Elements of Master Budget

In the current era, all business organisations have to incur different types of costs and this mandates the need for forming different types of budgets in order to keep track of the actual and estimated expenses. In this context, Armitage, Webb and Glynn (2016) advocated that a budget is a detailed future plan, which is usually denoted in formal quantitative terms. Thus, budgets help in communicating the plan of the management throughout the organisation. The aspect holds good for all ASX listed organisations and in order to meet the purpose of this report, Alpha HPA Limited is taken into consideration. It is an ASX listed organisation, which is involved in acquisition, exploration and mineral deposits development in Australia and Indonesia (Collerinacobalt.com.au 2019).

This report would provide a brief overview of the different elements of master budget. The second section would focus on comparing the top-down and bottom-up approach to the budget process and accordingly, the most suitable approach for Alpha HPA Limited would be considered. Finally, the report would shed light on developing the budgeted income statement for the concerned organisation for 2019 based on the actual data disclosed in its income statement in 2018 and accordingly, the impact of the changes owing to the projections made would be analysed.

In the words of Barr and McClellan (2018), master budget is a plan developed to manage the manufacturing and sales activities of an organisation for fulfilling profit and cash flow objectives. In order to develop a successful master budget, the different elements of the master budget need to be prepared in the initial stage accurately. In this way, master budget is deemed to be realistic; however, it is not complacent. The master is generally represented in either monthly or quarterly format and thus, it covers the full accounting year of an organisation. More precisely, a master budget acts the tool of central planning that a management team utilises in directing the activities of an organisation along with judging the performance of various responsibility centres. It is necessary for the top management in reviewing various iterations of the master budget along with including modifications until a budget is arrived at for accomplishing the desired outcomes (Baiman 2014). The master budget consists of a number of elements, which are illustrated in the form of a figure as follows:

Figure 1: Various components of the master budget

(Source: Noreen, Brewer and Garrison 2014)

Sales Budget

The above elements in the figure are discussed briefly as follows:

The most crucial component of the master budget is deemed to be sales budget, as it paves the path for the preparation of other elements associated with the master budget. By multiplying the selling units with the estimated per unit price, the total sales revenue for the period is calculated (Butler and Ghosh 2015). The influence of sales budget is either direct or indirect on the other elements of master budge as well. This is because the overall sales figure obtained from the sales budget is used in the form of a base figure in the budgets of the other components such as production budgets, pro-forma income statement, schedule of customer receipts and others. As the other master budget elements depend on sales budget, the expected selling price per unit and volume need to be predicted with adequate care, which mandates the employment of reliable forecast techniques (Otley 2016). In opposition, the master budget would not be effective for control and planning. The following format is used for sales budget:

Table 1: Format of sales budget

(Source: Horngren and Harrison 2015)

Production budget:

Production budget provides an overview to the business owners regarding the number of units to be manufactured for meeting selling needs and ending inventory requirements. The needed production is ascertained by deducting the opening finished goods inventory from the overall expected sales and planned closing inventory of the year (Dopson and Hayes 2016). After sales budget, it is necessary to prepare production budget, since it requires the estimated sales units from the sales budget. The following format is used for production budget:

Table 2: Format of production budget

(Source: Horngren and Harrison 2015)

Direct materials budget:

Direct materials budget computes the quantity of material needed for meeting the production budget, which might be either monthly or quarterly. Since the budgeted production figure is provided by the production budget, the production budget needs to be prepared at first for preparing the direct material purchases budget. The following format is used for direct materials budget:

Table 3: Format of direct materials budget

(Source: Horngren and Harrison 2015)

Direct labour budget indicates a budget of estimated expenditures in relation to direct labour. It assists the management in planning its labour force needs. It is deemed to be an element of master budget, as it is developed after the preparation of production budget (Shields 2015). This is because the budgeted production in units that the production budget has provided acts as the starting point in direct labour budget. The following format is used for direct labour budget:

Production Budget

Table 4: Format of direct labour budget

(Source: Horngren and Harrison 2015)

A manufacturing overhead budget indicates all cost by keeping aside direct materials and direct labour to be incurred by an organisation or any department in an accounting period (Finkler, Smith and Calabrese 2019). This budget is deemed to be an operational budget included in the master budget of an organisation. It has two sections, which include variable manufacturing costs and fixed manufacturing costs. For instance, the variable costs mainly include fuel, electricity, suppliers and others, while the fixed costs constitute of depreciation, rent and others planned for the period. The following format is used for manufacturing overhead budget:

Table 5: Format of manufacturing overhead budget

(Source: Horngren and Harrison 2015)

It could be defined as a schedule of planned operating costs except production cost. It is an element of master budget and all organisations irrespective of their type and nature prepare this budget before the budgeted income statement is prepared (Greenberg and Wilner 2015). This budget divides expenses into selling costs and administrative costs. Both these expenses could have variable and fixed costs. For instance, sales commission is a variable selling expense, while sales salary is classified as fixed selling expense. In a similar manner, depreciation on machinery is a fixed administrative expense, while utilities expense is a variable administrative expense. With the help of activity-based costing system, selling and administrative expenses budget could be prepared correctly, as these expenses tend to differ with different kinds of activities. The following format is used for selling and administrative expenses budget:

Table 6: Format of selling and administrative expenses budget

(Source: Horngren and Harrison 2015)

This budget is prepared for computing the cost of finished goods inventory after the completion of each budget period. The aim of preparing this budget is to provide the inventory amount to be included in the budgeted balance sheet, which is then used for ascertaining the cash required for investment in assets (Järvinen 2016). The following format is used for ending finished goods inventory budget:

Table 7: Format of ending finished goods inventory budget

(Source: Horngren and Harrison 2015)

This is a financial budget prepared for computing the expected outflows and inflows of cash in a period and the expected cash balance as soon as the period is over. With the help of cash budget, it becomes possible to ascertain any additional cash shortage or idle cash estimated during the period and accordingly, the managers could conduct effective planning (Kaplan and Atkinson 2015). The following format is used for cash budget:

Direct Materials Budget

Table 8: Format of cash budget

(Source: Horngren and Harrison 2015)

The statement of profit and loss and statement of financial position are included in the budgeted financial statements. With the help of budgeted income statement, it becomes easy to test whether the estimated financial outcomes of an organisation seem to be reasonable. When the same is used in combination with the budgeted balance sheet, certain scenarios are revealed, which are not financially supportable and accordingly, the management could undertake necessary measures through alterations of the budget assumptions. The following formats are used for budgeted income statement and budgeted balance sheet:

Table 9: Format of budgeted income statement

(Source: Horngren and Harrison 2015)

Table 10: Format of budgeted balance sheet

(Source: Horngren and Harrison 2015)

All business organisations mainly use one out of two budgeting techniques, which include top-down and bottom-up budgeting approaches. Bottom-up approach initiates from the lowest level in an organisation and it works its way up in formulating a budget (Khalil and Simon 2014). On the other hand, top-down budgeting starts from the management and it works its way down to lower-level units.

This process of budgeting initiates with the smallest elements of an organisation, mainly lower-level individual projects, for collective creation of a budget for the concerned organisation. In order to initiate the bottom-up approach of budgeting technique, it is crucial to review the steps required for conducting an individual project along with associating a cost to each step (Klemstine and Maher 2014). Moreover, it is necessary to conduct market research for ascertaining costs, if the organisation has not completed a similar project before. After this, the cost for each project needs to be added up to arrive at the total figure. This process needs to be conducted for each organisational level. For this, the managers on each level need to provide their inputs, which would assist them in gaining knowledge of the cost of the projects falling under their supervision (Weygandt, Kimmel and Kieso 2015). Therefore, for preparing the annual budget, all the monthly budgets needed to be added up for the year.

One of the primary benefits of this technique is that this budgeting technique could plan accurately all the phases of the project. This approach generally involves individuals of different levels within an organisation, which is a benefit for most organisations owing to the fact that it boosts the morale of the staffs (Krstevski and Mancheski 2016). However, one of the primary drawbacks of this budgeting approach is that budget could be overstated easily. This implies that lower-level participants might ask for additional money than required. Another drawback of this technique is that it would be easy to overlook a step in the process, which could lead to miscalculation of the budget needs.

Direct Labour Budget

Even though bottom-up budgeting is more common, some government agencies and organisations are abandoning conventional budgeting approaches for enforcing the top-down process. This budgeting approach initiates the process by projecting the cost of greater-level tasks within an organisation. The management has prepared the budgets and lower-level staffs do not have adequate input in the process. The management formulates the guidelines for the budgeting approach and guidelines are based potentially on estimated levels of sales or expenditure (Makrygiannakis and Jack 2016).

A benefit of top-down budgeting is that it could formulate organisational principles. For instance, if the management has budgeted estimated sales, it would motivate the staffs to carry out in a way so that the goals are accomplished. However, this approach has a major drawback, in which the lower-level staffs are excluded usually from the process, which could make them feel like the imposition of a budget on them against their will. This has the chance of weakening the morale of the staffs (Meyer and Meyer 2014).

Although both the budgeting approaches have a number of benefits as well as drawbacks, Alpha HPA Limited is advised to use the top-down budgeting approach for preparing the necessary budgets in order to support its business operations effectively. With the help of this approach, the organisation could design the needed level of income and expenses, which could be incurred in the accounting period.

For preparing the budgeted income statement for Alpha HPA Limited for 2019, the following assumptions are made:

• Sales revenue is expected to rise by 10%, as the company has no sales revenue, other income is estimated to rise by 10%
• The company has no cost of goods sold and thus, the assumption of rise in cost of goods sold would not be applicable in this case
• All line items of expenses including finance expenses are projected to increase by 2%
• For computing the income tax expense, the corporate tax rate of Australia, which is 30%, is taken into consideration. However, as the organisation has suffered loss before income tax expense, it is not possible to compute income tax expense for the projected year.  

The budgeted sales revenue could be accomplished by Alpha HPA Limited after it implemented considerable marketing tactics for raising the overall demand of its products. The organisation desires an expected increase in other income, since it would help the management in acquiring the considerable cash flows to provide support to the cash outflows. It is evident from the above table that the budgeted net income at the end of the period is deemed to be negative for Alpha HPA Limited in 2019, which shows significant decline its financial performance. As pointed out by Miller-Nobles, Mattison and Matsumura (2016), the budget process could have unfavourable effect on the business operations of an organisation in the absence of sufficient research at the time of preparing the master budget.  

By using the data from the income statement of Alpha HPA Limited in 2018, the projected income statement for the next year has been prepared accordingly. From the analysis, it has been found out that the net income in the budgeted income statement of 2019 has increased considerably owing to the increase of 10% in other income. Such increase in other income has assisted in generating cash inflows so that the organisation could cover its cash outflows or expenses (Mih?il? 2014).

Manufacturing Overhead Budget

The main reason behind such rise in other income is due to the assumption made of 10% increase for preparing the budgeted income statement. However, the rise in other expenses by 2% has resulted in further deterioration of overall operating income for the concerned organisation. Due to this, there has been significant decline in operating profit (loss) of the organisation from ($2,029,874) in 2018 to ($2,067,926) in 2019 (Collerinacobalt.com.au 2019). The budgeted income statement of Alpha HPA Limited comprises of a number of expenses, which has decreased the overall cash inflows in the year 2019. These expenses have represented relatively the rise in total cash outflows that would be conducted during 2019 estimated in the budget. The following expenses are inherent in case of Apha HPA Limited:

• Administration and consultant expenses
• Audit and other professional fees
• Depreciation and amortisation expenses
• Directors’ and company secretarial fees
• Exploration and evaluation expenditure- pre-licence costs
• Legal fees
• Share based payment
• Loss on sale of subsidiary
• Impairment loss- exploration and evaluation expenditure
• Finance income
• Finance expense

By considering all the above aspects, it could be stated that the entire changes in the budgeted income statement of Alpha HPA Limited are exaggerated relatively, which has result in minimised net income of the organisation from ($1,834,498) in 2018 to ($1,868,643) in 2019. The income tax expense for the budgeted year of 2019 would be nil, as the organisation has suffered loss before income tax expense in the budgeted year as well as in the actual year. Therefore, the budgeted values generated in the above table are definitely more than the actual figures disclosed in the budgeted financial statement of Alpha HPA Limited in 2018. Moreover, the increased expenses that the organisation has incurred in 2018 would not be minimised in 2018 owing to the assumption of 2% increase in all relevant expenses. Hence, the budget is required to be prepared on pertinent growth that is generated on the past fiscal year used on the part of the organisation (Shcherbina and Tamulevi?ien? 2016).

Conclusion:

The above analysis has assisted in understanding the importance of the budgeting process, which the organisations could utilise for identifying total income and expenses expected to be incurred in the upcoming periods. Moreover, the financial performance of Alpha HPA Limited is evaluated mainly for formulating the budgeted income statement, which would provide support to the cash inflows and outflows in the next accounting periods. Along with this, the significant elements of the master budget are discussed in this report. It has been analysed that master budget plays a crucial role in the budget process, since it assists the business organisations in formulating essential budgets for the upcoming accounting periods. By using the income statement of Alpha HPA Limited in 2018, the budgeted income statement for the organisation in 2019 has been prepared, which would assist in identifying the relevant income and expenses for the organisation.

Selling and Administrative Expenses Budget

From the analysis of bottom-up and top-down budget approaches, the elements of the master budget could be prepared so that the future operations of the business organisations could be supported adequately. By analysing these two approaches, the top-down budget approach is deemed to be favourable for Alpha HPA Limited, as it would aid the management of the organisation in conducting its business operations effectively. With the help of budgeted income statement, it becomes easy to test whether the estimated financial outcomes of an organisation seem to be reasonable. When the same is used in combination with the budgeted balance sheet, certain scenarios are revealed, which are not financially supportable and accordingly, the management could undertake necessary measures through alterations of the budget assumptions. Finally, the evaluation of financial performance has been conducted in the report, which has assisted in identifying the level of improvements carried out by the organisation.

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