Chapter 22
The Master
Budget and
Responsibility
Accounting
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 1 of 23
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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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How Managers Use Budgets
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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Benefits of Budgeting
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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Performance Report
• Identifies areas where the actual results
differed from the budget
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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Master
Budget
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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S22-2: UNDERSTANDING THE COMPONENTS OF THE MASTER
BUDGET
The following are some of the components
included in the master budget.
1.
a.
b.
c.
d.
e.
f.
Budgeted balance sheet
Sales budget
Capital expenditures budget
Budgeted income statement
Cash budget
Inventory, purchases, and cost of goods
sold budget
g. Budgeted statement of cash flows
List in order of preparation the items of the
master budget.
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
______
B
2. ______
F
3. ______
D
4. ______
C
5. ______
E
6. ______
A
7. ______
G
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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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 9 of 23
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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 10 of 23
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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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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)
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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Operating Expense Budget
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 14 of 23
The Budgeted Income Statement
• Prepared after sales budget, cost of goods sold
budget and operating expense budget
17
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 17 of 23
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.
Sales price per pair
Number of pairs
Total sales
Grippers
Sales Budget
January
February
Total
$
180
$
190
× 8,500
× 3,500
$1,530,000
$665,000 $2,195,000
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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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
($10,000 + 0.50× 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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 19 of 23
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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 20 of 23
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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 21 of 23
Budgeted Cash Collections from
Customers
• Cash collections from customers
– Cash sales from the sales budget
– Collections of prior month’s credit sales
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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•
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%
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 24 of 23
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.
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 25 of 23
Budgeted
Balance
Sheet
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 26 of 23
Budgeted Statement of Cash
Flows
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 28 of 23
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 $425,000.
50% 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.
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 29 of 23
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
18% of sales two months ago
Total cash collections
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
127,500
72,000
$ 964,500
459,000
76,500
$ 868,000
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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
Total cash payments
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
329,250
$ 622,500
259,650
$ 588,900
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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?
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 32 of 23
S22-7: PREPARING A FINANCIAL BUDGET
Grippers
Cash Budget
January and February 2012
January
Beginning cash balance
$ 12,500
Cash collections from customers
1,077,600
Cash available
1,090,100
Cash payments
Purchases of inventory
622,500
Operating expenses
65,300
Total cash payments
687,800
Ending cash balance
402,300
Less: Minimum cash balance desired
(10,000)
Cash excess (deficiency)
$ 392,300
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
February
$ 402,300
827,400
1,229,700
588,900
56,650
645,550
584,150
(10,000)
$ 574,150
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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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 34 of 23
Sensitivity Analysis and Rolling Up
Unit Budgets
• Sensitivity analysis
– 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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 35 of 23
Rolling Up Individual Budgets
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 36 of 23
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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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S22-9: USING SENSITIVITY ANALYSIS IN BUDGETING
Maplehaven Sporting Goods Store has the following sales
budget:
Riverbed Sporting Goods Store
Sales Budget
April - July
Cash sales, 80%
Credit sales, 20%
Total sales, 100%
April
$40,800
10,200
$51,000
May
$64,000
16,000
$80,000
June
$51,200
12,800
$64,000
July
$40,800
10,200
$51,000
April-July
Total
$246,000
Suppose June sales are expected to be $80,000 rather than
$64,000.
Riverbed Sporting Goods Store
Revised Sales Budget
April - July
Cash sales, 80%
Credit sales, 20%
Total sales, 100%
April
$40,800
10,200
$51,000
May
$64,000
16,000
$80,000
June
$64,000
16,000
$80,000
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
July
$40,800
10,200
$51,000
April-July
Total
$262,000
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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 decisionmaking authority and accountability
• Four types:
–
–
–
–
Cost center
Revenue center
Profit center
Investment center
• Decentralization highlights the need for reports
on individual segments
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 39 of 23
Responsibility Centers
Goal is to
control cost
Goal is to
increase
revenues
Goal is to
increase
profits
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Goal is to
increase ROI,
EVA, &
residual
income
Slide 40 of 23
Partial Organization Chart
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 41 of 23
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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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Example
• Traceable service costs = $30,000
• Base is number of orders
• $30,000 / $400,000 equals $0.075 cost per
order
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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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
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 47 of 23
Responsibility Accounting Reports
• Show the results of the segment or division for which a
particular manager is responsible
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
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