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  1. Preface
  2. 1 Accounting as a Tool for Managers
    1. Why It Matters
    2. 1.1 Define Managerial Accounting and Identify the Three Primary Responsibilities of Management
    3. 1.2 Distinguish between Financial and Managerial Accounting
    4. 1.3 Explain the Primary Roles and Skills Required of Managerial Accountants
    5. 1.4 Describe the Role of the Institute of Management Accountants and the Use of Ethical Standards
    6. 1.5 Describe Trends in Today’s Business Environment and Analyze Their Impact on Accounting
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Thought Provokers
  3. 2 Building Blocks of Managerial Accounting
    1. Why It Matters
    2. 2.1 Distinguish between Merchandising, Manufacturing, and Service Organizations
    3. 2.2 Identify and Apply Basic Cost Behavior Patterns
    4. 2.3 Estimate a Variable and Fixed Cost Equation and Predict Future Costs
    5. Key Terms
    6. Summary
    7. Multiple Choice
    8. Questions
    9. Exercise Set A
    10. Exercise Set B
    11. Problem Set A
    12. Problem Set B
    13. Thought Provokers
  4. 3 Cost-Volume-Profit Analysis
    1. Why It Matters
    2. 3.1 Explain Contribution Margin and Calculate Contribution Margin per Unit, Contribution Margin Ratio, and Total Contribution Margin
    3. 3.2 Calculate a Break-Even Point in Units and Dollars
    4. 3.3 Perform Break-Even Sensitivity Analysis for a Single Product Under Changing Business Situations
    5. 3.4 Perform Break-Even Sensitivity Analysis for a Multi-Product Environment Under Changing Business Situations
    6. 3.5 Calculate and Interpret a Company’s Margin of Safety and Operating Leverage
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  5. 4 Job Order Costing
    1. Why It Matters
    2. 4.1 Distinguish between Job Order Costing and Process Costing
    3. 4.2 Describe and Identify the Three Major Components of Product Costs under Job Order Costing
    4. 4.3 Use the Job Order Costing Method to Trace the Flow of Product Costs through the Inventory Accounts
    5. 4.4 Compute a Predetermined Overhead Rate and Apply Overhead to Production
    6. 4.5 Compute the Cost of a Job Using Job Order Costing
    7. 4.6 Determine and Dispose of Underapplied or Overapplied Overhead
    8. 4.7 Prepare Journal Entries for a Job Order Cost System
    9. 4.8 Explain How a Job Order Cost System Applies to a Nonmanufacturing Environment
    10. Key Terms
    11. Summary
    12. Multiple Choice
    13. Questions
    14. Exercise Set A
    15. Exercise Set B
    16. Problem Set A
    17. Problem Set B
    18. Thought Provokers
  6. 5 Process Costing
    1. Why It Matters
    2. 5.1 Compare and Contrast Job Order Costing and Process Costing
    3. 5.2 Explain and Identify Conversion Costs
    4. 5.3 Explain and Compute Equivalent Units and Total Cost of Production in an Initial Processing Stage
    5. 5.4 Explain and Compute Equivalent Units and Total Cost of Production in a Subsequent Processing Stage
    6. 5.5 Prepare Journal Entries for a Process Costing System
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  7. 6 Activity-Based, Variable, and Absorption Costing
    1. Why It Matters
    2. 6.1 Calculate Predetermined Overhead and Total Cost under the Traditional Allocation Method
    3. 6.2 Describe and Identify Cost Drivers
    4. 6.3 Calculate Activity-Based Product Costs
    5. 6.4 Compare and Contrast Traditional and Activity-Based Costing Systems
    6. 6.5 Compare and Contrast Variable and Absorption Costing
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  8. 7 Budgeting
    1. Why It Matters
    2. 7.1 Describe How and Why Managers Use Budgets
    3. 7.2 Prepare Operating Budgets
    4. 7.3 Prepare Financial Budgets
    5. 7.4 Prepare Flexible Budgets
    6. 7.5 Explain How Budgets Are Used to Evaluate Goals
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  9. 8 Standard Costs and Variances
    1. Why It Matters
    2. 8.1 Explain How and Why a Standard Cost Is Developed
    3. 8.2 Compute and Evaluate Materials Variances
    4. 8.3 Compute and Evaluate Labor Variances
    5. 8.4 Compute and Evaluate Overhead Variances
    6. 8.5 Describe How Companies Use Variance Analysis
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  10. 9 Responsibility Accounting and Decentralization
    1. Why It Matters
    2. 9.1 Differentiate between Centralized and Decentralized Management
    3. 9.2 Describe How Decision-Making Differs between Centralized and Decentralized Environments
    4. 9.3 Describe the Types of Responsibility Centers
    5. 9.4 Describe the Effects of Various Decisions on Performance Evaluation of Responsibility Centers
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Exercise Set A
    11. Exercise Set B
    12. Problem Set A
    13. Problem Set B
    14. Thought Provokers
  11. 10 Short-Term Decision Making
    1. Why It Matters
    2. 10.1 Identify Relevant Information for Decision-Making
    3. 10.2 Evaluate and Determine Whether to Accept or Reject a Special Order
    4. 10.3 Evaluate and Determine Whether to Make or Buy a Component
    5. 10.4 Evaluate and Determine Whether to Keep or Discontinue a Segment or Product
    6. 10.5 Evaluate and Determine Whether to Sell or Process Further
    7. 10.6 Evaluate and Determine How to Make Decisions When Resources Are Constrained
    8. Key Terms
    9. Summary
    10. Multiple Choice
    11. Questions
    12. Exercise Set A
    13. Exercise Set B
    14. Problem Set A
    15. Problem Set B
    16. Thought Provokers
  12. 11 Capital Budgeting Decisions
    1. Why It Matters
    2. 11.1 Describe Capital Investment Decisions and How They Are Applied
    3. 11.2 Evaluate the Payback and Accounting Rate of Return in Capital Investment Decisions
    4. 11.3 Explain the Time Value of Money and Calculate Present and Future Values of Lump Sums and Annuities
    5. 11.4 Use Discounted Cash Flow Models to Make Capital Investment Decisions
    6. 11.5 Compare and Contrast Non-Time Value-Based Methods and Time Value-Based Methods in Capital Investment Decisions
    7. Key Terms
    8. Summary
    9. Multiple Choice
    10. Questions
    11. Exercise Set A
    12. Exercise Set B
    13. Problem Set A
    14. Problem Set B
    15. Thought Provokers
  13. 12 Balanced Scorecard and Other Performance Measures
    1. Why It Matters
    2. 12.1 Explain the Importance of Performance Measurement
    3. 12.2 Identify the Characteristics of an Effective Performance Measure
    4. 12.3 Evaluate an Operating Segment or a Project Using Return on Investment, Residual Income, and Economic Value Added
    5. 12.4 Describe the Balanced Scorecard and Explain How It Is Used
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Exercise Set A
    11. Exercise Set B
    12. Problem Set A
    13. Problem Set B
    14. Thought Provokers
  14. 13 Sustainability Reporting
    1. Why It Matters
    2. 13.1 Describe Sustainability and the Way It Creates Business Value
    3. 13.2 Identify User Needs for Information
    4. 13.3 Discuss Examples of Major Sustainability Initiatives
    5. 13.4 Future Issues in Sustainability
    6. Key Terms
    7. Summary
    8. Multiple Choice
    9. Questions
    10. Thought Provokers
  15. Financial Statement Analysis
  16. Time Value of Money
  17. Suggested Resources
  18. Answer Key
    1. Chapter 1
    2. Chapter 2
    3. Chapter 3
    4. Chapter 4
    5. Chapter 5
    6. Chapter 6
    7. Chapter 7
    8. Chapter 8
    9. Chapter 9
    10. Chapter 10
    11. Chapter 11
    12. Chapter 12
    13. Chapter 13
  19. Index

Now that you have developed an understanding of operating budgets, let’s turn to the other primary component of the master budget: financial budgets. Preparing financial budgets involves examining the expectations for financing the operations of the business and planning for the cash needs of the organization. The budget helps estimate the source, amount, and timing of cash collection and cash payments as well as determine if and when additional financing is needed or debt can be paid.

Individual Financial Budgets

Preparing a financial budget first requires preparing the capital asset budget, the cash budgets, and the budgeted balance sheet. The capital asset budget represents a significant investment in cash, and the amount is carried to the cash budget. Therefore, it needs to be prepared before the cash budget. If the cash will not be available, the capital asset budget can be adjusted and, again, carried to the cash budget.

When the budgets are complete, the beginning and ending balance from the cash budget, changes in financing, and changes in equity are shown on the budgeted balance sheet.

Capital Asset Budget

The capital asset budget, also called the capital expenditure budget, shows the company’s plans to invest in long-term assets. Some assets, such as computers, must be replaced every few years, while other assets, such as manufacturing equipment, are purchased very infrequently. Some assets can be purchased with cash, whereas others may require a loan. Budgeting for these types of expenditures requires long-range planning because the purchases affect cash flows in current and future periods and affect the income statement due to depreciation and interest expenses.

Cash Budget

The cash budget is the combined budget of all inflows and outflows of cash. It should be divided into the shortest time period possible, so management can be quickly made aware of potential problems resulting from fluctuations in cash flow. One goal of this budget is to anticipate the timing of cash inflows and outflows, which allows a company to try to avoid a decrease in the cash balance due to paying out more cash than it receives. In order to provide timely feedback and alert management to short-term cash needs, the cash flow budget is commonly geared toward monthly or quarterly figures. Figure 7.15 shows how the other budgets tie into the cash budget.

Flow chart of the calculations for budgets. The Master Budget is at the top in purple. From it flow to lines to the Operating budget (all operating budgets are in yellow) and the Financial budget (all financial budgets are in blue). From the Operating Budget is a line going to the Sales budget (yellow). A green line goes from this Sales Budget to the Collections Budget (blue) to represent cash inflow. The Sales budget also has lines going to the D M, D L, and F O budgets (all yellow) which flow down to the Ending Inventory (yellow) and Payments (blue) Budgets. From the D M, D L, F O, and Ending Inventory Budgets flow lines to the C O G S Budget, which flows to the Income Statement Budget (all yellow). Also from the Sales Budget is a line going to the Selling & A D M Budget (both yellow), which flows to the Payments Budget (blue). From the Sales and Selling and A D M Budgets there are lines going to the Income Statement (all yellow). From the Financial Budget a line goes to the Cash Budget. This has inflow from the Collections Budget (with the green line representing cash inflow) and outflow to the Payments Budget with a red line representing cash outflow). There are also lines from the Cash Budget going to the Capital Budget and the Balance Sheet Budget. All of these mentioned budgets are blue. The Balance sheet also has lines going to it from the Income Statement (yellow) and the Capital Budget (blue).
Figure 7.15 Relationship between Budgets. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

Cash is so important to the operations of a company that, often, companies will arrange to have an emergency cash source, such as a line of credit, to avoid defaulting on current payables due and also to protect against other unanticipated expenses, such as major repair costs on equipment. This line of credit would be similar in function to the overdraft protection offered on many checking accounts.

Because the cash budget accounts for every inflow and outflow of cash, it is broken down into smaller components. The cash collections schedule includes all of the cash inflow expected to be received from customer sales, whether those customers pay at the same rate or even if they pay at all. The cash collections schedule includes all the cash expected to be received and does not include the amount of the receivables estimated as uncollectible. The cash payments schedule plans the outflow or payments of all accounts payable, showing when cash will be used to pay for direct material purchases. Both the cash collections schedule and the cash payments schedule are included along with other cash transactions in a cash budget. The cash budget, then, combines the cash collection schedule, the cash payment schedule, and all other budgets that plan for the inflow or outflow of cash. When everything is combined into one budget, that budget shows if financing arrangements are needed to maintain balances or if excess cash is available to pay for additional liabilities or assets.

The operating budgets all begin with the sales budget. The cash collections schedule does as well. Since purchases are made at varying times during the period and cash is received from customers at varying rates, data are needed to estimate how much will be collected in the month of sale, the month after the sale, two months after the sale, and so forth. Bad debts also need to be estimated, since that is cash that will not be collected.

To illustrate, let’s return to Big Bad Bikes. They believe cash collections for the trainer sales will be similar to the collections from their bicycle sales, so they will use that pattern to budget cash collections for the trainers. In the quarter of sales, 65% of that quarter’s sales will be collected. In the quarter after the sale, 30% will be collected. This leaves 5% of the sales considered uncollectible. Figure 7.16 illustrates when each quarter’s sales will be collected. An estimate of the net realizable balance of Accounts Receivable can be reconciled by using information from the cash collections schedule:

Quarter 4: Beginning balance of Accounts Receivable (Q 3 sales of $112,500 times 35% plus Q 2 sales of 70,000 times 5% plus Q 1 sales of 70,000 times 5%) $46,375 plus Quarter 4 sales 187,500 less Quarter 3 cash receipts (65% of quarter 4 sales equals 121,875 and 30% of quarter 3 sales equals 33,750) 155,625 equals Quarter 4 ending balance in gross accounts receivable 78,250.
Percentage of Sales Collected: In quarter 1: 30 percent of prior year quarter 4 sales plus 65 percent of quarter 1 sales. In quarter 2: 30 percent of quarter 1 sales plus 65 percent of quarter 2 sales. In quarter 3: 30 percent of quarter 2 sales plus 65 percent of quarter 3 sales. In quarter 4: 30 percent of quarter 3 sales plus 65 percent of quarter 4 sales.
Figure 7.16 Illustration of a Cash Collections Schedule. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

For example, in quarter 1 of year 2, 65% of the quarter 1 sales will be collected in cash, as well as 30% of the sales from quarter 4 of the prior year. There were no sales in quarter 4 of the prior year so 30% of zero sales shows the collections are $0. Using information from Big Bad Bikes sales budget, the cash collections from the sales are shown in Figure 7.17.

Big Bad Bikes, Cash Collections Schedule For the Year Ending December 31, 2019 Collections from: prior year Quarter 4 $0 sales, 0 quarter 1, 0 total; Quarter 1 $70,000 sales, $45,500 Q 1, 21,000 Q 2, 66,500 total; Quarter 2 70,000 sales, 45,500 Q 2, 21,000 Q 3, 66,500 total; Quarter 3 112,500 sales, 73,123 Q3, 33,750 Q4, 106,875 total; Quarter 4 187,500 sales, 121,875 Q 4, 121,875 total; Total collections on $440,000 sales, 45,500 Q 1, 66,500 Q 2, 94,125 Q 3, 155,625 Q 4, $361,750 total; Accounts receivable: 440,000 sales minus 361,750 collections equals $78,250.
Figure 7.17 Cash Collections Schedule for Big Bad Bikes. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

When the cash collections schedule is made for sales, management must account for other potential cash collections such as cash received from the sale of equipment or the issuance of stock. These are listed individually in the cash inflows portion of the cash budget.

The cash payments schedule, on the other hand, shows when cash will be used to pay for Accounts Payable. One such example are direct material purchases, which originates from the direct materials budget. When the production budget is determined from the sales, management prepares the direct materials budget to determine when and how much material needs to be ordered. Orders for materials take place throughout the quarter, and payments for the purchases are made at different intervals from the orders. A schedule of cash payments is similar to the cash collections schedule, except that it accounts for the company’s purchases instead of the company’s sales. The information from the cash payments schedule feeds into the cash budget.

Big Bad Bikes typically pays half of its purchases in the quarter of purchase. The remaining half is paid in the following quarter, so payments in the first quarter include payments for purchases made during the first quarter as well as half of the purchases for the preceding quarter. Figure 7.18 shows when each quarter’s purchases will be paid. Additionally, the balance of purchases in Accounts Payable can be reconciled by using information from the cash payment schedule as follows:

Quarter 4: Beginning balance of Accounts Payable $4,000* plus Quarter 4: Purchase of direct material 12,000 minus Quarter 4: Cash Payments 10,000 equals Quarter 4: Ending balance in Accounts Payable $6,000*; *Big Bad Bikes has a policy of paying 50 percent of purchases in the quarter of purchases, and the remaining 50 percent the month after the purchase. The beginning balance of accounts payable should be 50 percent of the prior quarter’s purchases.
Percentage of Cash Payments for Purchases. Prior year, Q 4 purchases: 50 percent Q 1; Quarter 1 purchases: 50 percent Q 1, 50 percent Q 2; Quarter 2 purchases: 50 percent Q 2, 50 percent Q 3; Quarter 3 purchases: 50 percent Q 3, 50 percent Q 4; Quarter 4 purchases: 50 percent Q 4.
Figure 7.18 Cash Payment Schedule. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

The first quarter of the year plans cash payments from the prior quarter as well as the current quarter. Again, since the trainers are a new product, in this example, there are no purchases in the preceding quarter, and the payments are $0. Figure 7.19.

Big Bad Bikes, Cash Payments Schedule For the Year Ending December 31, 2019. Payments from: prior year Quarter 4 $0 purchases, 0 quarter 1, 0 total; Quarter 1 $6,120 purchases, $3,060 Q 1, 3,060 Q 2, 6,120 total; Quarter 2 5,120 purchases, 2,560 Q 2, 2,560 Q 3, 5,120 total; Quarter 3 8,000 purchases,4,000 Q 3, 4,000 Q 4, 8,000 total; Quarter 4 12,000 purchases, 6,000 Q 4, 6,000 total; Total payments on $31,240 purchases, 3,060 Q 1, 5,620 Q 2, 6,560 Q 3, 10,000 Q 4, $25,240 Total.
Figure 7.19 Cash Payments Schedule for Big Bad Bikes. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

While the cash payments schedule is made for purchases of material on account, there are other outflows of cash for the company, and management must estimate all other cash payments for the year. Typically, this includes the manufacturing overhead budget, the sales and administrative budget, the capital asset budget, and any other potential payments of cash. Since depreciation is an expense not requiring cash, the cash budget includes the amount from the budgets less depreciation. Cash payments are listed on the cash budget following cash receipts. Figure 7.20 shows the major components of the cash budget.

General Overview of Cash Budget Components* Cash Receipts from Sales plus Other cash receipts (issuance of stock, borrowing money, receiving interest or dividends, from selling assets such as equipment, etc.) minus Cash Payments for Purchases or Production of Inventory minus Cash Payments for manufacturing expenses** minus Cash Payments for selling and administrative expenses ** minus Cash payments for capital asset purchases minus Other cash payments (paying interest, paying loan payments, etc.) equals Net Cash; *This is a general overview of the types of cash transactions that might appear in a cash budget and its representative of the components but not of a typical presentation of those components; **Note that depreciation, a non-cash expense, would be excluded from these expenses.
Figure 7.20 General Overview of Cash Budget Components. A cash budget will contain all the budgeted cash inflows and out flows from the sub-budgets as well as any cash items that might not appear on one of the sub-budgets. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

The cash budget totals the cash receipts and adds it to the beginning cash balance to determine the available cash. From the available cash, the cash payments are subtracted to compute the net cash excess or deficiency of cash for the quarter. This amount is the potential ending cash balance. Organizations typically require a minimum cash balance. If the potential ending cash balance does not meet the minimum amount, management must plan to acquire financing to reach that amount. If the potential ending cash balance exceeds the minimum cash balance, the excess amount may be used to pay any financing loans and interest.

Big Bad Bikes has a minimum cash balance requirement of $10,000 and has a line of credit available for an interest rate of 19%. They also plan to issue additional capital stock for $5,000 in the first quarter, to pay taxes of $1,000 during each quarter, and to purchase a copier for $8,500 cash in the third quarter. The beginning cash balance for Big Bad Bikes is $13,000, which can be used to create the cash budget shown in Figure 7.21.

Big Bad Bikes, Cash Budget, For the Year Ending December 31, 2019, Quarter 1, Quarter 2, Quarter 3, Quarter 4, Total (respectively): Beginning cash balance, $13,000, 10,000, 10,000, 10,000, 13,000; Collections from customers (Cash Collection Schedule) 45,500, 66,500, 94,125, 155,625, 361,750; Issuing of stock 5,000 –, –, –, 5,000; Total cash collected during the period 50,500, 66,500, 94,125, 155,625, 366,750; Total available cash 63,500, 76,500, 104,125, 165,625, 379,750; Less disbursements: Direct materials (cash payment schedule) 3,060, 5,620, 6,560, 10,000, 25,240; Direct labor (direct labor budget) 19,500, 17,250, 27,000, 42,000, 105,750; Manufacturing overhead less depreciation (MFG OH Budget) 28,925, 28,588, 30,050, 32,300, 119,863; Selling and Administrative expenses less depreciation (Sales and Admin. Expenses Budget) 18,500, 18,500, 19,750, 22,250, 79,000; Income tax expense 1,000, 1,000, 1,000, 1,000, 4,000; Purchase of copier (Capital Assets Budget) –, –, 8,500, –, 8,500; Total disbursements 70,985, 70,958, 90,860, 107,550, 342,353; Excess (deficiency) of available cash (7,485), 5,542, 11,265, 58,075, 37,397; Financing: Add borrowing 17,485, 4,458, –, –, 21,943; Less repayments including interest –, –, (1,265), (21,632), (22,897).Ending cash balance, 10,000, 10,000, 10,000, 36,443, 36,443.
Figure 7.21 Cash Budget for Big Bad Bikes. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

Budgeted Balance Sheet

The cash budget shows how cash changes from the beginning of the year to the end of the year, and the ending cash balance is the amount shown on the budgeted balance sheet. The budgeted balance sheet is the estimated assets, liabilities, and equities that the company would have at the end of the year if their performance were to meet its expectations. Table 7.1 shows a list of the most common changes to the balance sheet and where the information is derived.

Common Changes in the Budgeted Balance Sheet
Information Source Balance Sheet Change
Cash balance ending cash balance from the cash budget
Accounts Receivable balance uncollected receivables from the cash collections schedule
Inventory ending balance in inventory as shown from calculations to create the income statement
Machinery & Equipment ending balance in the capital asset budget
Accounts Payable unpaid purchases from the cash payments schedule
Table 7.1

Other balance sheet changes throughout the year are reflected in the income statement and statement of cash flows. For example, the beginning cash balance of Accounts Receivable plus the sales, less the cash collected results in the ending balance of Accounts Receivable. A similar formula is used to compute the ending balance in Accounts Payable. Other budgets and information such as the capital asset budget, depreciation, and financing loans are used as well.

To explain how to use a budgeted balance sheet, let’s return to Big Bad Bikes. For simplicity, assume that they did not have accounts receivable or payable at the beginning of the year. They also incurred and paid back their financing during the year, so there is no ending debt. However, the cash budget shows cash inflows and outflows not related to sales or the purchase of materials. The company’s capital assets increased by $8,500 from the copier purchase, and their common stock increased by $5,000 from the additional issue as shown in Figure 7.22.

Big Bad Bikes, Budgeted Balance Sheet, December 31, 2019 Jan 1 and Dec. 31, respectively: Cash 13,000, 36,443; Accounts Receivable 0, 78250; Less allowance for doubtful accounts 0, (22,000); Inventory 0, 42,629; Machinery and equipment 15,000, 23,500; Accumulated Depreciation (2,000), (22,000); Total assets $26,000, $136,822; Accounts Payable 0, 6,000; Line of credit 0, 0; Common Stock 15,000, 20,000; Retained Earnings 11,000, 110, 822; Total Liabilities and Owner’s Equity $26,000, $136,822.
Figure 7.22 Budgeted Balance Sheet for Big Bad Bikes. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

Though there seem to be many budgets, they all fit together like a puzzle to create an overall picture of how a company expects the upcoming business year to look. Figure 7.15 detailed the components of the master budget, and can be used to summarize the budget process. All budgets begin with the sales budget. This budget estimates the number of units that need to be manufactured and precedes the production budget. The production budget (refer to Figure 7.6) provides the necessary information for the budgets needed to plan how many units will be produced. Knowing how many units need to be produced from the production budget, the direct materials budget, direct labor budget, and the manufacturing overhead budget are all prepared. The sales and administrative budget is a nonmanufacturing budget that relies on the sales estimates to pay commissions and other variable expenses. The sales and expenses estimated in all of these budgets are used to develop a budgeted income statement.

The estimated sales information is used to prepare the cash collections schedule, and the direct materials budget is used to prepare the cash payment schedule. The cash receipts and cash payments budget are combined with the direct labor budget, the manufacturing overhead budget, the sales and administrative budget, and the capital assets budget to develop the cash budget. Finally, all the information is used to flow to the budgeted balance sheet.

Your Turn

Creating a Master Budget

Molly Malone is starting her own company in which she will produce and sell Molly’s Macaroons. Molly is trying to learn about the budget process as she puts her business plan together. Help Molly by explaining the optimal order for preparing the following budgets and schedules and why this is the optimal order.

  • budgeted balance sheet
  • budgeted income statement
  • capital asset budget
  • cash budget
  • cash collections schedule
  • cash payments schedule
  • direct materials budget
  • direct labor budget
  • master budget
  • manufacturing overhead
  • production budget
  • sales budget
  • selling and administrative budget

Solution

A master budget always begins with the sales budget must be prepared first as this determines the number of units that will need to be produced. The next step would be to create the production budget, which helps determine the number of units that will need to be produced each period to meet sales goals. Once Molly knows how many units she will need to produce, she will need to budget the costs associated with those units, which will require her to create the direct materials budget, the direct labor budget and the manufacturing overhead budget. But Molly will have costs other than manufacturing costs so she will need to create a selling and administrative expenses budget. Molly will need to determine what are her capital asset needs and budget for those. Now that Molly has all her revenues budgeted and her costs budgeted, she can determine her budgeted cash inflows and outflows by putting together the cash schedules that lead to the cash budget. Molly will then need to create a cash collections schedule and a cash payments schedule and that information, along with the cash inflow and outflow information from her other budgets, will allow her to create her cash budget. Once Molly has completed her cash budget she will be able to put together her budgeted income statement and budgeted balance sheet.

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