What is an Operational Budget?

Chapter 23: 

Discussion question 4, page 1018 

Identify at least five budgets or schedules that are often included in the master budget of a manufacturing business. 

Sales budget. 

Production budget 

Direct materials budget 

Cash payments budget 

Combined cash budget 

Budgeted balance sheet 

Discussion question 5, page 1018 

List in logical sequence the major steps in the preparation of a master budget 

Preparation of sales forecast 

Preparation of operations budget 

Budgeting of capital budgets 

Preparation of financial budget which include the cash budget, 

Preparation of budgeted income statement 

Preparation of budgeted balance sheet 

Discussion question 6, page 1018 

Why is the preparation of a sales forecast one of the earliest steps in preparing a master budget? 

Preparation of the sales forecast is the first step in the budgeting process because many budgeted amounts such as the production levels, manufacturing costs, operating expense, and cash payments and receipts usually depend on the projected volumes in sales. 

Exercise 23.4, page 1021 

Safe n Bright Inc., Budget. 

Product schedule in units for Safe ‘n’ Bright 

Budgeted Sales (units)	5,500
Target Ending Inventory	480
Units budgeted to be available for sale	5,980
Less: Beginning Inventory	(620)
Planned Production	5,360 doors

Direct materials purchase budgets for steel and glass 

Steel: 5,360 doors x 20 pounds/door = 107,200 lbs 

Glass: 5,360 doors x 6 square feet/door = 32,160 sq. ft 

Materials Purchases Budget: 

	Steel	Glass
Direct Materials Used	107,200 lbs	32,160 sq. ft.
Target Ending Inventory	80,000 lbs.	4,000 sq. ft.
Direct Material Available for use	187,200 lbs	36,160 sq. ft.
Less: Beginning Inventory	(40,000) lbs	(6,000) lbs
Raw Materials to be purchased	147,200 lbs.	30,160 sq. ft.
x Budgeted purchase price per unit	x $4	x $2
Budgeted Direct Materials Purchases	$588,800	$60,320

Safe ‘n’ Bright may decide to increase the ending inventory level of steel if the price of steel this year is expected to be lower than that of the coming year. However, this cost saving should be higher than the capital costs and increased storage associated with the large amounts of inventory. A decrease in glass inventory may be required to accommodate storage requirements as a result of the increased amount of steel. Glass is fragile and can be difficult to store. Doing this might minimize the amount of losses as a result of breakage and costs associated with the storage. 

Problem 23.6A pages 1026–1027 

Jake Marley, owner of Marley Wholesale. 

Monthly cash budget 

MARLEY WHOLESALE  Cash Budget  For Third Quarter of Current Year
Cash Balance at the beginning of the month	20,000	168,000	53,400
Receipts
Bank loan	194,000
Collections on receivable (Schedule 1)	120,000	280,000	345,000
Total cash Available	334,000	448,000	398,400
Disbursements
Purchase of equipment	16,000
Payments on accounts payable	150,000	394,600	235,900
Total disbursements	166,000	394,600	235,900
Cash balance at the end of the month	168,000	53,400	162,500

b. From the three-month budget, Marley will not be able to pay the bank the full amount of $200,000 due to the loan taken on September 30. The projected cash balance is expected to be $162,500 and he may reduce the loan by $140,000 to $150,000 based on the minimum cash balance required for operation. He can choose to either ask for an extension of time beyond September 30 to repay a part of the loan or find a new financing source. 

Problem 23.7A pages 1027–1028 

Four Flags is a retail department store. 

The schedule of comparison is shown below 

FF retail department store  Comparison of Flexible and Actual budgets
Particulars	Flexible	Actual	Over/ (under)
Net sales	$10,500,000	$10,500,000	$0
Less Cost of goods sold	$(6,300,000)	$(6,180,000)	$(120,000)
Gross profit	$4,200,000	$4,320,000	$ 120,000
Less Administrative and selling expenses
Selling and promotion	$ (1,071,000)	$ (1,020,000)	$ (51,000)
Building occupancy expenses	$ (417,000)	$ (420,000)	$ 3,000
Buying expenses	$ (570,000)	$ (594,000)	$ 24,000
Delivery expenses	$ (216,000)	$ (183,000)	$ (33,000)
Administrative expenses	$ (562,500)	$ (564,000)	$ 1,500
Total Operating expenses	$(2,929,500)	$ (2,871,000)	$ (58,500)
Operating Income	$ 1,270,500	$ 1,449,000	$(178,500)

The operating income was better than the budgeted income by $178,500. The result could have been caused by different factors such as; 

A better purchase performance than the initial budget 

A better expenditure performance than the initial budgeted. 

Reduced delivery expenses than the initial budgeted 

Reduced credit and collection expenses 

Better performance through building occupancy expenses, buying expenses, and general administrative expenses. 

In case the over expenditure for buying expenses and favorable cost of goods sold performance are related, then the net effect would be favorable. The company has realized savings through merchandise costs by spending less on buying realizing the anticipated gross profit. While the expenditures were $51,000 less than the budget, the actual sales were $1,500,000 less than the initial forecast. This questions whether the selling and promotion benefited the company. The management may carefully investigate the advertising strategy in order to find additional investment and savings options. The actual credit and collection expenses were lesser than that planned. These changes could have been due to an unusual savings achieved or having budget estimates that were unrealistic. 

Case 24.1, It’s Not My Fault 

The standard cost system involves a comparison of the standard cost of a product with the actual cost. An increase in the overtime premium would have caused an increase in the actual labor leading to an unfavorable variance in the labor rate. An unfavorable variance can result in another favorable variance. For the given problem, the volume variance would be favorable due to the increase in hours. The production manager would be responsible by netting the labor rate and the volume variance. 

One recommendation is that even though the labor rate may remain negative, the cost should not have been charged to the production manager. Instead, it should have been charged to a specific order. Another recommendation is that the overtime premium could have been charged to the general factory overhead pool.