Why is it a good idea to create a “budgeting assumptions” when creating a master budget?

0% found this document useful (0 votes)

43 views3 pages

Chap 8

Original Title:

chap 8

Uploaded by

Camilla Kaye Flores

Full description

Running Head: MASTER BUDGETING WITH IKEA; CASH DISBURSEMENT AND RECEIPTS 1

Master Budgeting with IKEA; Cash disbursement and receipts Managerial Accounting Sungah Byeon (5480015) Youngji Lee (5480106) Hyunjeong Lee (5480110) Suin Kim (5543030) Sehyun Lee (5543197) Jueun Gu (5543320) Sihyeong Ha (5543581) Keimyung Adams College

The Definition of ‘Master Budget’ A master budget is the aggregation of all lower-level budgets produced by a company’s various functional areas, and includes budgeted financial statements, a cash forecast, and a financing plan as well. The master budget is typically presented in either a monthly or quarterly format, and usually covers a company’s entire fiscal year. It is the central planning tool that a management team uses to direct the activities of a corporation, as well as to judge the performance of its various responsibility centers.

The Structure of ‘Master Budget’ The master budget consists of two main parts: a budgeted income statement and the budgeted balance sheet. More specifically, the budgeted income statement includes sales budget, cost of goods sold budget (including production budget, direct materials purchases budget, direct labor cost budget, manufacturing overhead cost budget) and selling and administrative expenses budget. And the budgeted balance sheet includes cash budget and capital expenditures budget. The following exhibit shows the relationship among the income statement budgets:

business or corporation, the company would have more trouble in understanding and modifying a master budget. The Beginning Balance Sheet Figure 1 is the balance sheet of IKEA for August 31, 2019. IKEA's Balance sheet is based on August 31, not the end of the year.

<Figure 1> The Budgeting Assumptions The budgeting assumption summarize the estimates and assumptions that provide the foundation for entire master budget. Also, it does not require adjusting data inputs within each master budget schedules. Formulas embedded in each of the budget schedules would automatically update the projected financial result.

In the figure 2, IKEA budgets quarterly sales at 55,000,000, 35,000,000, 25,000,000 and 45,000,000. Lot of sales are expected at first quarter and fourth quarter. It is budgeted selling

price is 155€ per product. The company expects to collect 60% of its credit sales in the quarter of sales, and the remaining 40% of credit sales will be collected in the quarter after sale. Also, IKEA will maintain ending finished goods inventory equal to 30% of the next quarter’s unit sales. The direct labor budget is that 0 direct labor-hours are required per product and the direct labor cost per hour is 14€. The variable overhead cost per direct labor-hour is 10€, the total fixed overhead per quarter is 55,000€ and the quarterly depreciation on factory assets is 27,250,000€. The budgeted variable selling and administrative expense per product is 2€ and fixed selling and administrative expenses per quarter include advertising, executive salaries, insurance, property tax and depreciation. IKEA expects to maintain a minimum cash balance each quarter of 150,000,000€. It plans to pay make quarterly equipment purchases of 330,000,000€, 200,000,000€ 120,000,000€ and 101,000,000€. It plans to pay quarterly dividends of 187,500,000€, and it expects to pay simple interest on borrowed money of 3% per quarter. For simplicity, IKEA assume that all quarterly estimates, except quarterly unit sales and equipment

purchases, will be the same for all quarters.

to collect 60% of this amount. The accounts receivable of 4,046,000,000€ that is collected in the first quarter. The company expects to collect the remaining 40% of this in the second quarter. Beginning accounts receivable is cash collections from last year’s fourth quarter sales. So, first quarter expects 9,161,000,000€ for total cash collections. The company expected total cash collections for 2020 are 26,056,000,000€. Uncollected fourth quarter sales appear as accounts receivable on the company’s budgeted balance sheet.

<Figure 3>

Production Budget The production budget is a next step of sales budget. Companies usually make budget for checking how much they should sell in next period and after that, plan how much they produce for achieving their goals. For this, they make a production budget.

And the determinations for production budget are budgeted unit sales, add desired units of ending finished goods inventory, total needs, less units of beginning finished goods inventory and required production in units. They are influenced by the desired level of the ending finished goods inventory which the number of production that company plan to manufacture in the period. Because if there is no budget for this, company could face the overstocked inventory and it would create storage problem and lead to lost sales and high costs.

Next, how can company budget it? For the case of IKEA, in figure 4, percentage of next quarter’s sales in ending finished goods inventory is 30 percent. This is the assumption and it means 30 percent of finished goods are sold in next quarter. The reason to choose 30 is because IKEA sells furniture and its expiration date is longer so it is easier to sell products in next quarter than candies whose company has 20 percent of it. With this condition, ‘desired units of ending finished goods inventory’ is computed by multiplying budgeted sales by the desired ending finished goods inventory. And since it is calculation about how much ending finished goods are sold in next quarter, the budgeted unit sales of next quarter is brought to ‘add desired units of ending finished goods inventory’ of this quarter.

From this way, we can calculate from budgeted unit sales to total needs. Budgeted unit sales are already introduced former presenter, from first quarter, 55 million, 35 million, 25 million and 45 million. Next, desired ending finished goods inventories are calculated as those. However, on 4th quarter, we assumed budgeted sales on next quarter as 53million because usually on the first quarter of year, sales are higher than following quarters so we assumed it as 53 million similar with 1st quarter of 2019. And as you can see, 4th quarter’s amount is same with the

<Figure 4> Direct Materials Budget A Direct Materials Budget is prepared after the production requirements have been computed. This 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 usually computed as: Required production in units of finished goods, units of raw materials needed per unit of finished goods, units of raw materials needed to meet production, add desired units of ending raw materials inventory, total units of raw materials needed, less units of beginning raw materials inventory, units of raw materials to be purchased, units cost of raw materials, and cost of raw materials. There are two basic calculations for direct materials budget. Adding raw materials required for production and planned ending inventory balance results total raw materials. When we get the total raw materials, deduct beginning raw materials inventory from total raw materials, which results raw materials to be purchased.

In the case of Direct Materials budget of IKEA, the numbers of required production in units are same as the final cost numbers of production budget. Then, multiply the production units cost by units of raw materials needed per production, which is assumed as 5, results units of raw materials needed to meet production. In first quarter of add desired units of ending raw materials inventory, bring numbers from the units of raw materials needed to meet production multiplied by 10%, which is the percentage of next quarter’s production needs in ending inventory. Then add two of them to get the total units of raw materials needed. In case of less units of beginning raw materials inventory, bring numbers from previous quarter units from add desired units of ending raw materials inventory. Then, add the total units of raw materials needed

with less units of beginning raw materials inventory, that results units of raw materials to be purchased. Our group assumed about 4 euros for the cost of raw materials per piece and multiplied with units of raw materials to be purchased, which results the cost of raw materials to be purchased.

<Figure 5> Continued from the direct materials budget, to find the expected cash disbursements of purchases of materials, our group assumed the beginning accounts payable as 5, 742,000, Euro. To calculate the first-quarter purchases, we brought first-quarter cost of raw materials to be purchased and multiplied by 50% each, which is our assumed percentage of purchases in the quarter and the quarter after purchase. That results 500,000,000 Euro for the first quarter purchases in first-quarter and the second-quarter. We do the same calculation until the fourth- quarter purchases. For total cash disbursements for materials, sum the units for each column and add everything to find the year budget of direct materials budget.

Direct Labor Budget Moving on to the Direct Labor Budget, this budget shows the direct labor-hours required to satisfy the production budget. It is useful for anticipating the number of employees who will be needed to staff the manufacturing area throughout the budget period. The basic calculation used for the direct labor budget is to multiply the units to be produced by the direct labor time needed to make each unit. Then, multiply the result by the average direct labor cost per hour.

<Figure 7> In the case of Manufacturing Overhead Budget of IKEA, the budgeted direct labor hours is equal to total direct labor-hours needed. After bringing those numbers, multiply them with variable manufacturing overhead rate, which is 10%, that results variable manufacturing overhead. Then, our group assumed the fixed manufacturing overhead as 55,000 and add them with the variable manufacturing overhead to get the total manufacturing overhead. IKEA’s depreciation per quarter is 27,250,000 and deduct the depreciation from total manufacturing overhead which results cash disbursements for manufacturing overhead. From the total manufacturing overhead and budgeted direct labor-hours, we can find predetermined overhead rate for the year. When dividing the total manufacturing overhead by the direct labor-hours and get the predetermined overhead rate for the year, the numbers are calculated correctly. These were the direct materials budget, direct labor budget, and manufacturing overhead budget of IKEA.

The Ending Finished Goods Inventory Budget The ending finished goods inventory budget calculates the cost of the finished goods inventory at the end of each period, and it requires three main costs: direct materials, direct labor,

and overhead allocation. This budget is to help determine cost of goods sold on the budgeted income statement and to value ending inventories on the budgeted balance sheet. Also, this budget contains the computation of cost of unsold units.

To budget this ending finished goods inventory in euros, companies should multiply the quantity of each items (direct materials, direct labor, manufacturing overhead) with cost of each items, and then sum all of them as total. Then, multiply the total with the ending finished goods inventory.

Applying this method to the budget of IKEA, the quantity of direct materials and the cost of direct material per piece are multiplied. Then, the direct labor hours and the cost per hour of direct labor are multiplied, and same process with manufacturing overhead. Finally, the unit production cost will be calculated, which is 36 euros. Previously calculated ending finished goods inventory in products, which was 15 million should be multiplied with calculated unit product cost. Then, the ending finished goods inventory in euros, about 585 million euros should be.

Applying this method to the budget of IKEA, the variable selling and administrative expense are calculated by multiplying budgeted units sales with the variable selling and administrative expense per product by quarters. To calculate the fixed selling and administrative expenses, advertising expenses, executive salaries, insurance, property taxes and depreciation by quarters should be summed. Then variable selling and administrative expenses should be added to reach the total selling and administrative expenses. But to get cash disbursements for selling and administrative expenses, the depreciation must be subtracted, which is a form of noncash expenses.

<Figure 9> Cash Budget The master budget concludes with the preparation of a cash budget. A cash budget is a detailed plan showing how cash resources will be acquired and used over a specified time- period. Also, it is an estimation of the cash flows for a business over a specific period of time. This budget is used to assess whether the entity has sufficient cash to operate. Its primary

purpose is to provide the status of the company’s cash position at any point of time. This helps the company make critical decisions such as creating cash reserves to make arrangements for projected shortages and using excess funds prudently. Additionally, the cash budget helps in prioritizing payments in the budget period. These cash budget is composed of four main sections. First is the cash receipts section. It lists all of the cash inflows, except from financing, expected during the budget period. The cash disbursements section is all cash payments that area planned for the budget period. It is composed of direct materials, selling and administrative and dividends and so on. Next is the cash excess or deficiency section, if a cash deficiency exists, the company will need to borrow money. And, if a cash excess occurs, the company can invest the excess funds or repay principal and interest to lenders. Lastly the financing section details the borrowings and principal and interest repayments.

Based on the previous calculations, the company can make a cash budget of IKEA for August 31, 2020.

for the next quarter. The way of calculation of quarter 2,3 and 4 are same with quarter 1. The beginning cash balance for the year is the same as the beginning cash balance for the first quarter and ending cash balance for the year is the same as the ending cash balance for the fourth quarter. The results of calculating each quarter’s cash are shown that the company will not need to borrow money during that period. In this case, the company can invest the excess funds and have opportunities for company expansion, which are positive signals to current and potential investors.

Cash budgeting is vital to an organization because it allows them to ensure they have enough cash on hand to cover periods of increased expenses and unforeseen circumstances in the market. The cash budget highlights a company’s probable income or deficit for a period, in deficit situation, the company must address by increasing sales or decreasing expenditures. By predicting cash requirements, a company can also evaluate future business opportunities in part based on an opportunity’s probable financing needs and costs. This process allows a company to select only those organizational goals that are financially feasible. Thus, the company has to use cash budget in order to predict the funding problems, create more outcomes and expand investment opportunities.

Feedback and Suggestion for Ikea from Master Budgeting According to the Cash Budget, direct material has the most significant portion among of the other budgets. This is because, Ikea is a furniture company, so there are a lot of costs involved in manufacturing furniture. As a result of Master Budgeting, including a few assumptions which our group made, there may be a suggestion for the Ikea company. Since the cost of raw materials accounts for a large portion of the Budget, our group think focusing on raw

materials rather than focusing on other costs would be a way to get a little more revenue to Ikea, considering how to bring raw materials in large quantities at a slightly lower price than before, or better quality at similar prices. Because if Ikea produces more furniture or produces better quality of furniture, Ikea can earn higher profits from the customers.

Importance of Master Budgeting Our group uses the given financial data and some assumptions to make the precedent part of Master Budgeting, about budgeted income statement: such as Sales budget, Production budget, Direct materials budget, Direct labor budget, Manufacturing overhead budget, Selling and administrative expense budget, etc. Budgets have interconnection to each other. Therefore, all budgets should be considered together to assign properly. Also, all of these steps could be viewed as playing a very significant role in creating a foundation of business because the rest steps of the Master Budgeting are complete with the rest of the master budgeting. Additionally, to the larger scale of the business and the more challenging the company, it is essential that the more accurate the master budgeting, and the more efficient execution of their budgets. For example, companies such as Toyota, Starbucks, and Apple are running master budgeting based on their financial reports.

Limitations and Problems of Master Budgeting It would be a perfect business if all the budgets are allocated and planned efficiently, but a few problems and limitations could arise in the course of Master Budgeting. This problems and limitations are usually related to the employee’s compensation. When a company makes a master budget for quarter or year, it tends to include budget objectives closely stick to their compensation plan, especially for senior management. Executing master budget has several

Why is it a good idea to create a budgeting assumption tab when creating a master budget in Microsoft Excel?

Why is master budgeting important?

Why is the cash budgeting so important in the master budgeting process?

What is the most important part of a master budget?