in question
RASCI