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Master budget for merchandising firm

cost and management accounting (Addis Ababa University)

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Cost and management accounting II

Chapter Two
2. Master Budget
2.1 Describing components of master Budget
Master Budget is the most widely used accounting tool for planning and
controlling and organizations activates.
The major par of master budget are operating budget and 昀椀nancial
budget
A- Operating budget:- it consists of the following component
i- sales budget:- accompanied by schedule of cash collection
from sales
ii- Purchase budget: accomplished by schedule of cash
disbursement to purchase.
iii-Cost of goods sold budget
iv- Operating expense budget:- accompanied by schedule of
cash disbursement for operating expenses.
v- Budgeted income statement
B. Financial budget:- it consists of the following components
i- capital budget
ii- Cash budget
iii- Budgeted balance sheet
N.B. In addition to the above budgets and schedules, the company may
prepare other budgets as ending inventory budget, Material, Labor,
and other budgets.
- The relationship between the master budget’s components can be
presented as follows.
Sales budget

Budgeted end Purchase budget

Operating budget Cost of goods sold budget

Operating expense budget

Budgeted income

Financial budget Capital Cash Budgeted

Budget Budget balance sheet

2.1 Operating budgets or (pro昀椀t plan) is a major port of master

budget that focuses on the income statement and its supporting
schedules.
Steps in preparing the master budget

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Cost and management accounting II

Step 1: Prepare the following detailed schedules for each of the months
of the planning period.
a. Sales budget
b. Cash collection from customer
c. Purchase budget
d. Disbursement for purchase
e. Operating expense budget
f. Disbursement for operating expense
Step 2:- using the above schedule prepare a budgeted income statement
NB- step 1 and 2 are used to prepare operating budget
Step 3:- prepare the following forecasted 昀椀nancial statements
a. Cash budget including details of borrowings, repayment and
interest for each month of the planning period.
b. Budgeted balance sheet as of end of the planning period.

Example
Use the following data to prepare the operating budget
The data are gathered from Cooking Hut Company (CHC) local retailer
For simplicity purpose, the planning period is only for four months. April
through July 2008.
The sale on march was Br. 40,000 the following monthly sales are
forecasted as follows.
April ----------------------------br 50,000
May ----------------------------- 80,000
June ----------------------------- 60,000
July ----------------------------- 50,000
August -------------------------- 40,000
Each item is sold at br. 5.
CHC expects 60% of sales is on cash and the remaining 40% on credit
All credit sales are collected one month after sales
March 31 A/R balance of Br. 16,000 (40% x 40,000)
Tax and uncollectible expense are ignored.
Average cost of goods sold is 70% of sales.
End inventory is 20,000 + 80% of the next months C.G.S.
A/P are paid as follows
50% in the month of purchase
50% in the next month of purchase
Wage & commission payables are paid semimonthly & are assumed to
be uniform each month.
Monthly 昀椀xed wage is br.2,500
Commissions 15% of sales.
CHC buys 昀椀xtures for br. 3,000 in April.
The followings are monthly expenditures
Miscellaneous expense 50% sales paid as incurred
Rent 2,000 paid as incurred
Insurance 200 expired per month
Depreciation including new furniture 500 per month.
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Cost and management accounting II

CHC wants a minimum cash balance of br. 10,000.

- Borrowing & repayment is made in multiples of 1,000.
- Borrowing occurs at the beginning of the month whereas
prepayment is at the end.
- Interest rate is 18%
- The following is the beginning balance sheet for the month of April.
The Cooking Hut Company
Balance Sheet
March 31, 2005
Asset
Cash ------------------------------------------------------------------- 10,000
A/R, net (0.4 X 40,000 march sales ------------------------------ 16,000
Inventory 20,000 + 0.8 (0.7X 50,000) -------------------------- 48,000
Unexpired insurance ----------------------------------------------- 1,800
Equipments, 昀椀xture and others ---------------------- 37,000
Lass Accumulated depn ----------------------------- (12,800) 24,200
Total assets
100,000
Liabilities $ owners equity
A/P (0.5 x march’s purchase 33,000) 16,800
Accrued wage and commission payable 4,250
Owners equity 78,950
Total liability & owner’s equity 100,000

Step 1. Preparing schedules that is accompanied with the budgeted

income statement
a. Sales budget is a formal plan that sets provides the 昀椀rm’s anticipated
sales in quantities and in Birr for the coming year on the bases of
sales forecast.
- It is the base for making other forecasts
Schedule – a
April May June Total
March July
Budgeted sales (unit) 10,000 16,000 12,000
8,000 10,000
Budgeted selling price Br. 5 Br. 5 Br. 5 240,00
br. 5 Br. 5 0
Total sales 50,000 80,000 60,000
40,00 50,000
Credit sales 40% 20,000 32,000 24,000 96,000
16,000 20,000 144,00
Cash sales 60% 30,000 48,000 36,000 0
24,000 30,000

Schedule B: Cash Collection budget

Credit sales 4% 16,000 20,000 32,000 24,000
20,000

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Cost and management accounting II

Cash sales 60% 24,000 30,000 48,000 36,000

30,000
Total sales 40,000 50,000 80,000 60,000
50,000 240,000
Cash collection
Cash sales in this month 30,000 48,000 36,000
30,000
Last month’s credit sales 16,000 20,000 32,000
24,000
Total collection 46,000 68,000 68,000 54,000
C. Merchandise purchase budget is a budget that is prepared by
adding desired ending inventory on and subtracting beginning
inventory from the budgeted cost-of-goods sold.

Schedule C
March April May June
July Total
End inv. (20,000 + 80% of Next c.g.s 48,000 64,800 53,600 48,000
42,400
Plus: Cost of goods sold (70% of sales) 28,000 35,000 56,000 42,000
35,000 168,000
Total good needed 76,000 99,800 109,600 90,000
77,400
Less beginning inventory 48,000 64,800 53, 600
48,000
Purchase 51,800 44,800 36,400
29,400 162,400

D. Disbursement for purchase

- This schedule is on the bases of the purchase budget.
- It includes i. 50% of the current month purchase and
ii. 50% of the previous month’s purchase

Schedule D Disbursement for purchases

March April May
June July
Purchase 33,600 51,800 44,800
36,400 29,400
Disbursement for purchases
50% of last month’s purchase 16,800 25,900
22,400 18,200
Plus 50% of this month’s purchase 25,900 22,400
18,200 14,700
Disbursement for purchase 42,700 48,300
40,600 32,900
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Cost and management accounting II

E. Operating expense budget

- The budgeting of operating expense depends on two factors
i- Change in sales volume (month –to month) eg. Sales volume, delivery
expenses
ii- Other cost driver activities. eg rent, insurance

Schedule E operating expense budget

March April May June July
Total
Wage (昀椀xed) 2,500 2,500 2,500 2,500 2,500
Commission (15% of monthly sales) 6,000 7,500 12,000 9,000
7,500
Total wage & commissions 8,500 10,000 14,500 11,500
10,000 54,500
Miscell. Exp (5% of monthly sales) 5,500 4,000 3,000
2,500 12,000
Rent (昀椀xed) 2,500 2,000 2,000 2,000
8,000
Insurance (Fixed) 200 200 200
200 800
Depreciation (昀椀xed 500 500 500
500 2,000
Total Operating Expense 15,200 21,200 17,200 15,200
68,800

F. disbursement for operating expense

- it is based on the operating budget
Schedule F
March April may June
July
Wage & commission expense 8,500 10,000 14,500 11,500
10,000
50% of the month 5,000 7,250 5,750
5,000
50% of last moths expense 4,250 5,000 7,250
5,750
Total wage and commission 9,250 12,200 13,000
10,750
Miscellaneous Expenses 2,500 4,000 3,000
2,500
Rent expense 2,000 2,000 2,000
2,000
Total disbursement 13,750 18,250 18,000
15,250

Step 2:- Preparing the budgeted income statement

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Step 1 a through F provides information to construct a budgeted income

statement. However, it can not be completed before the inclusion of
interest expense, which is computed after the cash budget, is prepared.
- It is used as a banc mark for jading management performance.
CHC Company
Budgeted income statement
For 4 months ended July 31, 2008
Source
Sales Sch-a 240,000
Cost of goods sold Sch-c (168,000)
Gross margin 72,000
Operating expense:-
Wage and commission Sch-e 46,000
Rent expanse Sch-e 8,000
Miscellaneous expense Sch-e 12,000
Insurance expense Sch-e 800
Depreciation expense Sch-e 2,000 (68,800)
Income from operation 3, 2000
Interest expense ?
Net income ?

Step 3 preparing 昀椀nancial Budget

a. Capital budget:- is a budget that details the planned expenditure
for faculties, equipment, new product and other long-term
investment.
- The preparation of capital budget is not covered by this course.
b. Cash budget:- it is a statement of planned cash receipts and
disbursements with in a speci昀椀c period of time.
- It help managers to avoid excessive cash on hand or cash
shortage.
The cash budget has the following major sections.
i- Total cash available before 昀椀nancing (Y)
It is the sum of the beginning cash balance and cash receipt.
- The cash receipt is taken form the cash collection schedule.
The total amount of each month’s collection is taken.
ii- Cash Disbursement (x)
a. Purchase:- the disbursement for purchase is taken from
schedule d
b. Payroll:- the wage and commission disbursement is taken
from schedule f
c. Some cost and expenses disbursements depend on their
agreement. Form example, rent, mortgage, miscellaneous
items,
- This payment is found form schedule f
d. Other disbursement includes outlay for 昀椀xed assets, long-term
investment, dividends and the links.
iii- Minimum cash balance(y)
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Cost and management accounting II

- Depending on the business nature, managers set this balance.

iv- Financing requirement (z)
- the amount of 昀椀nancing required depends on two factors
i. total cash available(w)
ii. Total cash needed (cash disbursement (x) & minimum cash
balance (y)
Therefore, if the total cash balance (w) is leas them the total cash
needed, borrowing is necessary.
V- Ending cash balance (w-x+z)
- It is computed by subtracting disbursements from total cash
available there by determining net cash balance and adding
昀椀nancing requirements or subtracting loan repayment on it
- The assumption is that when cash short occurs, seasonal borrowing
is made and when there is excess cash, it will be used for
repayment. This process is known as self liquidating.
CHC
Cash Budget
For 4 months ending July 31,2008
April May June July
Beginning cash balance 10,000 10,550 10,970
10,965
Add cash receipts:
Collections from customers (sale) 46,000 68,000
68,000 54,965
Total cash available bef. Fin (w) 56,000 78,000
78,970 64,965 Cash disbursements
Purchase (payment) 42,700 48,300
40,600 64,965
Operating expense 13,750 18,250
18,000 15,250
Purchase for 昀椀xture 3,000 -0- -0-
-0–
Total disbursements (x) 59,450 66,550
58,600 48,150
Minimum cash balance (y) 10,000 10,000
10,000 10,000
Less: total cash needed (69,450) (76,500)
(68,600) (58,150)
Net cash balance (de昀椀ciency) (13,450) (2,000)
10,370 6,815
Financing
Borrowing (at end of month) 14,000 -0- -0-
-0–
Repayment (at the end of month) -0- (1,000)
(9,000) (4,000)
Interest at 18 5 per year -0- (30)
(405) (240)

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Cost and management accounting II

Total cash inc. or dec. from 昀椀nancing (z) 14,000 (1,030)

(9,405) (4,240)
End of month cash balance (w-x + z) 10,550 10,970
10,965 12,575
Computations
End of month cash balance Interest
April 56,000 – 59, 450 + 14,000
= 10,550
May 78,550 – 66,550 (1,030 1,000 x 0.18 x 2/12 =
30
= 10,970
June 78,970 58,600 – 9,405 9,000 x 0.1 x 3/12 =
405
= 10,965
July 64,965 – 48,150 – 4,240 4,000 x 0.18 x
4/12 = 240
= 12,575

C - Budgeted balance sheet

It is the 昀椀nal step in preparing master budget. While preparing a budgeted
balance sheet, the beginning balance sheet is used as a base. It may
increase or decrease in light of the expected sash receipt and cash
payments and non-cash items operating on the income statement. Such
as prepaid insurance, equipments & properties
- After the preparation of master budget is completed, managers will
consider all the major 昀椀nancial statements as a basis for charging
undesired future events( eg. Cash shortage). Some of the changing
events could be
 Development of new sales strategies
 Adjusting the timing of cash receipts and disbursements.
- Therefore, the above all analysis indicate that the 昀椀rst draft of the
master budget is rarely become the 昀椀nal draft.
Important computations to construct the budgeted balance sheet.
1. Cash – beginning cash balance ------------------------------ 10,000
Add total cash receipts ------------------------------ 236,000
Borrowings ------------------------------- 14,000
Less total cash disbursements ---------------------- (232,750)
Repayments & interests -------------------- (14,675)
Ending cash balance ---------------------------------- 12,575 cash
budget
2. Account Receivable
- 40% soles is mad eon credit. The entire credit sale is collected in
the next month it is sold. Therefore, at July 31, 2007, none of the
credit sales for July will be collected and is account receivable
balance. 20,000 (0.4 x 50,000)
3. Merchandise inventory

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- End inventory is 20,000 plus 80% of the next month’s cost of goods
sold; therefore, the end inventory for July is computed as follows.
End inventory for July = 20,000 + 0.8 (0.7 x 40,000)
= 42,400
4. Unexpired (prepaid) insurance:-
Prepaid insurance as given on march 3, balance sheet was br. 1,800
the monthly insurance expense is br 200 for & months. Totaling br,
8000. Therefore, the end balance for July 31, is bro 1,000 (1,800-
800)
5. Plant asset and accumulated depreciation
The beginning balance for equipment, 昀椀xture & other was B br
37,000 which will increased by purchase for br, 14,8000 (12,800 +
2,000)
6. Account payable
- 50% of the monthly purchase price will be paid in the month the
purchase is made while the remaining is paid in the next month.
Therefore, the end balance for account payable is (29,400/2) =
14,700
7. Accrued wage and commission payable
- 50% of wage & commission incurred in a month will be paid in the
some month whereas the remaining is tin the next month. Those,
50% the waged commission expense incurred in July, will be
reported as payable is the balance sheet.
8. Owner’s equity
-It will increases by net income and decreases by dividend. Hence, the
owner’s equity balance as of July 31, is br 81,475 (78,950 + 2,525)

ABC Company
Budgeted balance sheet
As of July 51, 2007
Asset
Current asset
Cash (cash budget) 12,575
A/R net (0.4 x July sales 50,000) 20,000
Merchandise inventory (20,000 0.7 ( 0.8 x 40,000) 42,400
Prepaid insurance 1,000
75,975
Plant asset
Equipments, 昀椀xture and others 40,000
Accumulated depreciation (14,800) 25,200
Total asset
101,175
Liability & owner’s Equity
Current Liabilities
Account payable (0.5 x July 27,400purchase) 14,700
Accrued wages and commissions payable 5,000
19,700

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Cost and management accounting II

Owner’s equity (78,950 + 2, 552)

81,475
Total liabilities an owners equity
101,175

Illustration
ZYZ Company is a retail outlet for various products. The manager is
concerned to prepare a budget for the next quarter. He is so interested to
know the cash position so that he may need to borrow money to 昀椀nance
purchases. He has gathered all data necessary to prepare budget.
In addition.
- Equipment will be purchased in April for br. 19,750 cash and
dividend of br. 4,000 will be paid in June.
- The master budget is prepared for the month of April, May & June.
- Both borrowing & repayment occurs at the end of the month
- Interest is also paid at the end of a month at 12% annual rate on
the amount of the payable outstanding during the month.
XYZ Company
Balance sheet
As march 31, 2007
Asset Liability
& equity
Cash --------------------------- 9,000 Interest payable ------------------ 0
A/R --------------------- ----- 48,000 Notes payable ------------------ 0
Inventory ------------------- 12,600 Account payable ------------
18,300
Plant & equipment ------ -200,000 Capital stock ---------------
180,000
Total Asset ------------- 269,600 Retained earning -----------
71,300
Total liab. & equity
269,600

Monthly budgeted expense

Wage and salary ------------------------------------------ 7,500
Fright out as a % age of sales----------------------------- 6%
Advertising expense ---------------------------------------- 6,000
Depreciation expense ------------------------------------ 2,000
Other expense as a % age of sales 4%
Budgeted sales
March (actual) 60,000 June 90,00
April 70,000 July 50,00
May 85,000

- Required minimum cash balance 90,000

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Cost and management accounting II

- Minimum and inventory policy as a % age of next Mont’s C/G.S

30%
- Cash sales is 20% while the remaining 80% is credit sales which will
be collected in the next month.
- Gross pro昀椀t rate is 40%
- 50% of purchase is paid in the month of purchase the remaining
50% is paid in the next month.

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