After sales are budgeted, the production budget can be determined. But before going to the production budget, for simplification purpose, let’s use the following assumption:
- The company uses a single material and one type of labor in the manufacture of the product.
- It prepares a master budget on a quarterly basis.
- Work-in-process inventories at the beginning and end of the year are negligible and are ignored.
- The company uses a single cost driver—direct labor hours (DLH)—as the allocation base for assigning all factory overhead costs to the product.
And here is the sales budget (for easier reference):
The Production budget is a statement of the output by product and is generally expressed in units. It should take into account the sales budget, plant capacity, whether stocks are to be increased or decreased, and outside purchases. The number of units expected to be manufactured to meet budgeted sales and inventory requirements is set forth in the production budget.
The production budget is illustrated as below:
- Planned Sales: It is pulled from the “Sales Budget (Expected Sales)”
- Desired Ending Inventory : It is decided by the management, on this example Royal Bali Cemerlang policy put 10% of the next quarter’s sales (it may vary for your company).
- Total Need = Planned Sales + Desired Ending Inventory.
- Beginning Inventory: pulled from previous quarter ending inventory (previous book).
- Unit To Be Produced = Planned Sales + Desired Ending Inventory – Beginning Inventory
Inventory Purchases, Merchandising Firm
Royal Bali Cemerlang is a manufacturing firm, so it prepares a production budget, as shown above. If the company were a merchandising (retailing or wholesaling) firm, then instead of a production budget, it would develop a merchandise purchase budget showing the amount of goods to be purchased from its suppliers during the period. The merchandise purchases budget is in the same basic format as the production budget, except that it shows goods to be purchased RATHER THAN goods to be produced as shown on below example:
Next, let’s go head to “Direct Material Budget”…
Direct Material Budget
When the level of production has been computed, a direct material budget should be constructed to show how much material will be required for production and how much material must be purchased to meet this production requirement.
The purchase will depend on both expected usage of materials and inventory levels. The formula for computation of the purchase is:
Purchase in units = Usage + Desired ending material inventory units – Beginning inventory units
Here is the Direct Material Budget:
The direct material budget is usually accompanied by a computation of expected cash payments for materials. As shown below:
Next is Direct Labor and Factory Overhead Budget………………….
Direct Labor Budget
The production requirements as set forth in the production budget also provide the starting point for the preparation of the direct labor budget. To compute direct labor requirements, expected production volume for each period is multiplied by the number of direct labor hours required to produce a single unit. The direct labor hours to meet production requirements is then multiplied by the (standard) direct labor cost per hour to obtain budgeted total direct labor costs.
Below is the Direct Labor Budget illustration:
Factory Overhead Budget
The factory overhead budget should provide a schedule of all manufacturing costs other than direct materials and direct labor. Using the contribution approach to budgeting requires the cash budget, we must remember that depreciation does not entail a cash outlay and therefore must be deducted from the total factory overhead in computing cash disbursement for factory overhead.
Here is the Factory Overhead Budget:
Note: The above factory overhead budget is constructed based on the following assumption (for simplification)
- Total factory overhead budgeted = $18,300 fixed (per quarter), plus $2 per hour of direct labor. This is one example of a cost-volume (or flexible budget) formula (y = a + bx), developed via the least-squares method with a high R2.
- Depreciation expenses are $4,000 each quarter.
- Overhead costs involving cash outlays are paid for in the quarter incurred.