The Master Budget and its Role in Planning and Controlling Manufacturing Costs

Introduction

A budget is a financial plan that includes financial and non-financial details in cost accounting. The most obvious characteristics are expected to be projected revenue and expenses. The budget can also include non-financial details such as how many people you think that they are working.

Budgeting is a forecasting tool, but companies often use it as a financial monitoring tool. Financial control is a tool for tracking company activities. One control is to review your spending to ensure that you do not exceed your budget. Sometimes a company (or division within it) cannot invest more than intended. A budget is what is shared with outside parties who need your budget information. The bank where you got a loan may want to confirm your financial budget. In some cases, a government regulatory agency may want to review your budget.

The budget system has main objectives:

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1. Planning: The Budget’s simplest objective is to establish an action plan.
2. Communication and coordination: Each manager must be aware of the plans formed by the other managers within the organization
3. Resource Allocation: Budgets are an essential way of allocating money around the different uses.
4. Control and performance evaluation.
5. Stimulating individuals and divisions.

Meaning of Budget

An estimate of revenue and expenditure for a given period of time is normally collected and checked annually. Budgets can be made for an individual, a group of people, a company, a government or anything else that makes and spends money.

The Budgeting Process

Should be started early in the year preceding the budget year. The organizational structure of an entity, the size and complexity of its administrative structure, and the level of centralization in budget development will affect the budget development process and the time required to adopt the final budget document.

The Steps of Budget Process Consists of

The advantages of budgeting: An important step in the initiation of the company’s strategic plan is the creation of a budget. A good budgeting system will help a company reach its strategic goals by allowing management to plan and to control major categories of activity, such as revenue, expenses, and financing options. And it has some benefits such like: It’s a systematic way of communicating plans for an enterprise to internal stakeholders, such as directors, department managers and those responsible for managing the success of the company.

Preparing a budget requires managers to consider and evaluate the budget planning assumptions, financial objectives for the long term, financial goals for the short term, the role of the product on the market and how every ministry supports the strategic plan.

1. The master budget: is a one-year budget planning document for the firm encompassing all other budgets. It coincides with the fiscal year of the firm and can be broken down into quarters and further into months. If the firm plans for the master budget are to be an ongoing document, rolling from year to year, then normally a month is added to the end of the budget to facilitate planning. It is called continuous budgeting. And it contains the operating budget and the financial budget.
2. The operating budget: It shows income, including revenue and expenses, generated by the operations of the firm and it’s interrelated and connected to develop the income statement. It is important to note that operating revenues are not the same as net income, so you have to separate the financial budget to achieve a real net income.
3. The financial budget: shows the inflows and outflows of cash and other parts of the firm’s financial position. In-comings and outgoings of cash come from the cash budget and as such, the result of the financial budget is the budgeted balance sheet.

Also, there are three types of costs that are used to produce any product that called (Manufacturing Costs).

What are the manufacturing costs: are costs that are incurred to create a product that is intended for sale to customers. Product costs include direct material (DM), direct labor (DL), and manufacturing overhead (MOH).

1. Direct Material cost: The cost of raw materials or components directly into the production of products shall be direct material costs. For instance, if Company A is a toy manufacturer, the plastics used to make the toys will be an example of a direct material cost.
2. Direct Labor cost: Direct labor costs are paid to employees who are directly involved in the manufacture and distribution of the goods — e.g. assembly line employees or others who produce the products using the machinery.
3. Manufacturing overhead costs: costs include direct factory-related costs that are incurred in the production of a product, for example machinery costs and machinery operation costs.

Overhead production costs include certain indirect costs, for example: the indirect labor and indirect material costs.

Indirect materials: are materials which are not traceable directly to the product and which are used in the manufacturing process. For instance, glue, oil, tape, supplies of cleanliness, etc. are classified as indirect.

Indirect labor: is the task of those not interested directly in the manufacture of products. Security guards, managers and quality control workers in the factory will be an example. They would be classified as indirect labor costs for wages and benefits.

The Role of Budgeting in the Organization

Some managers, especially management consultants, criticize the budgets for requiring extra effort and wasting time, saying that there are so many estimates in the budget and that such estimates are inaccurate to support. But every large organization plans budgets, because it’s prompting managers to forecast, analyzing patterns and developing the strategies required. The budget can also prevent inevitable problems. Budgets are useful planning devices, which illustrate the period’s organizational and financial target.

Also, it can transmit to the upper and middle management which reflect the aspirations of top management and communicate the objectives of management to the lower levels. In certain situations, it can allow a manager to make other funds available but it can be limited budget, and set internal services rates and is the basis for an assessment of the results.

Summary

A budget is a financial plan that includes detail on both financial and non-financial costs.

There are many types of budgets and the important one of them is the master budget that consists of a projected income statement (planned operating budget) and a projected balance sheet (financial budget) showing the organization’s objectives and proposed ways of attaining them.The expected income statement or operating budget is therefore the appropriate starting point for planning a master budget.

But because the planned budget reflects the net effect of all of the interconnecting operations, before drawing up the expected operating budget the management will prepare many support budgets (sales, production and purchases, to name a few), the process starts from the sales budget .The sales budget: requires an estimate or prediction of the amount of demand for the product in a business and then calculation of whether a reasonable profit based on this demand can be achieved.

Directly after developing the sales budget, the next task in developing the operating budget is to put together the production budget. The production budget tells the business owner how many units of the product to produce to meet sales needs and ending inventory requirements, there are three parts to the production budget:

1. The direct material budget: That covers the raw materials needed for the company’s production process.
2. Direct labor budget: The budgeted hours for direct labor are determined by the relationship between labor and output.
3. The overhead budget: is all about that from production, which is not included in direct purchases of materials and direct labor budgets costs that differ with direct labor are referred to as variable overhead.

References

1. Accounting Principles, Prepared by Coby Harmon University of California, Santa Barbara Westmont College.
2. Avis Jo, (2009), Performance Management, Elsevier Ltd, UK.
3. Jan Irfanullah (2011-2013), Master Budget, retrieved on Monday 23rd November, 2015.
4. Master budget: What is it and why is it important? 22 November 2019, article by author Ash Baggett.
5. Miller Gerald J, Hildreth W. Bartley & Rabin Jack (2001), Performance-Based Budgeting.