Chapter 5 - Preparation of Master Budget

Learning Objectives
Upon finishing this lecture, you are expected to:
1. Know and explain the basic concept involving financial forecasting, corporate planning and budgeting.
2. Explain what are the pro-forma financial statements.
3. Construct a master budget.

Introduction and Core Values Integration

Budgeting is part of every organization. A budget serves as a financial plan that shows the revenues and
expenditures of an organization. A budget is supposed to provide a clear picture on how organizations will be using
their financial resources. Budgeting is a process that allows organizations both public and private, to see what
financial resources need to be allocated in order to achieve organizational goals and objectives. Budgeting involve
the process of examining past financial information to see how resources have been used in the past and what
goals and objectives were met.

To be able to achieve the goals of organizations, its members should be one with its objectives and engage
themselves with competence and accountability, treating the organization as their own, and wanting it to succeed
as they want themselves to.

Aside from the fact that we, the Wesleyan University - Philippines as a whole, wants you to learn how to be the best
finance and accounting people out there, we want to remind you first to be a good servant of God and conquer the
world with integrity and credibility with so much wisdom from God in every decision you will make.

Master Budget Definition

The master budget is basically management’s strategic plan for the future of the company. Every aspect of the
company operations is charted and documented for future predictions. You can almost think of the master budget
as a folder that includes all of the other budgets including:
1. Sales Budget
2. Production budget
3. Direct materials budget
4. Direct labor budget
5. Factory overhead budget
6. Ending inventory budget
7. Selling and administrative budget
8. Cash budget
9. Budgeted income statement
10. Budgeted balance sheet
SALES BUDGET
What is sales budget?
A sales budget is simply the amount of revenue you expect to bring in over the next year. While costs are an
important part of your master budget, they are not included in the sales budget.
Sales Budget Process vs. Sales Forecast
Both the sales budget process and sales forecast are tools used to by companies to get a glimpse into the future. An
idea of which direction they want the company to go in and whether or not they are on course to get there.

Although the sales forecasting process and budgeting are often used together, there are distinct differences
between the two:
• Budgeting is a quantified expectation of what a company hopes to achieve for any given period of time – a
summary of total revenue from all products or services sold. Forecasting on the other hand is an estimate of
how much will be sold over the set period of time.
• the sales budget process shows the direction your company would like to go in and the forecast indicates
how likely you are to arrive there on time.

The following data are needed to be able to get started with the step by step process of sales budget:
• Quantity of units/services (you plan to sell)
• Selling price of each unit/service
• Period of time (month, quarter or year)

Sample problem:

Assume that the firm is expecting to have the following quarterly sales:

First quarter 1,200 units

Second quarter 1,050 units
Third quarter 1,350 units
Fourth quarter 1,450 units

The selling price per unit is P120.

The table we will create therefore will look something a little like this:

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The table we will create therefore will look something a little like this:

Sales Budget
Q1 Q2 Q3 Q4
Expected sales in units 1,200 1,050 1,350 1,450
Price per unit 120 120 120 120

Expected sales or sales forecasts are usually based on historical sales data from the previous year(s).

If we don’t have any historical sales data to work with we can choose a qualitative method. These include:
• Market research studies
• Expert opinion panels
• Delphi method
• Sales force polls

The next step in the sales budget process is to multiply the number of units sold by the price per unit.

Sales Budget
Q1 Q2 Q3 Q4
Expected sales in units 1,200 1,050 1,350 1,450
Price per unit 120 120 120 120
Total Budgeted Sales 144,000 126,000 162,000 174,000

And for the estimated cash collections from the sales, let as assume further that 65% of the expected sales were
collected in the first quarter of the sale, 30% were collected in the quarter after the sale, and 5% were
uncollectible.

Q1 Q2 Q3 Q4
These are the 65% collected in the quarter’s sales.
Total Budgeted Sales 144,000 126,000 162,000 174,000
Ex: 65% of 144,000 (sales for the 1st quarter) which is
Estimated cash collections:
93,600 is collected on the same quarter. The 30% of
65% 93,600 81,900 105,300 113,100 144,000 which is 43,200 will be collected on the next
30% 43,200 37,800 48,600 quarter, as you can see in the table.
Total cash collections 93,600 125,100 143,100 161,700

In this particular problem, the total collection for the 1st quarter will be 65% of the 1st quarter’s sales which is
93,600 (144,000 x 65%). 30% will be collected on the next quarter, which is 43,200 (144,000 x 30%). The
remaining 5% will be assumed uncollected. The computation for the rest of the quarters will be the same. The
remaining 30% of the 4th quarter’s sales will remain as receivables.

Let’s try another example:

The following credit sales are budgeted by Brownie:

Sales Budget
January February March April May
Expected sales in units 1,240 1,200 1,350 1,400 1,420
Price per unit 100 100 100 100 100
Total Budgeted Sales 124,000 120,000 135,000 140,000 142,000

The company’s past experience indicates that 50% of the accounts receivable are collected in the month of sale,
30% in the following month, and 18% in the second month following the sale. Two percent are uncollectible. How
much does the company anticipate as cash receipts for March?

Answer:

Following the process we did earlier, this will be the computation:

January February March April May

Total Budgeted Sales 124,000 120,000 135,000 140,000 142,000
Estimated cash collections:
50% 62,000 60,000 67,500 70,000 71,000
30% 37,200 36,000 40,500 42,000
18% 22,320 21,600 24,300
Total cash collections 62,000 97,200 125,820 132,100 137,300

The anticipated cash receipts for march is P125,820.

Collections for the month of march:

March (135,000 x 50%) 67,500

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March (135,000 x 50%) 67,500
From the sales of February (120,000 x 30%) 36,000
From the sales of January (124,000 x 18%) 22,320
Total 125,820

PRODUCTION BUDGET

The expected volume of production is determined as follows:

Planned sales xx
Add: Desired ending inventory xx
Total needs xx
Less: Beginning inventory xx
Units to be produced xx

Sample problem:

Assume that the ending inventory is 15% of the next quarter’s sales and that the ending inventory for the fourth The desired ending inventory according to the problem is
quarter is 200 units. 15% of the next quarter’s sales. The ending inventory of
the 1st quarter is computed as follows: 1,050 (sales of
1 2 3 4 Total 2nd quarter) multiplied by 15% which is 158. So the
Budgeted sales volume (given) 1,200 1,050 1,350 1,450 5,050 ending inventory of 2nd quarter is 3rd’s quarter’s sales
multiplied by 15%, and so on.
Add: Desired ending inventory 158 203 218 200 200
Units available for sale 1,358 1,253 1,568 1,650 5,250
Less: Beginning inventory 180 158 203 218 180
Required production in units 1,178 1,095 1,365 1,432 5,070 The beginning inventory is the previous quarter’s ending
inventory. The beginning inventory of the 1st quarter is
the ending inventory of the previous quarter which is
DIRECT MATERIALS BUDGET assumed to be computed as follows, 1,200 (sales of 1st
quarter) multiplied by 15%.
The formula in computing the purchase is as follows:

Required production volume xx

Multiply materials allowed per unit of production xx
Materials needed in production xx
Add: desired ending inventory of materials xx
Total needs xx
Less: Beginning inventory of materials xx
Direct materials budget xx

Sample problem:

Assume that the ending is 15% of the next quarter’s production needs; the ending materials inventory for the
fourth quarter is 600 units; and 75% of each quarter’s purchases are paid in that quarter, with the remainder to be
paid in the following quarter. Also, 3 pounds of materials are needed per unit of product at a cost of P3 per pound.

1 2 3 4 Total
Required production volume 1,178 1,095 1,365 1,433 5,070 The computation of ending inventory has the same
process as mentioned above. Ex: the ending
multiply: Materials allowed per unit of production 3 3 3 3 3
inventory of 1st quarter is computed as 3,285 (2nd
Materials needed in production 3,534 3,285 4,095 4,299 15,210 quarter’s production need) multiplied by 15%.
Add: Desired ending inventory of materials 493 614 645 600 600 Same goes with the beginning inventory. The
Total needs 4,027 3,899 4,740 4,899 15,810 beginning inventory of the 1st quarter is the last
Less: Beginning inventory of materials 530 493 614 645 530 quarter’s ending inventory, which is computed as
3,534 (1st quarter’s production needs) multiplied
Direct materials to be purchased 3,497 3,406 4,126 4,254 15,280 by 15%.
Multiply: Unit price of the materials 3 3 3 3 3
Total purchases (purchase cost) 10,490 10,219 12,378 12,762 45,840

To get the total cash payments for purchases, the computation is as follow:

1 2 3 4
Total purchases (purchase cost) 10,490 10,219 12,378 12,762
Expected Cash Disbursement:
75% 7,867 7,664 9,284 9,572
25% 2,623 2,555 3,094
Total Cash Disbursement 7,867 10,287 11,839 12,666

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 Total Cash Disbursement 7,867 10,287 11,839 12,666

DIRECT LABOR BUDGET

Formula for the direct labor cost:

Units to be produced xx
Multiply by the direct labor hours per unit xx
Number of hours required xx
Multiply by the direct labor cost per hour xx
Total direct labor cost xx

Sample problem:

CBA Merchandising’s per unit of production requires 6 hours of labor. The laborers are paid with an hourly rate of
P8.

1 2 3 4 Total
Units to be produced 1,178 1,095 1,365 1,433 5,070
Multiply: Direct labor hours per unit 6 6 6 6 6
Total hours 7,068 6,570 8,190 8,598 30,420
Multiply: Direct labor cost per hour 8 8 8 8 8
Total direct labor cost 56,544 52,560 65,520 68,784 243,360

FACTORY OVERHEAD BUDGET

Formula for FOH:

Direct labor hours xx

Multiply by variable overhead rate xx
Budgeted variable overhead xx
Add: Budgeted fixed cost xx
Budgeted factory overhead xx
Less: Non-cash expenses xx
Cash payments for the overhead xx

Sample problem:

CBA Merchandising determined that the quarterly variable factory overhead rate is at P3.50 of the quarterly direct
labor hours. The fixed factory overhead is budgeted at P15,000 per quarter. The depreciation expense per quarter
is P12,500. Factory overhead costs are paid in the quarter when they are incurred.

1 2 3 4 Total
Direct labor cost per hour 7,068 6,570 8,190 8,598 30,420
Multiply: variable overhead rate 3.50 3.50 3.50 3.50 3.50
Budgeted variable overhead 24,738 22,995 28,665 30,093 106,470
Add: Budgeted fixed overhead 15,000 15,000 15,000 15,000 60,000
Budgeted factory overhead 39,738 37,995 43,665 45,093 166,470
Less: Non-cash expense
Depreciation 12,500 12,500 12,500 12,500 50,000
Cash payment for the overhead 27,238 25,495 31,165 32,593 116,470

ENDING INVENTORY BUDGET

Formula to determine the unit cost of the unsold units, the formula is as follows:

Direct Materials
Unit cost of direct materials xx
Multiply: Raw materials per unit of production xx
Total unit cost of direct materials xx
Direct Labor
Labor rate per hour xx
Multiply: Direct labor hours per unit of production xx

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 Multiply: Direct labor hours per unit of production xx
Total unit cost of direct labor xx
Variable Factory Overhead
Predetermined variable overhead rate xx
Multiply: Direct labor hours per unit of production xx
Total unit cost of variable factory overhead xx
Total Variable Manufacturing Cost xx

Sample Problem:

The following information provides the firm's total variable manufacturing cost per unit of production.

Direct Materials
Unit cost of direct materials P3.00
Multiply: Raw materials per unit of production x3
Total unit cost of direct materials P9.00
Direct Labor
Labor rate per hour P8.00
Multiply: Direct labor hours per unit of production x6
Total unit cost of direct labor 48.00
Variable Factory Overhead
Predetermined variable overhead rate P3.50
Multiply: Direct labor hours per unit of production x6
Total unit cost of variable factory overhead 21.00
Total Variable Manufacturing Cost P78.00

Ending Inventory Budget

Units Unit Costs Total
Direct Materials 600 P3.00 P1,800.00
Finished Goods 200 P78.00 P15,600.00

Note: The 600 units of direct materials came from the given information of materials ending inventory in direct
materials budget. And the 200 units of finished goods came from the given inventory in production budget.

SELLING AND ADMINISTRATIVE EXPENSE BUDGET

Formula for budgeted selling and administrative expense:

Budgeted sales volume xx

Multiply: Variable selling and administrative expense rate per unit xx
Budgeted variable selling and administrative expense xx
Add: Fixed selling and administrative expense xx
Budgeted selling and administrative expense xx

Sample Problem:
The variable selling and administrative expense of CBA Merchandising amounts to P6 per unit of sales, including sales
commission, freight, and office supplies. The fixed selling and administrative expense amounts to P12,000 per quarter.
The expenses are paid in the same quarter when they are incurred.

1 2 3 4 Total
Budgeted sales volume 1,200 1,050 1,350 1,450 5,050
Multiply: Variable selling and administrative expense rate per unit P6.00 P6.00 P6.00 P6.00 P6.00
Budgeted variable selling and administrative expense P7,200 P6,300 P8,100 P8,700 P30,300
Add: Fixed selling and administrative expense P12,000 P12,000 P12,000 P12,000 P12,000
Budgeted selling and administrative expense P19,200 P18,300 P20,100 P20,700 P78,300

References:
Fundamentals of Financial Management by Ma. Flordeliza L. Anastacio
Financial Management by Ferdinand L. Timbang, CPA, MBA
https://www.myaccountingcourse.com/accounting-dictionary/master-budget
https://www.coursehero.com/file/13843806/PPA-603-Public-Budgeting/#:~:text=Both%20budgeting%20and%20financial%
20reporting%20is%20necessary%20for%20effective%20decision%20making.&text=Budgeting%20and%20financial%20reporting%
20are,needed%20for%20the%20budgeting%20process.

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Chapter 5 - Preparation of Master Budget 2
Learning Objectives
Upon finishing this lecture, you are expected to:
1. Know and explain the basic concept involving financial forecasting, corporate planning and budgeting.
2. Explain what are the pro-forma financial statements.
3. Construct a master budget.

Introduction and Core Values Integration

Budgeting is part of every organization. A budget serves as a financial plan that shows the revenues and expenditures of
an organization. A budget is supposed to provide a clear picture on how organizations will be using their financial
resources. Budgeting is a process that allows organizations both public and private, to see what financial resources need
to be allocated in order to achieve organizational goals and objectives. Budgeting involve the process of examining past
financial information to see how resources have been used in the past and what goals and objectives were met.

To be able to achieve the goals of organizations, its members should be one with its objectives and engage themselves
with competence and accountability, treating the organization as their own, and wanting it to succeed as they want
themselves to.

Aside from the fact that we, the Wesleyan University - Philippines as a whole, wants you to learn how to be the best
finance and accounting people out there, we want to remind you first to be a good servant of God and conquer the
world with integrity and credibility with so much wisdom from God in every decision you will make.

Cash Budget
One of the final stages in the preparation of a budget is making the cash budget. A cash budget is an estimation of the
cash flows for a business over a specific period of time. This budget is used to assess whether the entity has sufficient
cash to operate.

The cash budget is composed of four major sections:

1. The cash receipts section lists all the cash inflows, except for financing, during the covered period of the budget.
Cash receipts start with the beginning balance where the cash collections from sales are added.
2. The cash payments section consists of all cash outflows in the budget period. Included in the cash payments are
direct material purchases, direct labor, factory overhead, and other cash payments.
3. The cash surplus or deficit section simply shows the difference between the cash receipts section and the cash
payments section. This section indicates if the firm needs to borrow funds to support the operations of the
company or use the excess money for paying their obligations or investing in other profitable activities.
4. The financing section shows the borrowings and payments made by the company.

How a Cash Budget Works

Companies use sales and production forecasts to create a cash budget, along with assumptions about necessary
spending and accounts receivable collections. A cash budget is necessary to assess whether a company will have enough
cash to continue operations. If a company does not have enough liquidity to operate, it must raise more capital by
issuing stock or taking on more debt.

A cash roll forward computes the cash inflows and outflows for a month, and it uses the ending balance as the beginning
balance for the following month. This process allows the company to forecast cash needs throughout the year, and
changes to the roll forward adjust the cash balances for all future months.

Sample Problem:

To prepare the cash budget of CBA Merchandising, further assume the following information:
1. The cash balance at the beginning of the first quarter is P10,000.
2. The management desires to maintain a P10,000 minimum cash balance at the end of each quarter.
3. CBA Merchandising has a credit line with RCBC that enables it to borrow at an interest rate of 12% per year. All
borrowings and repayments must be in multiples of P1,000 and take place at the beginning and at the end of each
quarter, respectively.
4. Additional equipment amounting to P25,000 is to be acquired in the third quarter
5. The board of directors approved a cash dividend of P1,500 per quarter.
6. The income tax payable amounting to P6,000 was paid in March of the period.

Answer:
CBA Merchandising
Cash Budget
For the year ended Dec. 31, 20xx

Q1 Q2 Q3 Q4 Total

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 Q1 Q2 Q3 Q4 Total
Cash balance, beginning P10,000 10,251 10,459 10,295 P10,000
Add: Cash receipts
Accounts receivable collections 93,600 125,100 143,100 161,700 523,500
Total cash available 103,600 135,351 153,559 171,995 533,500
Less:
Direct materials 7,867 10,287 11,839 12,666 42,659
Direct labor 56,544 52,560 65,520 68,784 243,408
Factory overhead 27,238 25,495 31,165 32,593 116,491
Selling and administrative expense 19,200 18,300 20,100 20,700 78,300
Purchase of equipment 25,000 25,000
Cash dividend 1,500 1,500 1,500 1,500 6,000
Income tax payment 6,000 6,000
Total cash payments 118,349 108,142 155,124 136,243 517,858
Cash surplus (deficit) (14,749) 27,209 (2,435) 35,752 46,687 This is to cover the cash
Financing deficit of each quarter and
maintain a minimum cash of
Borrowing 25,000 9,000 22,000 56,000 P10,000.
Repayment (25,000) (9,000) (22,000) (56,000)
Interest (750) (270) (660) (1,680)
Total Financing 25,000 (16,750) 12,700 (22,660) (1,680) The interest is computed
Cash balance, ending P10,251 P10,459 P10,295 P13,092 P13,092 based on the interest rate
and the period covered
before it is repaid.
Let's have another example:
In this particular problem,
it is computed as:
Albania Company expects its June sales to be P300,000, which is 25% higher than its May sales. Purchases were
For the Q1, ((25,000 x
P200,000 in May and are expected to be P240,000 in June. All sales are on credit and are collected as follows: 80% in the
12%)/4) since it is paid at
month of the sale and 20% in the following month. All payments in the month of sales are given 2% discount. Sixty
the end of the quarter.
percent of purchases are paid in the month of purchase to take advantage of purchase term of 1/10, n/40. The
remaining amount is paid in the following month. The beginning cash balance on June 1 is P20,000. The ending cash
balance on June 30 would be:

References:
Financial Management by Ferdinand L. Timbang, CPA, MBA
Fundamentals of Financial Management by Ma. Flordeliza L. Anastacio
https://www.investopedia.com/terms/c/cashbudget.asp

Financial Management Page 7