Al-bayan university

Faculty of Business Administrative

Accounting Department
Class Level: Fourth
Professor : Dr. Nassif J. M. Aljboory

Chapter 1
MASTER BUDGET

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INTRODUCTION
Financial statements and managerial reports are often prepared to summarize historical
transactions that occurred in a company to evaluate past performance. This information is also
used as an integral part of the process of moving forward. Combined with insights into
consumer trends and current economic, legal, social, and political environments, managers
forecast future operations and developstrategies for achieving projected goals.

A budget is a quantitative, written statement of a company’s action plan for a future period of
time. Budgets are planning tools that companies use to determine future activities and to keep
financial control of operations
Benefits of Budgeting
Coordination: activities of all units contribute to meeting the company’s overall goals.
Communication: management plans throughout the organization.
Motivation: through participation in the budgeting process and establishment of attainable
goals.
Planning: focuses on future opportunities.
Control: provides a benchmark for evaluating performance.

Types of Budgets
The master budget is a comprehensive financial plan for the year made up of various individual
departmental and activity budgets. A master budget can be divided into operating and financial
budgets. Operating budgets are concerned with the income- generating activities of a firm:
sales, production, and finished goods inventories. The ultimate outcome of the operating
budgets is a pro forma or budgeted income statement. Note that “pro forma” is synonymous
with “budgeted” and “estimated.” In effect, the pro forma income statement is done
“according to form” but with estimated, not historical, data. Financial budgets are concerned
with the inflows and outflows of cash and with financial position. Planned cash inflows and
outflows are detailed in a cash budget, and expected financial position at the end of the
budget period is shown in a budgeted, or pro forma, balance sheet. Exhibit 8-2 illustrates the
components of the master budget.

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 The master budget is usually prepared for a 1-year period corresponding to the company’s fiscal
year. The yearly budgets are broken down into quarterly and monthly The figure below lays out
how operating budgets and financial budgets are related within a master budget.

Operating Budgets, Financial Budgets, and the Relationship between Budgets.

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 The following are the components of the operating budget.
1. Sales budget
2. Production budget
3. Direct materials purchases budget
4. Direct labor budget
5. Overhead budget
6. Ending finished goods inventory budget
7. Cost of goods sold budget
8. Marketing expense budget
9. Research and development expense budget
10. Administrative expense budget
11. Budgeted income statement
You may want to refer back to above Exhibit to see how these components of the
operating budget fit into the master budget.
Sales Budget :-
The sales budget is the projection approved by the budget committee that describes
expected sales for each product in units and dollars.
The first step in preparing the master budget is the sales budget, which shows the
planned sales units and the expected dollars from these sales.
Analysis of economic and market conditions + Business capacity and advertising
plans.

– Estimated Unit Sales

– Estimated Unit Price
= Estimated sales revenues

The sales budget may be prepared under the following classification orcombination of
classifications:-

1. Products or groups of products.

2. Areas, towns, salesmen and agents.
3. Types of customers as for example: (i) Government, (ii) Export, (iii)Home sales, (iv) Retail
depots.
4. Period—months, weeks, etc.
5.

Example #1:
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 Budgeted units to be sold for each quarter of 2022:- 1000, 1200, 1500 and 2000. Selling price is
$10 per T-shirt.
Prepare : - asales budget for each quarter and year.

Solution #1:
Varman’s T-shirts Sales
Budget
For the year ending, December 31, 2022
Quarter
1 2 3 4 Year
Units 1,000 1,200 1,500 2,000 5,700
Unit SP *$10 *$10 *$10 *$10 *$10
Budgeted $10,000 $12,000 $15,000 $20,000 $57,000
sales

Production Budget :-
The production budget tells us how many units must be produced to meet sales needs and to
satisfy ending inventoryrequirements. Production budget shows the production for the
budget period based upon:
1. Sales budget,
2. Production capacity of the factory,
3. Planned increase or decrease in finished stocks, and
4. Policy governing outside purchase.
Production budget is normally stated in units of output. Production should be carefully
coordinated with the sales budget to ensure that production and sales are kept in balance
during the period. The number of units to be manufactured to meet budgeted sales and
inventory needs for each product is set forth in the production budget.

 Units to be produced = Expected unit sales + Units in desired ending inventory (EI) – Units in
beginninginventory (BI)

OR
The following formula provides the computation for units to be produced:-
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 Number of units to be sold (from sales budget) XXX
Number of units desired in ending inventory XXX
= Total units needed during period XXX
- Number of units in beginning inventory (XXX)
= Units to be produced XXX

Example #2:
Budgeted units to be sold for each quarter of 2022: 1000, 1200, 1500 and 2000. Company policy requires 20%
of next quarter’s sales in ending inventory and that beginning inventory of T-shirts for the first quarter of the
year was 180 units. Sales for first quarter of 2023 are estimated at 1000 units

Solution #2:
 Ending Inventory, quarter 1 = 0.20 * 1,200 units = 240 units
 Ending Inventory, quarter 2 = 0.20 * 1,500 units = 300 units
 Ending inventory, quarter 3 = 0.20 * 2,000 units = 400 units
 Ending inventory, quarter 4 = 0.20 * 1,000 units = 200 units

Varman’s T-shirts
Production Budget
For the Year Ending December 31, 2022
Quarter

1 2 3 4 Year

Sales in units 1,000 1,200 1,500 2,000 5,700

Desired EI 240 300 400 200 200

Total Needs 1,240 1,500 1,900 2,200 5,900

Less: BI (180) (240) (300) (400) (180)

Units to be produced 1,060 1,260 1,600 1,800 5,720

Direct Materials Budget:-

The production budget is the starting point for determining the estimated quantities of direct materials to be
purchased
The direct materials (DM) purchases budget shows the amount and cost of raw materials to be purchased in each
timeperiod; it depends on the expected use of materials in production and the raw materials inventory needs of the
firm.
 DM to be Purchased = DM needed for production + DM materials in desired EI – DM in BI

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 OR :-

Estimated units to be produced xxx

Number of pounds per unit x xx

DM required for production = xxx

Desired ending inventory, (EI) + xxx

Total pounds needed = xxxx

Estimated beginning inventory, (BI) - (xxx)

Total pounds to be purchased = xxxx

Price per pound x $xx

Total direct materials to be purchased cost = $xxxx

Example #3:
Budgeted units to be produced for each quarter of 2022 : - 1060, 1260, 1600 and 1800. Plain T-shirts cost $3
each and ink costs $0.20 per gram. Factory needs one plain t-shirt and 5 grams of ink for the log per shirt. The
policy is to have 10% of the following quarter’s production needs in ending inventory. The factory had 58 plain t-
shirts and 390 grams of ink on January1, 2023. At the end of the year, desired ending inventory is 106 plain t-
shirts and 530 grams of ink.
Solution #3:
 Ending inventory plain T-shirts, quarter 2 = 0.10 * (1,600 units * 1 T-shirt) = 160
 Ending inventory plain T-shirts, quarter 3 = 0.10 * (1,800 units * 1 T-shirt) = 180
 Ending inventory ink, quarter 2 = 0.10 * (1,600 units * 5 grams) = 800
 Ending inventory ink, quarter 3 = 0.10 * (1,800 units * 5 grams) = 900

Varman’s T-shirts
Direct Materials Purchases Budget For the Year Ending December 31, 2022
Quarter
MATERIAL :plain T-shirts

1 2 3 4 Year
Units to be produced 1,060 1,260 1,600 1,800 5,720
DM per unit *1 *1 *1 *1 *1
Production needs 1,060 1,260 1,600 1,080 5,720
Desired EI 126 160 180 106 106
Total needs 1,186 1,420 1,780 1,906 5,826
Less: BI (58) (126) (160) (180) (58)
DM to be purchased 1,128 1,294 1,620 1,726 5,768
Cost (price) per plain T-shirt *$3 *$3 *$3 *$3 *$3

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Total purchase cost T-shirts $3,384 $3,882 $4,860 $5,178 $17,304

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 MATERIAL - Ink

1 2 3 4 Year

Units to be produced 1,060 1,260 1,600 1,800 5,720

DM per unit *5 *5 *5 *5 *5

Production needs $5,300 $6,300 $8,000 $9,000 $28,600

Desired EI 630 800 900 530 530

Total needs 5,930 7,100 8,900 9,530 29,130

Less: BI (390) (630) (800) (900) (390)

DM to be purchased 5,540 7,100 8,900 9,530 29,130

Cost(price) per gram *$0.20 *$.020 *$0.20 *$0.20 *$0.20

Total purchase cost of ink $1,108 $1,294 $1,620 $1,726 $7,784

Total DM purchase cost $4,492 $5,176 $6,480 $6,904 $23,052

Direct Labor Budget:-

The direct labor budget shows the total direct labor hours and direct labor cost needed for the number of
units in theproduction budget.
● The budgeted hours are determined by the relationship between labor and output.

Total units to be produced xxx

Production time per unit x xx
Hours required for production = xxx
Labor rate per hour x xx
Budgeted Total direct labor cost = xxxx
●

Example #4:
Recall the production budget, that budgeted units to be produced for each quarter of 2022 are: 1060,
1260, 1600 and1800. It takes 0.12 DL hour to produce one T-shirt. The average wage cost per hour is
$11.50. Prepare a direct labor budget.

Solution #4:

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 Varman’s T-shirts
Direct Labor Budget
For the Year Ending December 31, 2022
Quarter
1 2 3 4 Year

Units to be produced 1060 1260 1600 1800 5720

DL time per unit in hours *0.12 *0.12 *0.12 *0.12 *0.12

Total hours needed 127.20 151.20 192.00 216.00 686.40

Average wage per hour *11.50 *11.50 *11.50 *11.50 *11.50

Total direct labor cost $1,463 $1,739 $2,280 $2,484 $7,894

Overhead Budget:-
The overhead budget shows the expected value of all production costs other than DM and DL. Many use DL hours as the
driver for overhead and vary with direct labor hours are pooled and called variable overhead. The remaining goes into
fixed overhead.

Example #5:
Refer to the DL budget. The variable overhead rate is $5 per DL hour, fixed overhead is budgeted at $1,645 per quarter
(this amount includes $540 per quarter for depreciation). Prepare an overhead budget.

Solution #5:
Varman’s T-shirt
Overhead Budget
For the Year Ending December 31, 2019
Quarter
1 2 3 4 Year

Budgeted DL hours 127.20 151.20 192.00 216.00 686.40

Variable OH rate *$5 *$5 *$5 *$5 *$5

Budgeted variable OH $636 $756 $960 $1,080 $3,432

Budgeted fixed OH 1,645 1,645 1,645 1,645 6,580

Total overhead $2,281 $2,401 $2,605 $2,725 $10,012

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Ending Finished Goods Inventory Budget
This budget supplies information needed for the balance sheet and serves as an important input for the preparation of the
cost of goods sold budget. The unit cost of each T-shirt is needed.

Example #6:
Refer to your DM, DL and OH budgets. Calculate the unit product cost and prepare an ending finished goods inventory
budget.

Solutions

(1) Unit Cost Computation

Direct Materials

Plain T-shirt $3.00

Ink $1.00 $4.00

Direct Labor (0.12hr @ $11.50) $1.38

Overhead

Variable (0.12 hr @ $0.50) $0.60

Fixed (0.12 hr @ $9.59) 1.15

Total unit cost $7.13

(2) Varman’s T-shirt

Ending Finished Goods Inventory Budget
For the Year Ending December 31, 2022
Logo t-shirts 200

X Unit cost $7.13

= Total ending inventory cost $1,426

Cost of Goods Sold Budget:-

The cost of goods sold budget reveals the expected cost of goods to be sold. Both cost of goods sold budgets that follow
include beginning and ending work in process and beginning and ending finished goods amounts.
The calculations begin with what was available at the beginning of the period, add what was transferred in during the
period, and deduct what was remaining at the end of the period to determine what was transferred out. A transfer out from
finished goods, of course, indicates a sale and a move to cost of goods sold.

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 Finished good inventory, January 1 xxx
Work in process inventory, January 1 Xxx
Direct materials Xxxx
Direct labor + Xxxx
Factory overhead + Xxxx
Total manufacturing costs for the year = Xxx
Work in process inventory, December 31 Xxx
Cost of goods manufactured + xxxx
Cost of finished goods available for sale = xxxx
Finished goods inventory, December 31 - (xxx)
Cost of goods sold = xxxx

Example #7:
Refer to the DM, DL, OH and ending finished goods budgets. Prepare a cost of goods sold budget.

Solution #7:

Varman’s T-shirts
Cost of Goods Sold Budget
For the Year Ending December 31, 2022

DM used (5720 plain t-shirts * 3) + (28600 grams ink * 0.20) $22,800

DL used $7,894

Overhead $10,012

Budgeted manufacturing costs $40,786

Beginning finished goods $1,251

Goods available for sales $42,307

Less: Ending finished goods $(1,426)

Budgeted cost of goods sold $40,611

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 Cash budget :-

(1) - Accounts Receivable Collections Schedule

 Shows the amount of Accounts Receivable that you are collecting during a quarterly or monthly basis.

Example #8:
Varman’s T-shirts expects that, on average 25% of total sales are cash and 75% of total sales are on credit. Of the credit
sales, Varman’s T-shirts expects that 90% will be paid in cash during the quarter of sale, and the remaining 10% will be
paid in the following quarter. From the sales budget you expect in quarter 1 to earn $10,000, quarter 2 to earn $12,000,
quarter 3 to earn $15,000 and quarter 4 to earn $20,000. The balance in accounts receivable as of the last quarter of
2018 was $1,350. This will be collected in cash during the first quarter of 2022.
1) Calculate cash sales expected in each quarter of 2019.
2) Prepare a schedule showing cash receipts from sales expected in each quarter of 2019.

Solution #8:
 Cash sales expected in Quarter 1 = $10,000 * 0.25 = $2,500
 Cash sales expected in Quarter 2 = $12,000 * 0.25 = $3,000
 Cash sales expected in Quarter 3 = $15,000 * 0.25 = $3,750
 Cash sales expected in Quarter 4 = $20,000 * 0.25 = $5,000

Quarter
1 2 3 4

Cash sales $2,500 $3,00 $3,750 $5,000

Received on account:

Q4, 2018 $1,350

Q1, 2019 $6,750 $750

($10,000*0.75(0.9) ($10,000*0.75)(0.1)

Q2, 2019 $8,100 $900

($12,000*0.75)(0.9) ($12,000*0.75)(0.1)

Q3, 2019 $10,125

($15,000*0.75)(0.9)

Q4, 2019 $13,500

($20,000*0.75)(0.9)

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 (2) - Cash Payments on Accounts Payable
The amount of cash that you will be paying on a quarterly or monthly basis

Example #9:
Varman’s T-shirts purchased raw materials on account: 80% of purchases are paid for in the quarter of purchase. The
remaining 20% are paid for in the following quarter. The purchases for the fourth quarter 2018 were $5,000. The direct
materials budget shows the expected purchases of raw materials purchases for each quarter of 2022. Quarter 1 was
$4,492, Quarter 2 was $5,176, Quarter 3 was $6,480, Quarter 4 was $6,904 were the direct materials expected to
purchase. Prepare a schedule showing anticipated payments for accounts payable for materials.

Solution #9:
Quarter
1 2 3 4

Q4, 2018 $1,000

($5,000*0.20)

Q1, 2019 $3,594 $898

($4,492*0.80) ($4,492*0.20)

Q2, 2019 $4,141 $1,035

($5,176*0.80) ($5,176*0.20)

Q3, 2019 $5,184 $1,296

($6,480*0.80) ($6,480*0.20)

Total cash needed $4,594 $5,039 $6,219 $6,819

(3) Cash Budget:-

The Cash budget includes cash receipts, disbursements, any excess or deficiency of cash and financing. At its simplest,
cash budget is cash inflows minus cash outflows.

Example #10:
Refer to direct labour budget, overhead budget, selling and administrative expenses budget, budgeted income statement,
accounts receivable schedule and cash payments schedule the following details as well:
1) A $1,000 minimum cash balance is required for the end of each quarter. Interest is 12% per year on any amounts
borrowed. Interest payments are made only for the principal being repaid. All borrowing takes place at the
beginning of a quarter and all repayments takes place at the end of the quarter.
2) Budgeted depreciation is $540 per quarter for overhead and $150 per quarter for selling and administrative
expenses.

3) The capital budget for 2019 revealed plans to purchase additional screen-printing equipment. The cash outlay for
the equipment, $6,500 will take place in the first quarter. The company plans to finance the acquisition of the
equipment with operating cash, supplementing it with short-term loans as necessary.
4) Corporate income taxes are approximately $3,068 and will be paid at the end of the fourth quarter
5) Beginning cash balance is $5,200.
6) All amounts in the budgets are to be rounded to the nearest dollar. Prepare a cash budget.

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Solution #10:
Varman’s T-shirts
Cash Budget
For the Year Ending December 31, 2022
Quarter
1 2 3 4 Year

Beg. cash balance $5,200 $1,000 $1,183 $3,046 $5,200

Cash sales and collections $10,600 $11,850 $14,775 $19,625 $56,850

Total cash available $15,800 $12,850 $15,958 $22,671 $62,050

Payments for:

Raw materials (4,594) (5,039) (6,219) (6,819) (22,671)

Direct labour (1,463) (1,739) (2,208) (2,484) (7,894)

Overhead (1,741) (1,861) (2,065) (2,185) (7,852)

Selling and admin (1,670) (1,790) (2,420) (2,170) (8,050)

Income taxes (3,068) (3,068)

Equipment (6,500) (6,500)

Total disbursements (15,968) (10,249) (12,912) (16,726) (56,035)

Excess (deficiency) of cash (168) 2,421 3,046 5,945 6,015

Financing:

Borrowings 1,168 1,168

Repayments (1,168) (1,168)

Interest (70) (70)

Total financing 1,168 (1,238) (70)

Ending cash balance $1,000 $1,183 $3,046 $5,945 $5,945

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 QUESTIONS,EXERCISES, AND, PROBLEMES

Sales and Cash Collections Budget

 The foundation and starting point for the master budget.

 Determines the anticipated unit and dollar sales for the budgeted incomestatement.
 May also include a schedule of expected cash collections that determines the amount of
expected cash collections from customers for each period based on anexpected collections
pattern.

Example #1

Company A is expecting to sell 10,000 cases in July, 20,000 cases in August, and 30,000in September of Year
2. Selling price per case is $30. All sales are on account. The sales are collected 70% in the month of sale
and 30% in the month following sale. Junesales totaled $200,000. Bad debts are negligible and can be
ignored.

Required: a) Prepare a sales budget.

b) Prepare a schedule of expected cash collections from sales, bymonth and in total,
for the third quarter.
c) Assume that the company will prepare a budgeted balance sheet
as of September 30. Determine the accounts receivable as of thatdate.

Solution #1

a) Sales budget:
Quarter
July August September Total
Budgeted Sales 10,000 20,000 30,000 60,000
x Selling price per unit $30 $30 $30 $30
Total Sales $300,000 $600,000 $900,000 $1,800,000

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 b) Schedule of expected cash collections:
Quarter
July August September Total
June sales ($200,000 X 30%) $60,000 $60,000
July sales ($300,000 X 70%,
30%) $210,000 $90,000 300,000
August sales ($600,000 X 70%,
30%) 420,000 $180,000 600,000
September sales ($900,000 X
70%) 630,000 630,000
Total cash collections $270,000 $510,000 $810,000 $1,590,000

c) Account Receivable as of September 30:

From September ($900,000 X 30%) = $270,000

Production Budget

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Example #2

Bell Telecom has budgeted sales of its innovative mobile phone for next four monthS as follows:
Sales Budget in Units
July 30,000
August 45,000
September 60,000
October 50,000

The company is now in the process of preparing a production budget for the thirdquarter.
Ending inventory level must equal 10% of the next month’s sales.

Required: a) Calculate the ending inventory as of June 30.

b) Prepare a production budget for the third quarter showing the number of units to
be produced each month and for the quarter in
total.

Solution #2

a) Ending inventory:
Since the ending inventory level must equal 10% of the next month’s sales, theending inventory for the
month of June must be 10% of July’s sales of 30,000 or 3,000 units.

b) Production Budget
Quarter
July August September Total October
Budgeted sales in units 30,000 45,000 60,000 135,000 50,000
+ ending inventory 4,500 6,000 5,000 5,000
= Total needs 34,500 51,000 65,000 140,000
- beginning inventory 3,000 4,500 6,000 3,000 5,000
= Required production 31,500 46,500 59,000 137,000

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 Direct Materials Budget

Example #3

Texas Products has developed a very powerful electronic calculator. Each calculator requires three small
chips that cost $2.00 each and are purchased from an overseas supplier. Texas Products has prepared a
production budget for the calculator by quartersfor Year 2 and for the first quarter of Year 3, as follows:

Year 2 Year 3
First Second Third Fourth First
Budgeted productions,in
calculators 60,000 90,000 150,000 100,000 80,000

The inventory of the chips at the end of a quarter must be equal to 20% of the followingquarter’s production
needs. There will be 36,000 chips on hand to start the first quarter of Year 2.

Required: Prepare direct materials budget for the chips, by quarter and in
total, for Year 2 including the dollar amount of purchases for eachquarter and for
the year in total.

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Solution #3

Year 2 Year 3
First Second Third Fourth First
Calculators produced 60,000 90,000 150,000 100,000 80,000
X Chips per calculator 3 3 3 3 3
= Production needs - chips 180,000 270,000 450,000 300,000 240,000
+ Ending inventory - chips 54,000 90,000 60,000 48,000 48,000
= Total needs - chips 234,000 360,000 510,000 348,000 1,248,000
- Beginning inventory - chips 36,000 54,000 90,000 60,000 36,000
= Required purchases - chips 198,000 306,000 420,000 288,000 1,212,000
X Purchase cost per chip $2.00 $2.00 $2.00 $2.00 $2.00
= Total purchase cost $396,000 $612,000 $840,000 $576,000 $2,424,000

Direct Labor Budget

Example #4

The production department of the Company B has submitted the following forecast ofunits to be produced
by quarter for the upcoming fiscal year:

First Second Third Fourth

Units to be produced 10,000 8,000 8,500 9,000

Each unit requires 0.6 direct labor-hours and at a cost of $15.00 per direct labor hour.The workforce can
be adjusted each quarter for the expected production level

Required: Prepare the company’s direct labor budget for the next fiscal year.

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 Revised Summer 2015
Solution #21

First Second Third Fourth

Required production – units 10,000 8,000 8,500 9,000
X Direct labor hours per unit 0.6 0.6 0.6 0.6
= Total direct labor-hours needed 6,000 4,800 5,100 5,400
X Direct labor cost per hour $15.00 $15.00 $15.00 $15.00
= Total direct labor cost $90,000 $72,000 $76,500 $81,000

Manufacturing Overhead Budget

Example #5

Company C’s variable manufacturing overhead rate is $2.00 per direct labor-hour and the company’s fixed
manufacturing overhead is $40,250 per quarter. The only non-cashexpense included in the fixed overhead
is depreciation of $12,000 per quarter.

The budgeted direct labor-hours for each quarter are as followed:

First Second Third Fourth

Budgeted direct labor hours 5,000 6,500 6,000 5,500

Required: a) Construct company’s manufacturing overhead budget for the year.

b) Compute the company’s variable, fixed and total manufacturingoverhead rates
for the year.

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Solution #5

a) Overhead budget
First Second Third Fourth Year
Budgeted direct labor-hours 5,000 6,500 6,000 5,500 23,000
X Variable overhead rate $2.00 $2.00 $2.00 $2.00 $2.00
= Variable overhead $10,000 $13,000 $12,000 $11,000 $46,000
+ Fixed overhead 40,250 40,250 40,250 40,250 161,000
= Total overhead $50,250 $53,250 $52,250 $51,250 $207,000
- Deprecation 12,000 12,000 12,000 12,000 48,000
= Cash disbursements $38,250 $41,250 $40,250 $39,250 $159,000

b) Overhead rate

Overhead Direct Labor Hours Overhead Rate

Variable overhead $46,000 / 23,000 = $2.00
Fixed overhead $161,000 / 23,000 = $7.00
Total overhead $207,000 / 23,000 = $9.00

Selling and Administrative Expense Budget

 Selling and Administrative (S&A) expense budget is similar to the manufacturingoverhead

budget as it includes variable and fixed expenses.
 Budgeted variable S&A expenses depend on the number of units sold or salesdollars from
the sales budget.
 Budgeted fixed S&A expenses depend on the total cost expected to be incurredfor each type of
fixed S&A cost.
 Any noncash fixed S&A costs, such as depreciation expense, is deducted from thetotal S&A
expenses to determine the cash disbursements for S&A expenses. (Remember that depreciation
expense is a non-cash expense. The cash was spent when the depreciable asset was acquired
and not when the asset is depreciated.)

Cash Budget

 Cash budget is composed of four major sections:

o Cash Receipts
o Cash Disbursements
o Cash Excess or Deficiency
o Financing
 The cash budget uses information from all of the other budgets: cash receiptsfrom the sales
budget, cash disbursements from direct materials budget, cashdisbursements from the
direct labor, manufacturing overhead and selling administrative expense budget.
 It may also include other sources of cash receipts such as proceeds from the saleof plant assets,
issuance of stock or issuance of bonds.
 It may also include other sources of cash disbursements such as the purchase ofplant assets and
the payment of cash dividends.
 The company may also have to meet a minimum balance requirement for its cashaccount that is
imposed by the bank. If the cash balance falls short of the minimum required, the company will
have to borrow money to increase the cash balance to the minimum. If the company has cash in
excess of the minimum balance required, it is obligated to pay off any outstanding borrowings
and the related interest payable. After the borrowings and interest have been paid off, the
company may leave the “excess” cash in the cash account.

Budgeted Financial Statements

 Budgeted financial statements are prepared after all of the other budgets,including the
cash budget, have been prepared.
 They serve as a benchmark against which subsequent actual companyperformance
can be measured.
 Practice Problems

Practice Problem #1

Peak sales for J & J Products, a wholesale distributor of leaf rakes, occur in August.Sales the company’s
planning budget for the third quarter are shown below:

July August September Total

Budgeted Sales on account $600,000 $900,000 $500,000 $2,000,000

From past experience, the company has learned that 20% of a month’s sales are collected in the month of
sale, another 70% are collected in the month following sale and the remaining 10% are collected in the
second month following sale. Bad debts arenegligible and can be ignored. May sales totaled $430,000 and
June sales totaled
$540,000.

Required: a) Prepare a schedule of expected cash collections from sales, bymonth and in
total, for the third quarter.
b) Compute the accounts receivable as September 30.

Practice Problem #2

Micro Corporation has budgeted sales of its microchips for next four month as follows:

Units Sold
April 20,000
May 25,000
June 35,000
July 40,000

The company is preparing a production budget for the third quarter. Ending inventory
level must equal 20% of the next month’s sales.

Required: a) Calculate the ending inventory as of March 31.

b) Prepare a production budget for the third quarter by month and intotal.
Practice Problem #3

Company A sells a single product. Each unit takes two pounds of material and costs
$3.00 per pound. Company A has prepared a production budget by quarters for Year 2and for the first
quarter of Year 3, as follows:

Year 2 Year 3
First Second Third Fourth First
Budgeted production 30,000 60,000 90,000 100,000 50,000

The ending inventory at the end of a quarter must be equal to 25% of the following quarter’s
production needs. 26,000 pounds of material are on hand to start the firstquarter of Year 2.

Required: Prepare direct materials budget for the chips by quarter and in forYear 2 in total
including the dollar amount of purchases.

Practice Problem #4

The production department of the Hampton Freeze, Inc. has submitted the followingforecast of units to be
produced by quarter for the upcoming fiscal year.

First Second Third Fourth

Units to be produced 8,000 7,500 7,000 9,500

Each unit requires 0.4 direct labor-hours. Direct labor rate is $10.00 per hour.

Required: Prepare the direct labor budget for the upcoming fiscal year.

Practice Problem #5

The budgeted direct labor-hours for the Texaco Company are as followed:

First Second Third Fourth

Budgeted direct labor hours 15,000 16,500 16,000 15,500

Texaco Company’s variable manufacturing overhead rate is $1.5 per direct labor-hour and the company’s
fixed manufacturing overhead is $60,000 per quarter. The only non-cash item included in the fixed mfg.
overhead is depreciation, which is $18,000.
 Required: a) Prepare a manufacturing overhead budget for the year.
b) Compute the variable, fixed and total manufacturing overheadrates for the
year.

Practice Problem #6

The Goose Grease Company had cash of $13,000 on hand on January 1, 2010. During2010, the company
expected the following cash collections from customers by quarter:

First Second Third Fourth

Cash collections 110,000 177,500 183,700 136,000

Direct materials purchases in tons were budgeted as follows:

First Second Third Fourth

Direct materials
purchases 65,000 75,000 55,000 50,000

The production budget showed the following unit production by quarter with an averagelabor rate of $40.00:

First Second Third Fourth

Units to be produced 1,500 2,000 1,700 1,500

Goose Grease planned to pay dividends of $10,000 per quarter during the year. DuringJuly, new equipment
costing $60,000 will be purchased. An additional $16,000 was planned to installation costs during the
fourth quarter.

The company was required to maintain a minimum cash balance of $15,000. A line of credit was available
for short-term borrowings in increments of $1,000. All borrowings will be made at the beginning of a
quarter and repaid at the end of a quarter. Interest on the short-term borrowings will be paid at 0.5% per
quarter on the amount repaid in any quarter when a loan repayment is made. All other interest expense
will be accruedeach quarter.

Required: Prepare a cash budget by quarter and for the year in total.
 True / False Questions
1. A short-term objective is a specific action managers use to reach their long-term goals.

True False

2. The strategic plan is management's vision of what they desire the organizationto achieve over
the long term.
True False

3. An advantage of budgeting is that it requires managers to evaluate why thingsdid not progress
according to the plan.
True False

4. Participative budgeting allows employees throughout the organization to haveinput into the
budget-setting process.
True False

5. Budgets that are tight but attainable are less likely to motivate people thanbudgets that
are easy to achieve.
True False

6. Operating budgets focus on the financial resources needed to supportoperations.

True False

7. The direct labor budget is based on budgeted sales levels.

True False

8. Budgeted manufacturing overhead includes indirect manufacturing costs, butnot selling or

administrative costs.
True False

9. Cash budget is a detailed plan showing how the cash will be acquired and usedover a specific
time period.
True False

10. A short-term objective is a specific action managers use to reach their long-term goals.

True False
11. The strategic plan is management's vision of what they desire the organizationto achieve over
the long term.
True False

12. Merchandising companies prepare the production budget after preparing thesales budget.

True False

13. Budget preparation is best determined in a top-down managerial approach.

True False

14. Past performance is the best overall basis for evaluating current performanceand assessing
the need for corrective action.
True False
 Multiple Choice Questions
1. A master budget consists of
a) An interrelated long-term plan and operating budgets
b) Financial budgets and a long-term plan
c) Interrelated financial budgets and operating budgets
d) All the accounting journals and ledgers used by a company

2. A production budget is prepared befor the direct materials budget because:

a) Direct materials are needed in the production process
b) The order in which the budgets are prepared doesn’t matter
c) The production budget is not prepared before the direct materials budget.
d) Production budgets but not direct materials budgets are prepared bymerchandising firms.

3. Aya Company produces hand tools. For March, budgeted sales are 12,000 units, beginning
finished goods inventory is budgeted to be 1,200 units, andending finished goods inventory is
budgeted to be 1,400 units. How many
units will be produced in March?
a) 10,900
b) 11,800
c) 12,200
d) 14,600

4. Jasim Company produces hand tools. Budgeted sales will be: March 12,000units, April 14,000,
May 16,000 and June 19,000. Ending finished goods inventory policy is 10% of the following
month's sales. What is budgeted
finished goods inventory for May?
a) 1,000
b) 1,300
c) 1,600
d) 1,900

5. Heba Company produces hand tools. Budgeted sales will be: March 12,000units, April 13,000,
May 15,000 and June 19,000. Ending finished goods inventory policy is 10% of the following
month's sales. March 1 inventory is projected to be 1,500 units. How many units will be
produced in March?
a) 11,800
b) 12,200
c) 13,000
d) 14,800
6. What is the proper preparation sequencing of the following budgets?1 - Budgeted
Balance Sheet
2 - Sales Budget
3 - Selling and Administrative Budget4 -
Budgeted Income Statement
a) 1, 2, 3, 4
b) 2, 3, 1, 4
c) 2, 3, 4, 1
d) 2, 4, 1, 3

7. Al-blad Inc. produces leather handbags. The production budget for the nextfour months is: July
6,000 units, August 8,000, September 7,500, October 8,000. Each handbag requires 0.5 square
meters of leather. Albertville Inc's leather inventory policy is 30% of next month's production
needs. On July 1 leather inventory was expected to be 2,000 square meters. Leather is
expected to cost $5.00 per square meter in June, but go up to $6.00 per square meter in July.
What is the expected cost of leather purchases in July?

a) $13,100
b) $13,200
c) $16,200
d) $16,300

8. Al- nahren Inc. produces leather handbags. The production budget for the nextfour months is:
July 5,000 units, August 8,000, September 9,500, October 10,800. Each handbag requires 1.3
hours of unskilled labor (paid $8 per hour)and 2.2 hours of skilled labor (paid $15 per hour).
How many unskilled and
skilled labor hours will be budgeted for August?
a) 10,400
b) 17,600
c) 28,000
d) 28,800

9. Al-forat Inc.. produces leather handbags. The production budget for the nextfour months is:
July 6,000 units, August 7,000, September 7,500, October 8,000. Each handbag requires 1.3
hours of unskilled labor (paid $8 per hour)
and 2.2 hours of skilled labor (paid $15 per hour). How much will be paid toskilled labor
during the Quarter 3 (July-September)?
a) $292,500
b) $676,500
c) $677,500
d) $742,500
10. Basam, co. has forecast production for the next three months as follows: July 5,000 units,
August 6,600 units, September 7,500 units. Monthly
manufacturing overhead is budgeted to be $17,000 plus $5 per unit produced.What is
budgeted manufacturing overhead for July?
a) $24,500
b) $41,500
c) $42,000
d) $47,000

11. Tomi has forecast sales for the next three months as follows: July 7,000 units, August 8,000
units, September 8,500 units. Tomi's policy is to have an ending inventory of 40% of the next
month's sales needs on hand. July 1 inventory is projected to be 1,500 units. Selling and
administrative costs are budgeted to
be $15,000 per month plus $5 per unit sold. What are budgeted selling and administrative
expenses for July?
a) $24,500
b) $38,500
c) $49,000
d) $50,000

12. Al-hasan has forecast sales to be $120,000 in February, $145,000 in March,

$170,000 in April, and $180,000 in May. The average cost of goods sold is 60% of sales. All
sales are on made on credit and sales are collected 60% in
the month of sale, and 40% the month following. What are budgeted cashreceipts in March?

a) $131,000
b) $135,000
c) $94,500
d) $91,700

13. Ahamad co. has forecast sales to be $215,000 in February, $260,000 in March,
$300,000 in April, and $310,000 in May. All sales are made on credit and salesare collected
50% in the month of sale, 30% the month following and the remainder two months after the
sale. What are budgeted cash receipts in
April?
a) $174,000
b) $217,000
c) $271,000
d) $371,500
14. Al-hager Inc. has forecast purchases on account to be $210,000 in March,
$270,000 in April, $320,000 in May, and $390,000 in June. Seventy percent of
purchases are paid for in the month of purchase, the remaining thirty percentare paid in the
following month. What are budgeted cash payments for April?
a) $252,000
b) $285,000
c) $159,000
d) $126,000

15. Al-wesam has forecast sales to be $225,000 in February, $235,000 in March,

$250,000 in April, and $240,000 in May. All sales are made on credit and sales are collected 60%
in the month of sale, and 40% the month following. What is
the budgeted Accounts Receivable balance on May 31?
a) $69,000
b) $96,000
c) $98,000
d) $106,000

16. Baghdad, Inc. sells a single product. Forecasted sales are July 4,000 units, August 7,000 units,
September 7,500 units. Company’s policy is to have anending inventory of 40% of the next
month's sales needs on hand. July 1
inventory is projected to be 1,500 units. What are budgeted units for August?
a) 6,600 units
b) 7,400 units
c) 7,200 units
d) 1,400 units

17. Al-farah Company’s production budget for the first quarter was based on sales on442,000 units
and a beginning inventory of 12,900 units. How many units should be produced during the
quarter if the company desires 15,000 units
available to start the next quarter?
a) 431,500
b) 439,900
c) 441,400
d) 444,100

18. Babelon Co. desires a December 31 ending inventory of 2,840 units. Budgetedsales for
December are 4,000 units. The November 30 inventory was 1,800 units. Budgeted purchases
are:
a) 5,040 units
b) 1,240 units
c) 6,840 units
d) 4,000 units
19. A department store has budgeted sales of 12,000 men's suits in September. Management
wants to have 6,000 suits in inventory at the end of the month to prepare for the winter
season. Beginning inventory for September is
expected to be 4,000 suits. What is the dollar amount of purchase of suits?Each suit has a
cost of $75.
a) $750,000
b) $900,000
c) $1,050,000
d) $1,200,000

20. Northern Company is preparing a cash budget for June. The company has
$12,000 cash at the beginning of June and anticipates $30,000 in cash receipts and $34,500
in cash disbursements during June. Northern Companyhas an agreement with its bank to
maintain a cash balance of at least
$10,000. As of May 31, the company owes $15,000 to the bank. To maintainthe $10,000
required balance, during June the company must:
a) Borrow $4,500
b) Borrow $2,500
c) Borrow $10,000
d) Borrow $7,500
 Solutions to Practice Problems

Practice Problem #1

a) Schedule of Cash Collections:

July August September Total
May sales ($430,000 X10%) $43,000 $43,000

June sales ($540,000 X70%,10%) 378,000 54,000 432,000

July sales ($600,000 X 20%,,70%,10%) 120,000 420,000 60,000 600,000

August sales ($900,000 X20%,70%) 180,000 630,000 810,000

September sales ($500,000x 20%) 100,000 100,000

Total cash collections $541,000 $654,000 $790,000 $1,985,000

b) Account receivable at September 30:

From August sales: $900,000 X 10% $90,000

From September sales: $500,000 X (70% + 10%) 400,000
Total account receivable $490,000

Practice Problem #2

a) Since the ending inventory for the month of March must be 20% of April’s sales of20,000 units, ending
inventory = 4,000 units.

b) Production Budget:
April May June Quarter
Budgeted sales in units 20,000 25,000 35,000 80,000
Add desired ending inventory* 5,000 7,000 8,000** 8,000
Total needs 25,000 32,000 43,000 88,000
Less beginning inventory 4,000 5,000 7,000 4,000
Required production 21,000 27,000 36,000 84,000

*10% of the following month's unit sales

**July sales = 40,000 X 20% = 8,000
 Practice Problem #3

Quarter - Year 2 First Year 3

Second Third Fourth First
Required production 30,000 60,000 90,000 100,000 50,000

Pounds of materialper unit 2 2 2 2 2

Total production
needs 60,000 120,000 180,000 200,000 100,000

Production needs 60,000 120,000 180,000 200,000 560,000

Add desired ending
inventory 30,000 45,000 50,000 25,000 25,000
Total needs Less 90,000 165,000 230,000 225,000 585,000
beginninginventory
26,000 30,000 45,000 50,000 26,000
Required purchases Cost of 64,000 135,000 185,000 175,000 559,000
purchase perunit
$3.00 $3.00 $3.00 $3.00 $3.00
Total costs of
purchase $192,000 $405,000 $555,000 $525,000 $1,677,000

Practice Problem #4

First Second Third Fourth Year

Required production 8,000 7,500 7,000 9,500 32,000
Direct labor-hour per unit 0.4 0.4 0.4 0.4 0.4
Total direct labor hours 3,200 3,000 2,800 3,800 12,800
Direct labor costs per dlh $10.00 $10.00 $10.00 $10.00 $10.00
Total direct labor cost* $32,000 $30,000 $28,000 $38,000 $128,000

*Assume that the direct labor workforce will be fully adjusted to the total direct labor-hours needed each
quarter
Practice Problem #5

First Second Third Fourth Year

Budgeted direct labor-hours 15,000 16,500 16,000 15,500 63,000
Variable mfg. overhead rate $1.50 $1.50 $1.50 $1.50 $1.50
Variable mfg. overhead $22,500 $24,750 $24,000 $23,250 $94,500
Fixed mfg. overhead 60,000 60,000 60,000 60,000 240,000
Total mfg. overhead $82,500 $84,750 $84,000 $83,250 $334,500
Less deprecation 18,000 18,000 18,000 18,000 72,000
Cash disbursement for mfg.
overhead. $64,500 $66,750 $66,000 $65,250 $262,500

Total manufacturing overhead $334,500

Budgeted direct labor-hours 63,000
Predetermined overhead rate for the year = $5.31

Practice Problem #6

First Second Third Fourth Year

Beginning cash balance $13,000 $15,000 $15,380 $15,080 $13,000
+ Cash collections 110,000 177,500 183,700 136,000 607,200
= Cash available $123,000 $192,500 $199,080 $151,080 $620,200
- Cash Disbursements:
Direct materials purchases 65,000 75,000 55,000 50,000 245,000
Direct labor 60,000 80,000 68,000 60,000 268,000
Plant assets 60,000 16,000 76,000
Dividends 10,000 10,000 10,000 10,000 40,000
Excess (deficiency) ($12,000) $27,500 $6,080 $15,080 ($8,800)
Financing:
+ Borrowings 27,000 9,000 36,000
- Repayments (12,000) (12,000)
- Interest paid (120) (120)
= Ending cash balance $15,000 $15,380 $15,080 $15,080 $15,080

- Interest paid $12,000 X 0.5% X 2 qtrs = $120

 Solutions to True / False Problems

1. False - A short-term objective is not an action but rather a specificgoal to be

achieved within one year to reach long-term goals.
2. True
3. False - This is not a requirement of budgeting.
4. True
5. False - Budgets that are tight but attainable are more motivatingpeople than
budgets that are too easy or too difficult to achieve.
6. False - Operating budgets cover the organization's planned operating activities for
a particular period; financial budgets focuson the financial resources needed to
support operations
7. False - The direct labor budget is based on budgeted productionlevels not the
budgeted sales levels.
8. True
9. True
10. False - A continuous or perpetual budget is a 12-month budget that rolls forward
one period as the current period is completed.
11. True
12. False – merchandising companies do not prepare a productionbudget, as they do
not make any products.
13. False – Budgets should be developed from the bottom-up to encourage all
employees to strive to achieve budgeted goals.
14. False – Past performance is only one component of evaluatingcurrent
performance

Solutions to Multiple Choice Questions

1. C
2. C
3. C
4. D
5. A
6. C
7. B
8. C
9. B
10. C
11. D
12. B
13. C
14. A
15. B
16. C
17. D
18. A
19. C
20. B