CH20

Introduction to
Management Accounting:
The Master Budget
Chapter 20
HORNGREN HARRISON BAMBER BEST FRASER WILLETT

Objectives
1. Distinguish between financial accounting

and management accounting, and use
management accounting information for
decision making.
2. Describe the value chain and classify costs
by value-chain function
3. Distinguish direct costs from indirect costs
4. Distinguish among full product costs,
inventoriable product costs and period
costs
Horngren Harrison Bamber Best Fraser Willett, Accounting 4e Copyright 2004 Pearson Education Australia 20 - 2
Objectives
5. Prepare the financial statements of a

manufacturing company
6. Identify the benefits of budgeting
7. Prepare an operating budget for a
company
8. Prepare the components of a financial
budget
9. Use sensitivity analysis in budgeting.
The Functions of Management
Planning Acting Controlling
Feedback
Objective 1
Distinguish between financial

accounting and management
accounting, and use
management accounting
information for decision-making
Management Accounting
and Financial Accounting
Primary Users
Internal
Internal managers
managers of
of the
the business
business
Investors,
Investors, Creditors,
Creditors,
Government
Government authorities
authorities (ATO,
(ATO, ASIC
ASIC etc.)
etc.)
Purpose of Information
Help
Help managers
managers plan
plan and
and
control
control business
business operations
operations
Help
Help investors,
investors, creditors,
creditors, and
and others
others make
make
investment,
investment, credit,
credit, and
and other
other decisions
decisions
Focus and Time Dimension
Relevance
Relevance
Reliability,
Reliability, objectivity,
objectivity, and
and focus
focus on
on the
the past
past
Type of Report
Internal
Internal reports
reports not
not restricted
restricted by
by GAAP
GAAP
Financial
Financial statements
statements restricted
restricted by
by GAAP
GAAP
Verification
No
No independent
independent audit
audit
Annual
Annual independent
independent audit
audit
Scope of Information
Detailed
Detailed reports
reports on
on
parts
parts of
of the
the company
company
Summary
Summary reports
reports primarily
primarily
on
on the
the company
company as
as aa whole
whole
Behavioral Implications
Concern
Concern about
about how
how reports
reports
will
will affect
affect employees
employees behavior
behavior
Concern
Concern about
about adequacy
adequacy of
of disclosure
disclosure
Service, Retail,
and Manufacturing Companies
Service
Service Company:
Company:
provides
provides intangible
intangible services,
services,
rather
rather than
than tangible
tangible products
products
Retail
Retail Company:
Company:
resells
resells products
products previously
previously
bought
bought from
from suppliers
suppliers
Service, Retail,
and Manufacturing Companies
Manufacturing
Manufacturing Company:
Company:
uses
uses labour,
labour, plant,
plant, and
and equipment
equipment toto convert
convert
raw
raw materials
materials into
into finished
finished products
products
Materials
Materials inventory
inventory
Work
Work in
in process
process inventory
inventory
Finished
Finished goods
goods inventory
inventory
Objective 2
Describe the value

chain
and classify costs by
value-chain
functions.
Value Chain
Research and Production or

Design
Development Purchases
Customer
Marketing Distribution
Services
Objective 3
Distinguish direct
costs
from indirect costs.
Cost Objects, Direct Costs,
and Indirect Costs
Cost objects are anything for which a
separate measurement of costs is
desired.
Cost drivers are any factors that affect
cost.
and Indirect Costs
What are examples of cost objects?
individual products
alternative marketing strategies
geographic segments of the business
departments
and Indirect Costs
What are direct costs?
Direct costs are those costs that can be
specifically traced to the cost object.
What are indirect costs?
Indirect costs are costs that cannot be
specifically traced to the cost object.
Objective 4
Distinguish among full

product
costs, inventoriable
product
costs, and period costs.
Product Costs
What are product costs?

They are the costs to produce (or
purchase) tangible products intended
for sale.
There are two types of product costs:
Full
Full Inventoriable
Inventoriable
product
product product
product
costs
costs costs
costs
External Reporting
Inventoriable
Inventoriable
Period
Period
product
product costs
costs
costs
costs
Inventoriable Product Costs
For external reporting, a retailers

inventoriable product costs includes
only costs that are incurred in the
purchase of goods.
Inventoriable costs are an asset.
Period costs flow as expenses directly
to the statement of financial
performance.
For external reporting, manufacturers

inventoriable product costs include raw
materials plus all other costs incurred in
the manufacturing process.
Inventoriable product costs are incurred
only in the third element of the value
chain.
Costs incurred in other elements of the
value chain are period costs.
Direct Direct Indirect Indirect

Other
Materials Labour Labour Materials
Manufacturing Overhead
Direct Direct
Materials Labour
Prime Costs = Direct Materials + Direct Labour
Direct Indirect Indirect

Other
Labour Labour Materials
Conversion Costs = Direct Labour

+ Manufacturing Overhead
Objective 5
Prepare the financial

statements
of a manufacturing
company.
Financial Statements for
Service Companies
There is no inventory and thus no
inventoriable costs.
The statement of financial performance
does not include cost of goods sold.
Revenues Expenses = Net Profits
Retail Companies
Statement of Financial Statement of Financial
Position Performance
Inventoriable Sales Revenue
Costs
when deduct
Purchases of sales
occur Cost of
Inventory plus Inventory
Goods Sold
Freight-In
equals Gross Profit
deduct
Period Operating
Costs Expenses
equals Net Profit
Manufacturing Companies
Statement of Financial Statement of Financial
Position Performance
Inventoriable
Costs Sales Revenue
when deduct
Materials Finished sales
Inventory occur Cost of
Goods
Goods Sold
Inventory
equals Gross Profit
deduct
Work in
Period Operating
Process Costs Expenses
Inventory equals Net Profit
Manufacturing Company Example
Kendall Manufacturing Company:

Beginning and ending work-in-process
inventories were $20,000 and $18,000.
Direct materials used were $70,000.
Direct labour was $100,000.
Manufacturing overhead incurred was
$150,000.
What is the cost of goods manufactured?
Beginning work in process $ 20,000

Direct labour $100,000
Direct materials 70,000
Mfg. overhead 150,000 320,000
Ending work in process 18,000
Cost of goods manufactured $322,000
Kendall Manufacturing Companys

beginning finished goods inventory was
$60,000 and its ending finished goods
inventory was $55,000.
How much is the cost of goods sold?
Beg. finished goods inventory $ 60,000

+ Cost of goods manufactured 322,000
= Cost of goods available for sale $382,000
Ending finished goods 55,000
= Cost of goods sold $327,000
Kendall Manufacturing Company had

sales of $627,000 for the period.
How much is the gross profit?
Sales $627,000
Cost of goods sold 327,000
= Gross profit $300,000
Kendall Manufacturing Company had

operating expenses as follows:
Sales salaries and commissions $ 80,000
Delivery expense 10,000
Administrative expenses 30,000
Total $120,000
What is Kendalls net profit?
Gross profit $300,000

Operating expenses 120,000
= Net Profit $180,000
Flow of Costs through a
Manufacturers Accounts
Work in Process Inventory
Direct Materials Beginning inventory
Inventory + Direct materials used
Beginning inventory
+ Purchases and
+ Direct labour
freight-in
+ Manufacturing overhead
= Total manufacturing costs
= Direct materials to account for
available for use Ending inventory
Ending inventory = Cost of goods manufactured
= Direct materials used
Flow of Costs through a
Manufacturers Accounts
Finished Goods Inventory

Beginning inventory
+ Cost of goods manufactured
= Cost of goods available for sale
Ending inventory
= Cost of goods sold
Objective 6
Identify the benefits

of budgeting.
Benefits of Budgeting
requires managers to plan

promotes coordination
and communication
helps managers motivates employees to

evaluate performance achieve company goals
Components of the Master
Budget
Inventory
Inventory
Budget
Budget
____
____ ____
____
____ ____
____ ____
____
____
____ ____
____
____
____ ____
____ ____
____ ____
Sales
Sales Purchases
Purchases Cost
Costof
of Operating
Operating Budgeted
Budgeted
Budget
Budget Budget
Budget Goods
GoodsSold
Sold Expenses
Expenses Statement
Statementofof
____
____ ____
____ ____
____ ____
____ Budget Budget Financial
Financial
____ ____ ____ ____ Budget
____ ____ Budget
____ ____
____ ____
____ ____ ____ ____
____ ____ ____ ____ ____ ____ Performance
Performance
____ ____
____ ____ ____
____ ____ ____
____ ____
____ ____ ____
____ ____
____ ____
____ ____
____
____
____ ____ ____
____ ____ ____ ____ ____ ____
____ ____ ____ ____ ____ ____
____ ____ ____ ____
____ ____ ____ ____
____
____ ____ ____ ____ ____ ____ ____ ____ ____
____ ____
____
____
____ ____
Operating Budget
Components of the Master
Budget
Cash
Cash
Budget
Budget
_____
_____ _____
_____
_____ _____
_____ _____
_____
Budgeted Capital _____
_____ _____
_____
Budgeted Capital _____
Statement
Statementof
of Expenditures
Expenditures _____ _____
_____ _____
Financial Budget _____ _____ Financial Budget
Financial Budget_____
_____
Performance
Performance _____ _____
_____
_____ _____ _____
_____ _____
_____
_____
_____ _____
_____ _____
_____ _____
_____ _____ _____
_____ _____
_____ _____ _____
_____ Budgeted
Budgeted Budgeted
Budgeted
_____ _____
_____ _____ _____
_____ _____
_____ _____ _____ Statement
Statementofof Statement
Statement
_____
_____ _____ Financial of Cash Flows
Financial of Cash
_____ Flows
_____
Position
Position _____ _____
_____
_____ _____ _____
_____ _____
_____
_____
_____ _____
_____ _____
_____ _____
_____ _____ _____
_____ _____
_____
_____ _____
_____ _____ _____
_____
_____ _____
_____ _____
_____ _____
_____ _____
_____ _____
Preparing the Master Budget
(An expanded example in your textbook pages 838

45)
Suppose you manage Whitewater

Sporting Goods store No. 18.
Selected parts of the master budget will
be prepared for Store No. 18 for October,
November, December and January.
Sales are 60% cash and 40% on credit.

Credit sales are collected in the month
following the sale.
Accounts receivable on September 30
amounted to $16,000.
How much were total sales in Sept.?
$16,000 .40 = $40,000
Projected Sales
October. $50,000
November. $80,000
December.. $60,000
January.. $50,000
Whitewater maintains inventory equal to

$20,000 plus 80% of the budgeted cost of
goods sold for the following month.
Cost of goods sold averages 70% of
sales.
What is the ending inventory on Sept. 31?
$20,000 + (0.80 0.70 October sales of
$50,000) = $48,000
What is the beginning inventory in September?

$20,000 + (0.80 0.70 $40,000) = $42,400
Opening Inventory $ 42,400
Plus Purchases $?
Minus Closing Inv.$ 48,000
Equals COGS (70% x $40,000) $ 28,000
? = $ 33,600
Whitewater pays for inventory as

follows: 50% during the month of
purchase and 50% during the next
month.
September purchases were $33,600.
How much was paid in September for
Septembers purchases?
$33,600 50% = $16,800
Objective 7
Prepare an operating budget

for a company.
Sales Budget (Schedule A)
Sales revenue is the key measure of

business activity.
The budgeted total sales revenue for
each product is the sales price
multiplied by the expected number of
units sold.
Sales Budget (Schedule A)
Oct. Nov. Dec. Jan.

Cash sales 60% $30,000 $48,000 $36,000 $30,000
Credit sales 40% 20,000 32,000 24,000 20,000
Total $50,000 $80,000 $60,000 $50,000
Total sales Oct through Jan = $240,000
Purchases, Cost of Goods
Sold,
and Inventory Budget
Cost of goods sold = 70% sales
How much are the cost of goods sold for
November?
70% $80,000 = $56,000
What is the desired ending inventory for
October?
$20,000 + (80% $56,000) = $64,800
Purchases, Cost of Goods
Sold,
and Inventory Budget
Beginning inventory + Purchases
Ending inventory = Cost of goods sold
Cost of goods sold + Ending inventory

Beginning inventory = Purchases
Schedule B
Oct. Nov. Dec. Jan.

Cost of goods sold
(70% sales) $35,000 $56,000 $42,000 $35,000
Desired ending
inventory 64,800 53,600 48,000 42,400
Total required $99,800 109,600 90,000 77,400
Beginning inv. 48,000 64,800 53,600 48,000
Purchases $51,800 $44,800 $36,400 $29,400
Operating Expenses Budget
Assume that Whitewater incurs $5,200

of fixed expenses every month and that
commissions and other variable
expenses equal 20% of sales.
What is the operating expenses budget
(Schedule C)?
Operating Expenses
Budget
(Schedule C)
Oct. Nov. Dec Jan.
Variable expenses
(From Schedule A)
20% of sales $ 10,000 $ 16,000 $12,000 $10,000
Fixed expenses 5,200 5,200 5,200 5,200
Total $15,200 $21,200 $17,200 $15,200
Total wages and commission: $68,800
Budgeted Statement of
Financial Performance
Whitewater Sporting Goods Store No. 18
Budgeted Statement of Financial Performance
Four Months Ending January 31, 2005
Amount Source
Sales $240,000 Schedule A
Cost of goods sold 168,000 Schedule B
Gross profit $ 72,000
Operating expense 68,800 Schedule C
Net profit $ 3,200
Objective 8
Prepare the
components
of a financial budget.
Preparing the Financial
Budget
The financial budget includes:
Budgeted
Cash budget Statement of
Financial Position
Preparing the Cash Budget
The cash budget has the following major parts:

cash collections from customers (Schedule D)
cash disbursements for purchases (Schedule E)
cash disbursements for operating expenses
(Schedule F)
capital expenditures (not illustrated in this
chapter)
Cash Collections from
Customers
(Schedule D)
From Schedule A
Oct. Nov. Dec. Jan.
Cash sales $30,000 $48,000 $36,000 $30,000
Collections of last
months credit sales 16,000* 20,000 32,000 24,000
Total $46,000 $68,000 $68,000 $54,000
Total collections: $236,000
*16,000 = September 30 accounts receivable

Cash Disbursements for
Purchases
(Schedule E)
From Schedule B
Oct. Nov. Dec. Jan.
Payment of last
months purchases $18,800 $25,900 $22,400 $18,200
Payment of this
months purchases 25,900 22,400 18,200 14,700
Total $42,700 $48,300 $40,600 $32,900
Total disbursements: $164,500
Cash Disbursements for
Operating Expenses (Schedule
F)
From Schedule C
Oct. Nov. Dec. Jan.
Payment of last
months expenses $ 4,250 $ 5,000 $7,250 $ 5,750
Payment of this
months expenses 5,000 7,250 5,750 5,000
Rent and Misc. 4,500 6,000 5,000 4,500
Total $13,750 $18,250 $18,000 $15,250
Total disbursements: $65,250
Cash Budget
Whitewater Sporting Goods Store No. 18

Cash Budget
Four Months Ending January 31, 2005
Budgeted cash receipts $236,000
Budgeted cash disbursements
Purchases $164,500
Operating expenses 65,250 229,750
Budgeted cash increase $ 6,250
Preparing the Budgeted
Statement of Financial Position
Assets, liabilities, and owners equity are
projected based upon the previous
schedules.
Assume that the cash balance on
September 30 was $15,000.
What is the budgeted cash balance on
January 31?
$15,000 + $6,250 expected increase =
$21,250
Objective 9
Use sensitivity analysis

in budgeting.
Budgeting and Sensitivity
Analysis
Sensitivity analysis helps managers
plan for different courses of action.
This type of what if analysis shows the
result of changing an underlying
assumption in the budgeting process.
Sensitivity analysis may affect very
specific plans.
End of Chapter
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Introduction to

HORNGREN HARRISON BAMBER BEST FRASER WILLETT

1. Distinguish between financial accounting

5. Prepare the financial statements of a

Planning Acting Controlling

Distinguish between financial

Focus and Time Dimension

Describe the value

Research and Production or

Distinguish among full

What are product costs?

For external reporting, a retailers

For external reporting, manufacturers

Direct Direct Indirect Indirect

Prime Costs = Direct Materials + Direct Labour

Direct Indirect Indirect

Conversion Costs = Direct Labour

Prepare the financial

Revenues Expenses = Net Profits

Kendall Manufacturing Company:

What is the cost of goods manufactured?

Beginning work in process $ 20,000

Kendall Manufacturing Companys

Beg. finished goods inventory $ 60,000

Kendall Manufacturing Company had

Kendall Manufacturing Company had

What is Kendalls net profit?

Gross profit $300,000

Finished Goods Inventory

Identify the benefits

requires managers to plan

helps managers motivates employees to

(An expanded example in your textbook pages 838

Suppose you manage Whitewater

Sales are 60% cash and 40% on credit.

Whitewater maintains inventory equal to

What is the beginning inventory in September?

Whitewater pays for inventory as

Prepare an operating budget

Sales revenue is the key measure of

Oct. Nov. Dec. Jan.

Total sales Oct through Jan = $240,000

Cost of goods sold + Ending inventory

Oct. Nov. Dec. Jan.

Assume that Whitewater incurs $5,200

Total wages and commission: $68,800

The cash budget has the following major parts:

*16,000 = September 30 accounts receivable

Whitewater Sporting Goods Store No. 18

Use sensitivity analysis

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