Accounting: The Language of Business - Vol. 1 (Part 131)

"I don't have any use for bodyguards, but I do have a specific use for two highly trained certified public accountants."

—Elvis Presley

 Budgeting  (Part D)

by

Charles Lamson

Master Budget

Manufacturing operations require a series of budgets that are linked together in a master budget. The major parts of the master budget are as follows:

Exhibit 6 shows the relationship among the income statement budgets. The budget process begins by estimating sales. The sales information is then provided to the various units for estimating the production and selling and administrative expenses budgets. The production budgets are used to prepare the direct materials purchases, direct labor cost, and factory overhead cost budget. These three budgets are used to develop the cost of goods sold budget. Once these budgets and the selling and administrative expenses budget have been completed, the budgeted income statement can be prepared, as we illustrate in the following section.

EXHIBIT 6 Income Statement Budgets

After the budgeted income statement has been developed, the budgeted balance sheet can be prepared. Two major budgets comprising the budgeted balance sheet are the cash budget and the capital expenditure budget, which we illustrate later.

Income Statement Budgets

In the following sections, we will illustrate the major elements of the income statement budget. We will use a small manufacturing business, Elite Accessories Inc., as the basis for our illustration.

Sales Budget

The sales budget normally indicates for each product (1) the quantity of estimated sales and (2) the expected unit selling price. These data are often reported by regions or by sales representatives.

In estimating the quantity of sales for each product, past sales volumes are often used as a starting point. These amounts are revised for factors that are expected to affect future sales, such as the factors listed below.

• backlog of unfilled sales orders

• planned advertising and promotion

• expected industry and general economic conditions

• productive capacity

• projected pricing policy

• findings of market research studies

Once an estimate of the sales volume is obtained, the expected sales revenue can be determined by multiplying the volume by the expected unit sales price. Exhibit 7 is the sales budget for Elite Accessories Inc.

EXHIBIT 7 Sales Budget

For control purposes management can compare actual sales and budgeted sales by product, region, or sales representative. Management would investigate any significant differences and take possible corrective actions.

Production Budget

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. The budgeted volume of production is determined as follows:

Exhibit 8 is the production budget for Elite Accessories Inc.

EXHIBIT 8 Production Budget

Direct Materials Purchases Budget

The production budget is the starting point for determining the estimated quantities of direct materials to be purchased. Multiplying these quantities by the expected unit purchase price determines the total cost of direct materials to be purchased.

In Elite Accessories Inc.'s production operations, leather and lining are required for wallets and handbags. The quantity of direct materials expected to be used for each unit of product is as follows:

Based on these data and the production budget, the direct materials purchases budget is prepared. As shown in the budget in Exhibit 9, for Elite Accessories Inc. To produce 520,000 wallets, 156,000 square yards (520,000 units * 0.30 square yard per unit) of leather are needed. Likewise, to produce 292,000 handbags, 365,000 square yards (292,000 units * 1.25 square yards per unit) of leather are needed. We can compute the needs for lining in a similar manner. Then adding the desired ending inventory for each material and deducting the estimated beginning inventory determines the amount of each material to be purchased. Multiplying these amounts by the estimated cost per square yard yields the total materials purchase cost.

EXHIBIT 9 Direct Materials Purchases Budget

The direct materials purchases budget helps management maintain inventory levels within reasonable limits. For this purpose, the timing of the direct materials purchases should be coordinated between the purchasing and production departments. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 878-882*

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