1. The Master Budget and Responsibility Accounting
Chapter 22
The Master Budget and Responsibility Accounting

2. Why Managers Use Budgets
To plan and control actions and the related revenues and expenses
To incorporate management’s strategic and operational plans
Planning technology upgrades
Planning capital asset replacements, improvements, or expansions
Compare actual results with budgeted amounts to determine corrective actions

3. How Managers Use Budgets

4. Benefits of Budgeting

5. Performance Report
Identifies areas where the actual results differed from the budget

6. Steps Managers Take To Prepare A Budget
Master budget—the set of budgeted financial statements and supporting schedules for the entire organization
Budget includes three types of budgets:
The operating budget
Projects sales revenue, cost of goods sold, and operating expenses
The capital expenditures budget
The plan for purchasing property, plant, equipment, and other long-term assets
The financial budget
Plans for raising cash and paying debts
Contain projected amounts, not actual amounts

7. Master Budget

8. S22-2: Understanding the components of the master budget
The following are some of the components included in the master budget.
Budgeted balance sheet
Sales budget
Capital expenditures budget
Budgeted income statement
Cash budget
Inventory, purchases, and cost of goods sold budget
Budgeted statement of cash flows
List in order of preparation the items of the master budget.
______ B F D C E A G

9. Prepare an operating budget
First three components
Sales budget
Inventory, purchases, and cost of goods sold budget
Operating expenses
Feed into the budgeted income statement

10. Sales Budget Cornerstone of master budget
Level of sales affect all other elements
Projected sales are calculated as:
Each product multiplied by expected units sold

11. Inventory, Purchases, and Cost of Goods Sold Budget
Budget determines:
Cost of goods sold for the budgeted income statement
Ending inventory for the budgeted balance sheet
Purchases for the cash budget
Familiar equation is used
Beginning inventory + Purchases – Ending inventory = Cost of goods sold
Rearrange equation to solve for unknowns
Purchases = Cost of goods sold + Ending inventory – Beginning inventory

12. Inventory, Purchases, and Cost of Goods Sold Budget
70% cost of goods sold figure uses sales budget created earlier
Desired ending inventory is derived from company policies
Desired ending inventory becomes beginning inventory for next period (month, quarter, or year)

13. Operating Expense Budget
Prepared after sales budget and cost of goods sold budget
Shows estimated expenses for the period
Includes fixed and/or variable expenses
Examples:
Fixed and variable salaries, commissions
Rent
Insurance
Advertising
Miscellaneous
Look at prior income statements

14. Operating Expense Budget

15. Budgeted Income Statement

16. Budgeted Income Statement

17. The Budgeted Income Statement
Prepared after sales budget, cost of goods sold budget and operating expense budget

18. S22-3: Preparing an operating budget
Grippers sells its rock-climbing shoes worldwide. Grippers expects to sell 8,500 pairs of shoes for $180 each in January, and 3,500 pairs of shoes for $190 each in February. All sales are cash only.
Prepare the sales budget for January and February.
Grippers
Sales Budget
January
February
Total
Sales price per pair $ $
Number of pairs
× 8,500
× 3,500
Total sales
$1,530,000
$665,000
$2,195,000

19. S22-4: Preparing an operating budget
Review your results from S22-3. Grippers expects cost of goods sold to average 60% of sales revenue, and the company expects to sell 4,100 pairs of shoes in March for $260 each. Grippers’ target ending inventory is $10,000 plus 50% of the next month’s cost of goods sold.
Use this information and the sales budget prepared in S22-3 to prepare Grippers’ inventory, purchases, and cost of goods sold budget for January and February.
Grippers
Inventory, Purchases, and Cost of Goods Sold Budget
January
February
Cost of goods sold
(0.60 × sales from S 21-3)
$ 918,000
$ 399,000
+ Desired ending inventory
($10, × Cost of goods
sold for next month)
209,500
329,800
= Total inventory required
1,127,500
728,800
− Beginning inventory
(469,000)
(209,500)
= Purchases
$ 658,500
$ 519,300

20. Financial Budget Cash budget Project cash receipts and payments
Budgeted balance sheet
Project each asset, liability, and stockholders’ equity account
Budgeted statement of cash flows
Project cash flows from operating, investing, and financing activities

21. Cash Budget Statement of budgeted cash receipts and payments
Details how to go from the beginning cash balance to the desired ending balance
Four major parts:
Cash collections from customers
Cash payments for purchases
Cash payments for operating expenses
Cash payments for capital expenditures
Depends on operating budget

22. Budgeted Cash Collections from Customers
Cash sales from the sales budget
Collections of prior month’s credit sales

23. Budgeted Cash Payments for Purchases
Payments for operating expenses
Payments during the month of purchase—assume 50%
Payments following the month of purchase—assume 50%
x 50%

24. Budgeted Cash Payments for Operating Expenses
Use the operating expenses budget and payment information to compute cash payments for operating expenses
Payment of 50% of current month’s salary and commissions
Payment of 50% of prior months salary and commissions
Payment for rent and miscellaneous expenses in the same month
Depreciation is a non-cash expense
Insurance was prepaid in the prior quarter

25. The Cash Budget
8. Greg’s plans to purchase a used delivery truck in April for $3,000 cash.
9. Greg’s requires a minimum cash balance of $10,000 before financing at the end of each month.

26. Budgeted Balance Sheet

27. Budgeted Statement of Cash Flows

28. Getting Employees to Accept the Budget
Most important part of the budgeting system
Getting managers and employees to accept the budget
Managers must motivate employees to accept the budget’s goals
How?
Managers must support the budget themselves, or no one else will
Managers must show employees how budgets can help them achieve better results
Managers must have employees participate in developing the budget
Do not build in slack–becomes less accurate

29. S22-5: Preparing a financial budget
Refer to the Grippers sales budget that you prepared in S22-3. Now assume that Grippers’ sales are collected as follows: November sales totaled $400,000 and December sales were $425, % in the month of the sale 30% in the month after the sale 18% two months after the sale 2% never collected Prepare a schedule for the budgeted cash collections for January and February. Round answers to the nearest dollar.

30. S22-5: Preparing a financial budget
Grippers
Budgeted Cash Collections from Customers
January
February
Cash sales (50% of current month )
$ 765,000
$ 332,500
Collection of sales:
30% of prior month credit sales
127,500
459,000
18% of sales two months ago
72,000
76,500
Total cash collections
$ 964,500
$ 868,000

31. S22-6: Preparing a financial budget
Refer to the Grippers inventory, purchases, and cost of goods sold budget your prepared in S22-4. Assume Grippers pays for inventory purchases 50% in the month of purchase and 50% in the month after purchase. Prepare a schedule for the budgeted cash payments for purchases for January and February.
Grippers
Budgeted Cash Payments for Purchases
January
February
50% of last month
$ 293,250
$ 329,250
50% of current month
329,250
259,650
Total cash payments
$ 622,500
$ 588,900

32. S22-7: Preparing a financial budget
Grippers has $12,500 in cash on hand on January 1. Refer to S22-5 and S22-6 for cash collections and cash payment information. Assume Grippers has cash payment for operating expenses including salaries of $50,000 plus 1% of sales, all paid in the month of sale. The company requires a minimum cash balance of $10,000. Prepare a cash budget for January and February. Will Grippers need to borrow cash by the end of February?

33. S22-7: Preparing a financial budget
Grippers
Cash Budget
January and February 2012
January
February
Beginning cash balance
$ 12,500
$ 402,300
Cash collections from customers
1,077,600
827,400
Cash available
1,090,100
1,229,700
Cash payments
Purchases of inventory
622,500
588,900
Operating expenses
65,300
56,650
Total cash payments
687,800
645,550
Ending cash balance
402,300
584,150
Less: Minimum cash balance desired
(10,000)
Cash excess (deficiency)
$ 392,300
$ 574,150

34. Using Information Technology for Sensitivity Analysis and Rolling Up Unit Budgets
Technology makes it more cost-effective for managers to:
Conduct sensitivity analysis on their own unit’s budget
Combine individual unit budgets to create the companywide master budget
Master budget models the company’s planned activities
Must support key strategies

35. Sensitivity Analysis and Rolling Up Unit Budgets
What-if technique that determines the result if predicted amounts differ from those budgeted
Spreadsheet programs used for budgeting make sensitivity analysis cost-effective
What-if budget questions easily changed within Excel with a few keystrokes
Makes it cost-effective to perform more comprehensive sensitivity analyses
Managers react quickly if key assumptions underlying the master budget (such as sales price or quantity) turn out to be wrong

36. Rolling Up Individual Budgets

37. Rolling Up Individual Budgets
Individual operating units roll up budgets to prepare company-wide budget
Budget management software is used
Often part of Enterprise Resource Planning (ERP) system
Allows management to conduct sensitivity analysis on unit data
Managers can spend less time compiling and summarizing data and more time analyzing it

38. S22-9: Using sensitivity analysis in budgeting
Maplehaven Sporting Goods Store has the following sales budget: Suppose June sales are expected to be $80,000 rather than $64,000.
Riverbed Sporting Goods Store
Sales Budget
April - July
April
May
June
July
April-July
Total
Cash sales, 80%
$40,800
$64,000
$51,200
Credit sales, 20%
10,200
16,000
12,800
Total sales, 100%
$51,000
$80,000
$246,000
Riverbed Sporting Goods Store
Revised Sales Budget
April - July
April
May
June
July
April-July
Total
Cash sales, 80%
$40,800
$64,000
Credit sales, 20%
10,200
16,000
Total sales, 100%
$51,000
$80,000
$262,000

39. Responsibility Accounting
A system for evaluating the performance of each responsibility center and its manager
A responsibility center is the part of the organization for which a particular manager is responsible
Is a part of the organization for which a manager has decision-making authority and accountability
Four types:
Cost center
Revenue center
Profit center
Investment center
Decentralization highlights the need for reports on individual segments

40. Responsibility Centers
Goal is to control cost
Goal is to increase revenues
Goal is to increase profits
Goal is to increase ROI, EVA, & residual income

41. Partial Organization Chart

42. Responsibility Accounting Performance Reports
Performance reports compare budgeted and actual amounts
Reporting at all levels:
Division (investment centers)
Product lines (profit centers)
Production (cost centers)
Sales (revenue centers)
Management by exception
Shows variances between actual and budgeted amounts

43. Learn about Service Departments
Departments that provide services to multiple departments or divisions for the company
Usually do not generate revenues
Similar to the shared production overhead
Nonproduction related service departments
Examples:
Payroll and Human Resources
Accounting
Copying/Graphic Services
Physical Plant (repairs and maintenance)
Advertising (companywide, not specific products)
Mail and Shipping Services
Shared Facilities (meeting rooms used by various departments)
Legal Services
Travel Booking Services

44. Traceable Fixed Costs
Costs directly associated with an individual product, division, or business segment
Would disappear if the company discontinued the product , division or segment
Assigning traceable fixed costs
Splitting the cost equally–not fair
Based on use of the services–fair
Small users charged less
Larger users charged more
Identify cost drivers (ABC costing) suitable for assigning traceable service department charges
Common service departments listed on next slide

46. Example Traceable service costs = $30,000 Base is number of orders
$30,000 / $400,000 equals $0.075 cost per order

47. Example $30,000 / $400,000 equals $0.075 cost per order
Apply to divisions based upon number of orders
The DVD division can further split the traceable cost between Excel DVDs and Specialty DVDs
$10,500 - $3,500 known untraceable = $7,000
Calculate a cost per order as ($7,000/140,000) = $0.05

48. Responsibility Accounting Reports
Show the results of the segment or division for which a particular manager is responsible