EXAMPLES AND PRACTICE PROBLEMS

The following examples and end of chapter practice problems will help you become
familiar with the master budget concepts and techniques. The examples and practice
problems are simplified to facilitate the learning process. The first example below and
most of the practice problems assume that only one period is involved and that only one
product is produced from a single direct material. Of course these assumptions are not
realistic, but they allow us to prepare budgets by hand in a timely manner to develop an
understanding of the budgeting process.

PREPARATION OF MASTER BUDGET (Merchandising Company)

EXAMPLE 1. YZ Company’s newly hired accountant has persuaded management to

prepare a master budget to aid financial and operating decisions. The planning horizon is
only three months, January to March. Sales in December (20x3) were Br. 40, 000.
Monthly sales for the first four months of the next year (20x4) are forecasted as follows:

January Br. 50, 000

February 80, 000
March 60, 000
April 50, 000

Normally 60% of sales are on cash and the remainders are credit sales. All credit sales are
collected in the month following the sales. Uncollectible accounts are negligible and are to
be ignored.

Because deliveries from suppliers and customer demand are uncertain, at the end of any
month Blue Nile wants to have a basic inventory of Br. 20, 000 plus 80% of the expected
cost of goods to be sold in the following month. The cost of merchandise sold averages
70%of sales. The purchase terms available to the company are net 30 days. Each month’s
purchase are paid as follows:
50% during the month of purchase and,
50% during the month following the purchases.
Monthly expenses are:
Wages and commissions………………………Br. 2, 500 + 15%of sales, paid as incurred.
Rent expense……………………………… Br. 2, 000 paid as incurred.
Insurance expense…………………………Br.200 expiration per month.

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Depreciation including truck……………………. Br.500 per month
Miscellaneous expense……………………5% of sales, paid as incurred.

In January, a used truck will be purchased for Br. 3, 000 cash. The company wants a
minimum cash balance of Br. 10, 000 at the end of each month. Blue Nile can borrow cash
or repay loans in multiples of Br. 1, 000. Management plans to borrow cash more than
necessary and to repay as promptly as possible. Assume that the borrowing takes place at
the beginning, and repayment at the end of the months in question. Interest is paid when
the related loan is repaid. The interest rate is 18% per annum. The closing balance sheet
for the fiscal year just ended at December 31, 20x3,is:

XYZ Company
Balance Sheet
December 31, 20x3

ASSETS
Current assets:
Cash Br. 10, 000
Account receivable 16,000
Merchandise inventory 48, 000
Unexpired insurance 1,800 Br.75, 800

Plant assets:
Equipment, fixture and other Br.37, 000
Accumulated depreciation 12, 800 Br.24, 200
Total assets Br.100,000

LIABILITIES AND OWNERS’ EQUITY

Liabilities:
Accounts payable Br.16, 800
Accrued wages and commissions payable 4, 250 Br.21, 050

Capital:
Owners’ equity 78, 950

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Total liabilities and owners’ equity Br.100, 000

Instructions:
1) Using the data given above, prepare the following detailed schedules for the first
quarter of the year:
1) Sales budget
2) Cash collection budget
3) Purchase budget
4) Disbursement for purchases
5) Operating expenses budget
6) Disbursement for operating expenses
2) Using the budget data given above and the schedules you have prepared, construct the
following pro forma financial statements
a. Income statement for the first quarter of the year.
b. Cash budget including receipts, payments, and effect of financing
c. Balance sheet at March 31, 20x3.
STEPS IN PREPARATION OF MASTER BUDGET
1. a) Sales budget
Jan.-Mar.
December* January February March Total
Cash sales (40%) Br.24, 000 Br.30, 000 Br.48, 000 Br.36, 000 Br.114, 000
Credit sales
(60%) 16, 000 20, 000 32, 000 24,000 76, 000
Totals Br.40, 000 Br.50, 000 Br.80, 000 Br.60, 000 Br.190, 000

*December sales are included in the schedule (a) because they affect cash collected in
January.
b) Cash collection budget
January February March
Cash sales of the month Br.30, 000 Br.48, 000 Br.36, 000
Credit sales of last
month 16, 000 20, 000 32, 000
Total cash collected Br.46, 000 Br.68, 000 Br.68, 000

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c). Purchase budget
January February March Jan.-Mar
Required ending Br.64, 800 Br.53, 600 Br.48, 000
inventory
Cost of gods sold 35, 000 56, 000 42, 000 Br.133, 000
Total needed Br.99, 800 Br.109, 600 Br.90, 000
Beginning inventory 48, 000 64, 800 53, 600
Purchases budget Br.51, 800 Br.44, 800 Br.36, 400

d). Disbursement for purchases

January February March
50% of last month’s purchase Br.16, 800 Br.25, 900 Br.22, 400
50% of current month’s purchase 25, 900 22, 400 18, 200
Total disbursement for purchase Br.42, 700 Br.48, 300 Br.40, 600

e). Operating expense budget

January February March Jan.-Mar.
Wages and commissions Br.10, 000 Br.14, 500 Br.11, 500 Br.36, 000
Rent expense 2, 000 2, 000 2, 000 6, 000
Insurance expense 200 200 200 600
Depreciation expense 500 500 500 1, 500
Miscellaneous expense 2, 500 4, 000 3, 000 9, 500
Total Br.15, 200 Br.21, 200 Br.17, 200 Br.53, 600
f). Disbursement for operating expenses budget
January February March
Wages and commissions Br.14, 250 Br.14, 500 Br.11, 500
Rent expense 2, 000 2, 000 2, 000
Miscellaneous expense 2, 500 4, 000 3, 000
Total Br.18, 750 Br.20, 500 Br.16, 500

g) Budget income statement

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YZ Company
Budget Income Statement
For the Quarter Ended, March 31, 20x3
Sales (schedule 1(a)) Br.190, 000
Cost of goods sold (schedule 1(c)) 133,000
Gross profit 57,000
Operating expenses
Wages and commissions Br.36, 000
Rent expense 6, 000
Insurance expense 600
Depreciation expense 1,500
Miscellaneous expense 9, 500 53, 600
Operating income 3, 400
Interest expense* 885
Net income 2, 515

*Interest expense computation

Paid interest = 11, 000*0.18 * 3/12= 495
Accrued amount:
On the first batch borrowing:
8, 000 * 0.18* 3/12= 360
On the second batch borrowing:
1, 000 * 0.18 * 2/12= 30
Total interest expense incurred Br.885
b) Cash budget including receipts, payments and effects of financing
January February March
Beginning balance Br.10, 000 Br.10, 550 Br.10, 750
Collections (Schedule1 (b)) 46, 000 68, 000 68, 000
Cash available for the use (x) Br.56, 000 Br.78, 550 Br.78, 750
Cash disbursements for:
Purchases (Schedule 1(d)) 42, 700 48, 300 40, 600
Operating expenses (Schedule1 (f)) 18, 750 20, 500 16, 500
Truck purchases 3, 000 - -
Total disbursement (y) Br.64, 450 Br.68, 800 Br.57, 100
Minimum cash balance required 10, 000 10, 000 10, 000
Total cash needed Br.74, 450 Br.78, 800 Br.67, 100

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 Cash excess (deficiency) Br.(18, 450) Br.( 250) Br.11, 650
Effects of financing
Borrowing 19, 000 1, 000 -
Payment of the principal - - (11, 000)
Payment of interest - - (495)
Net effect of financing (z) Br.19, 000 Br.1, 000 Br.(11, 495)

c) Budgeted balance sheet

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XYZ Company

Budgeted Balance Sheet

March 31, 20x3
ASSETS
Current assets
Cash Br. 10, 155
Accounts receivable 24, 000
Merchandise inventory 48, 000
Unexpired insurance 1, 200 Br. 83, 355
Plant assets
Equipment, Fixture and others 40, 000
Accumulated depreciation 14, 300 25, 700
Total assets Br. 109, 055

LIABILITIES AND OWNER’S EQUITY

Liabilities
Accounts payable Br.18, 200 Loan payable
9, 000
Interest payable 390
Total liabilities Br.27, 590
Capital
Beginning owners’ equity Br.78, 950
Net income 2, 515
Ending capital balance 81, 465

Total equities Br.109, 055

PREPARATION OF MASTER BUDGET (Manufacturing Company)

Example (2) Great Company manufactures and sells a product whose peak sales occur in
the third quarter. Management is now preparing detailed budgets for 20x4- the coming
year and has assembled the following information to assist in the budget preparation:

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The company’s product selling price is Br. 20 per unit. The marketing department has
estimated sales in units as follows for the next six quarters.

20x4 Quarters 20x5 Quarters

Quarter 1 10000 15000
Quarter 2 30000 15000
Quarter 3 40000
Quarter 4 20000

Sales are collected in the following pattern: 70% of sales are collected in the quarter in
which the sales are made and the remaining 30% are collected in the following quarter. On
January1, 20x4, the company’s balance sheet showed Br.90, 000 in account receivable, all
of which will be collected in the first quarter of the year. Bad debts are negligible and can
be ignored.

The company maintains an ending inventory of finished units equal to 20% of the next
quarter’s sales. The requirement was met on December 31, 20x3, in that the company had
2, 000 units on hand to start the new year.

Fifteen pounds of raw materials are needed to complete one unit of product. The company
requires an ending inventory of raw materials on hand at the end of each quarter equal to
10% of the following quarter’s production needs of raw materials. This requirement was
met on December 31, 20x3 in that the company had 21, 000 pounds of raw materials to
start the New Year.

The raw material costs Br.0.20 per pound. Raw material purchases are paid for in the
following pattern: 50% paid in the quarter the purchases are made, and the remainder is
paid in the following quarter. On January 1,20x4, the company’s balance sheet showed
Br.25, 800 in accounts payable for raw material purchases, all of which be paid for in the
first quarter of the year.
Each unit of Great’s product requires 0.8 hour of labor time. Estimated direct labor cost
per hour is Br.7.50.
Variable overhead is allocated to production using labor hours as the allocation base as
follows:
Indirect materials Br.0.40
Indirect labor 0.75

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 Fringe benefits 0.25
Payroll taxes 0.10
Utilities 0.15
Maintenance 0.35

Fixed overhead for each quarter was budgeted at Br. 60, 600. Of the fixed overhead
amount, Br. 15, 000 each quarter is depreciation. Overhead expenses are paid as incurred.

The company’s quarterly budgeted fixed selling and administrative expenses are as
follows:

20X4 Quarters
1 2 3 4
Advertising Br.20, 000 Br.20, 000 Br.20, 000 Br.20, 000
Executive salaries 55, 000 55, 000 55, 000 55, 000
Insurance - 1, 900 37,750 -
Property taxes - - - 18, 150
Depreciation 10, 000 10, 000 10, 000 10, 000

The only variable selling and administrative expense, sales commission, is budgeted at
Br.1.80 per unit of the budgeted sales. All selling and administrative expenses are paid
during the quarter, in cash, with exception of depreciation. New equipment purchases will
be made during each quarter of the budget year for Br. 50, 000, Br. 40, 000, & Br.20, 000
each for the last two quarter in cash, respectively. The company declares and pays
dividends of Br.8, 000 cash each quarter. The company’s balance sheet at December 31,
20x3 is presented below:

ASSETS
Current assets:
Cash Br. 42, 500
Accounts Receivable 90, 000
Raw Materials Inventory (21, 000 pounds) 4, 200
Finished Goods Inventory (2, 000 units) 26, 000
Total current assets Br.162, 700
Plant and Equipment:
Land Br.80, 000

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 Building and Equipment 700, 000
Accumulated Depreciation (292, 000)
Plant and Equipment, net 488, 000
Total assets Br.650, 700

LIABILTIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable (raw materials) Br.25, 800
Stockholders’ equity:
Common stock, no par Br.175, 000
Retained earnings 449, 900
Total stockholders’ equity 624, 900
Total liabilities and stockholders’ equity Br.650, 700

The company can borrow money from its bank at 10% annual interest. All borrowing
must be done at the beginning of a quarter, and repayments must be made at the end of a
quarter. All borrowings and all repayments are in multiples of Br. 1,000.

The company requires a minimum cash balance of Br.40, 000 at the end of each quarter.
Interest is computed and paid on the principal being repaid only at the time of repayment
of principal. The company whishes to use any excess cash to pay loans off as rapidly as
possible.

Instructions: Prepare a master budget for the four-quarter period ending December 31.
Include the following detailed budget and schedules:
1. a) A sales budget, by quarter and in total
b) A schedule of budgeted cash collections, by quarter and in total
c) A production budget
d) A direct materials purchase budget
e) A schedule of budgeted cash payments for purchases by quarter and in total
f) A direct labor budget
g) A manufacturing overhead budget
h) Ending finished goods inventory budget
i) A selling and administrative budget
2. A cash budget, by quarter and in total

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 3. A budgeted income statement for the four- quarter ending December 31, 20x4
4. A budgeted balance sheet as of December 31, 20x4.

a. Sales budget
Great CO
Sales Budget
For the year ended Dec. 20x5
Quarter
1 2 3 4 Year
Budgeted sales in units 10,000 30,000 40,000 20,000 100,00
X X X
Selling price per unit X $20 $20 $20 X $20 $20
Total Sales $ 200,000 $ 600,000 $ 800,000 $ 400,000 $ 2,000,000
b) Schedule of Expected Cash Collections
Great Co.
Cash collection Budget
For the year ended Dec. 20x5
Quarter
1 2 3 4 Total
30% of the previous Br.180, Br.240,
quarter sales Br. 90, 000 Br.60, 000 000 000 Br.570, 000
70% of the current
quarter sales 140, 000 420, 000 560, 000 280, 000 1, 400, 000
Br.230, Br.480, Br.740, Br. 520, Br.1, 970,
Total collections 000 000 000 000 000

c) Production Budget

After the sales budget has been prepared, the production requirements for the forth-coming
budget period can be determined and organized in the form of a production budget.
Sufficient goods will have to be available to meet sales and provide for the desired ending
inventory. A portion of these goods will already exist in the form of a beginning
inventory. The remainder will have to be produced. Therefore, production needs can be
determined as follows:

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 Budgeted sales in units ………………………………..…………xxxx
Add desired ending inventory……………….………………….xxxx
Total needs…………………………………………………………xxxx
Less beginning inventory………………………………….……..xxxx
Required production…………………………………….………..xxxx

The schedule given below shows the production budget for Great Company. Note that the
desired level of the ending inventory influences production requirements for a quarter.
Inventories should be carefully planned. Excessive inventories tie up funds and create
storage problems. Insufficient inventories can lead to lost sales or crash production efforts
in the following period

Quarter Total
1 2 3
4
Expected sales(units) 10, 000 30, 000 40, 000 20, 000 100, 000
Add: Desired Ending 3, 000
Inventory 6, 000 8, 000 4, 000 3, 000
Total needs 16, 000 38, 000 44, 000 23, 000 103, 000
Lees: Beginning Inventory 2, 000 6, 000 8, 000 4, 000 2, 000
Units to be produced 14, 000 32,000 36, 000 19, 000 101, 000

d) Direct Materials Budget

Returning to Great Company’s budget data, after the production requirements have been
computed, a direct materials budget can be prepared. The direct materials budget details
the raw materials that must be purchased to fulfill the production budget and to provide for
adequate inventories. The required purchases of raw materials are computed as follows:

Raw materials needed to meet the production schedule…………………………….xxxx

Add desired ending inventory of raw materials……………….……………………. .xxxx
Total raw materials needs…………………………………………………… xxxx
Less beginning inventory of raw materials………………………….… … xxxx
Raw materials to be purchased…………………………………………… xxxx

Quarter
Total
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Raw Materials to be purchased (in birrs)
1 2 3 4 Total
Raw materials to be
purchased 237, 000 486, 000 514, 500 279, 000 1, 516, 500
Raw materials cost per
pound x Br.0.20 x Br.0.20 x Br.0.20 x Br.0.20 x Br.0.20
Br.47, Br.97, Br.102, Br.55,
Total 400 200 900 800 Br.303, 300

e) Schedule of Expected Cash Disbursements (for Materials Purchase)

Quarter Total
1 2 3 4
50% of the previous
quarter Br. 25, 800 Br.23, 700 Br.48, 600 Br.51, 450 Br.149, 550
50% of the current 151,
quarter 23, 700 48, 600 51, 450 27, 900 650
Total cash Br.101,
disbursement Br.49, 500 Br.72, 300 050 Br.79, 350 Br.301, 200

f) Direct Labor Budget

The direct labor budget is also developed from the production budget. Direct labor
requirements must be computed so that the company will know whether sufficient labor
time is available to meet production needs. By knowing in advance just what will be
needed in the way of labor time throughout the budget year, the company can develop
plans to adjust the labor force as the situation may require. Firms that neglect to budget run
the risk of facing labor shortage or having to hire and lay off at awkward times. Erratic
labor policies lead to insecurity and inefficiencies on the part of employees.

To compute direct labor requirements, the number of units of finished product to be

produced each produced each period (month, quarter, and so on) is multiplied by the
number of direct labor-hours required to produced a single unit. Many different types of
labor may be involved. If so, then the computation should be by type of labor needed. The
labor requirements can then be translated into expected direct labor costs. How this is done

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 will depend on the labor policy of the firm. In schedule given below, the management of
Great Company has assumed that the direct labor force will be adjusted as the work
requirement change from quarter to quarter (for example as units produced changes from
l4, 000 units in quarter 1 to 32, 000 units in quarter 2 for Great Company, the direct labor
work force will be fully adjusted to the workload, i.e., total hours of direct labor time
needed). In that case, the total direct labor cost is computed by simply multiplying the
direct labor-hour required by the direct labor rate hour as was done in the schedule here
under.

Quarter Total
1 2 3 4
Direct labor time
needed 11, 200 25, 600 28, 800 15, 200 80, 800
Direct labor cost
per hour x Br.7.50 x Br.7.50 x Br.7.50 x Br.7.50 x Br.7.50
Total direct labor Br.84, Br.192,
cost 000 000 Br.216, 000 Br.114, 000 Br.606, 000

g) Manufacturing Overhead (MOH) Budget

The manufacturing overhead budget provides a schedule of all costs of production other
than direct materials and direct labor. These costs should be broken down by cost
behavior for budgeting purposes and a predetermined overhead rate developed. This rate
will be used to apply manufacturing overhead to units of product throughout the budget
period.
A computation showing budgeted cash disbursement for manufacturing overhead should
be made for use in developing the cash budget. Since some of the overhead costs do not
represents cash outflows, the total budgeted manufacturing overhead costs must be
adjusted the determine the cash disbursement for manufacturing overhead. At Great
Company, the only significant non cash manufacturing overhead cost is depreciation. Any
depreciation charges included in manufacturing overhead must be deducted from the total
in computing expected cash payments, since depreciation is a non-cash charge.
Quarter
Total
1 2 3 4
Variable
overhead Br.22, 400 Br.51, 200 Br.57, 600 Br.30, 400 Br.161, 600

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 Fixed overhead 60, 600 60, 600 60, 600 60, 600 242,400
Total MOH Br.111, Br.118,
Br.83, 000 800 200 Br.91, 000 Br.404, 000
Less:
Depreciation 15, 000 15, 000 15, 000 15, 000 60, 000
Cash
disbursements for Br.103,
MOH Br.68, 000 Br.96, 800 200 Br.76, 000 Br.344, 000
h) Ending Finished Goods Inventory Budget
After completing schedules (a) to (g), the company had all of the data needed to compute
unit product costs. This computation was needed for two reasons: first, to know how much
to charge as cost of goods sold on the budgeted income statement; and second, to know
what amount to put on the balance sheet inventory account for unsold units.
The carrying cost of the unsold units is computed on the ending finished goods inventory
budget
Budgeted Finished Goods Inventory 3, 000
Unit product cost Br.13 Ending
Finished Goods Inventory in birrs Br.39, 000

Production cost per unit

Quantity (unit) Cost Total
Direct materials 15 pounds Br.0.20 per pound Br.3
Direct labor 0.8 hours 7.50 per hour 6
Manufacturing overhead 0.8 hours 5.00 per hour 4
Unit product cost Br.13

MOH rate= Total MOH = 404, 000 = Br.5.00

Direct labor hours 80, 800

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 Quarter Total
1 2 3 4
Variable selling expenses Br.18, 000 Br.54, 000 Br.72, 000 Br.36, 000 Br.180, 000
Fixed selling &
administrative expenses
Advertising 20, 000 20, 000 20, 000 20, 000 80, 000
Executive
salaries 55, 000 55, 000 55, 000 55, 000 220, 000
Insurance - 1, 900 37, 750 - 39, 650
Property taxes - - - 18,150 18,150
Depreciation 10, 000 10, 000 10, 000 10, 000 40, 000
Total budgeted selling & Br.140, Br.194, Br.139,
administrative expenses Br.103, 000 900 750 150 Br.577, 800

i) Selling and Administrative Expenses Budget

Disbursement for Selling & Administrative Expenses
Quarter Total
1 2 3 4
Budgeted Selling & Br.103, Br.140, Br.139,
Administrative 000 900 Br.194, 750 150 Br.577, 800
Less: Depreciation 10, 000 10, 000 10, 000 10, 000 40, 000
Total Cash Disbursements Br.130, Br.129,
Br.93, 000 900 Br.184, 750 150 Br.537, 800

2. a) Cash Budget

Quarter Total
1 2 3 4
Cash balance, beginning Br.40,
Br.42, 500 000 Br.40, 000 Br.40, 500 Br.42, 500
Add : Collection from 1, 970,
customers 230, 000 480, 000 740, 000 520, 000 000
Total cash available before financing 2, 012,
272, 500 520, 000 780, 000 560, 500 500
Less: Disbursements for

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 Direct materials 49, 500 72, 300 100,050 79, 350 301,200
Direct labor 84, 000 192, 000 216,000 114, 000 606,000
Manufacturing overhead 68, 000 96, 800 103,200 76, 000 344,000
Selling & Administrative 93, 000 130, 900 184,750 129, 150 537,800
Equipment purchases 50, 000 40, 000 20,000 20,000 130,000
Dividend 8, 000 8, 000 8, 000 8, 000 32,000
Total disbursements 352, 500 540,000 632,000 426,500 1,951,000
Minimum cash balance 40, 000 40, 000 40, 000 40, 000 40, 000
Total need 392, 500 580, 000 672, 000 466, 500 1, 991,000
Excess (deficiency) of cash
available over total need (120, 000) (60, 000) 108, 000 94, 000 21, 500
Financing:
Borrowing(at beginning) 120,000 60, 000 - - 180, 000
Repayments( at ending) - - (100, 000) (80,000) (180,000)
Interest(at 10% per annum) - - (7,500) (6,500) (14,000)
Total financing 120, 000 60, 000 (107,500) (86,500) (14,000)
Cash balance, ending Br.40, Br.47,
Br.40,000 000 Br.40, 500 500 Br.47, 500

b) Budgeted Income Statement

Great Company
Budgeted Income Statement
For the Year Ended December31, 20x4
Sales [100, 000units at Br.20 Schedule 1(a)] Br.2, 000, 000
Cost of Goods Sold
[100, 000 units at Br.13 Schedule1 (h)] 1, 300, 000
Gross Margin 700, 000
Selling & Administrative Expenses [Schedule 1 (i)] 577, 800
Net Operating Income 122, 200
Interest Expense [Schedule 2(a)] 14, 000
Net Income Br. 108, 200

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c) Budgeted Balance Sheet
Great Company
Budgeted Balance Sheet
December31, 20x4
ASSETS
Current assets:
Cash [ Schedule 2(a)] Br. 47, 500
Accounts Receivable 120, 000
Raw Materials Inventory 4, 500
Finished Goods Inventory 39, 000
Total current assets Br.211, 000

Plant and Equipment:

Land Br.80, 000
Building and Equipment 830, 000
Accumulated Depreciation (392, 000)
Plant and Equipment, net 518, 000
Total assets Br.729, 000
LIABILTIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable (raw materials) Br.27, 900
Stockholders’ equity:
Common stock, no par Br.175, 000
Retained earnings 526, 100
Total stockholders’ equity 701, 100
Total liabilities and stockholders’ equity Br.729, 000

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