Post on 01-Jun-2018
8/9/2019 L3 - Operating Budget
1/44
Operating Budget
M.Sc. Elham Safari
elham.safari@saimia.fi
Based on the lecture slides by
Senior Lecturer Jukka Sirki
8/9/2019 L3 - Operating Budget
2/44
Outline
Preparing the Operating Sub-Budgets
Sales Budget & Production Budget (recap.)
Direct Material (DM) Budget Direct Manufacturing Labor (DL) Budget
Manufacturing Overhead (MOH) Budget
Ending Inventory Budget
Cost of Goods Sold Budget
Preparing the Budgeted Income Statement
8/9/2019 L3 - Operating Budget
3/44
Basic Operating
Budget Steps1. Prepare the revenues
budget.
2. Prepare the production
budget (in units).3. Prepare the direct materials
(usage and purchases)budget.
4. Prepare the directmanufacturing labor budget.
5. Prepare the manufacturingoverhead costs budget.
8/9/2019 L3 - Operating Budget
4/44
Basic Operating
Budget Steps6. Prepare the endinginventories budget.
7. Prepare the cost of goods
sold budget.8. Prepare the operating
expense budget.
9. Prepare the budgeted
income statement.
8/9/2019 L3 - Operating Budget
5/44
Remark1: Manufacturing Costs
Manufacturing costs are divided into three groups:
Direct Material (DM) Costs
Cost of buying materials that will become part of output product
(e.g. cost of buying cocoa in Fazer Co.)
Direct Manufacturing Labor (DL) Costs
All cost associated with manufacturing labors who are directly related tooutput products (e.g. wages and benefits paid to assembly-line workers whoconvert direct materials to finished goods)
Manufacturing Overhead / Indirect Manufacturing Costs
All manufacturing costs that are indirectlyrelated to the output product.In other words, all manufacturing costs that cannot be put into DM or DL costs(e.g. indirect materials such as lubricants,
indirect manufacturing labor such as plant maintenance and cleaning labor,plant rent, plant insurance, property taxes on the plant, plant depreciation,and the compensation of plant managers)
8/9/2019 L3 - Operating Budget
6/44
Remark2: Types of Inventory
Manufacturing-sector companies usually have one or more of thefollowing types of inventories:
Finished Goods (FG) Inventoryincludes products that are ready to
be sold (but not sold yet).
Direct Materials (DM) Inventoryincludes direct materials that willlater be used in production.
Work-in-Process / Work-in-Progress (WIP) Inventoryincludesgoods that are not complete yet (for example, mobile phones that areat different stages of completion, but are not finished yet).
8/9/2019 L3 - Operating Budget
7/44
Sales Budget / Revenues Budget
A detailed plan which identifies the product (or service)sales that are expected in the accounting period
Expressed in terms of both units &(or $, or etc.)
Prepared before any other budget To prepare this budget, a sales forecast by managers
should be done.
Estimation of the future sales revenues is important:
It will affect the level of operating activities and the amount ofresources needed for the operations
When this estimation is done, other budgets can be developedbased on it.
8/9/2019 L3 - Operating Budget
8/44
Sales Budget / Revenues Budget
Number of units to be sold
x Sales price per unit= Total Sales Revenue
8/9/2019 L3 - Operating Budget
9/44
Example 1: XYZ company
XYZ company is preparing budgets for the quarter ending inJune 30, 2014. (a)The budgeted sales for the months April toAugust are as follows: 10000, 20000, 30000, 35000, and
40000(all in units) respectively. Prepare a Sales Budget.
Selling price is10/unit.April May June Quarter
Budgeted Sales (in units) 60000
Selling Price(per unit)
10000 20000 30000
10 10 10 10
Total Budgeted Sales () 600000100000
x
=
200000
x
=
300000
x
=
+ + =x
=
8/9/2019 L3 - Operating Budget
10/44
Production Budget
A detailed plan which shows the number of units a companymust produce to meet budgeted sales and budgetedinventory levels
Expressed in terms of units
Production managers use this information to plan for thematerials and human resources that production activities willrequires
To prepare a production budget, managers must know:
Budgeted number of sales units (from the sales budget)
Desired level of ending inventory for each period in thebudget year
8/9/2019 L3 - Operating Budget
11/44
Production Budget
In inventory accounts, there are two items onthe debit side, and two items on the credit side
Beginning
Inventory
Additionsto
Inventory
Withdrawals(Desired)Ending
Inventory= ++
Beginning
Inventory
(BI)
Additions to
Inventory
(To be produced)
Withdrawals(To be sold)
Ending
Inventory
(EI)= -+
8/9/2019 L3 - Operating Budget
12/44
Production Budget
Units needed for sales
+ Desired ending inventory= Total units needed
- Beginning inventory
= Required Production
(or: To Be Produced)
8/9/2019 L3 - Operating Budget
13/44
Example 1b: Production Budget
(b) Suppose that the management of XYZ company wants theending inventory to be equal to 20% of the following monthsbudgeted sales in units. Prepare a Production budget. OnMarch 31, 2000 units were on hand.
April May June Quarter
Budgeted Sales (in units) 10000 20000 30000 60000
ADD: DesiredEnding Inv. 4000 6000 7000 7000
Total Needs 14000 26000 37000 67000
LESS: BeginningInv. 2,000 4000 6000 2000
Required Production 12000 22000 31000 65000
+ + =+
=-
=
8/9/2019 L3 - Operating Budget
14/44
Direct Material Purchases/Usage Budget
A detailed plan that identifies the quantity of direct materials required to meet budgeted
production & the cost of acquiring them (DM Usage)
the quantity of direct materials required to meet budgetedproduction as well as inventory needs, and the costsassociated with purchasing them (DM Purchases)
To prepare a DM budget, managers must know:
The amount of production needs in the next period
Desired level of direct material inventory for each period
Per unit cost of direct materials
8/9/2019 L3 - Operating Budget
15/44
Direct Material Usage Budget
Quantity of Finished Goods Production
x Quantity of Materials needed per unit of FG
= Quantity of DM to be used for production
x Cost of direct material per (its) unit
= Total cost of (DM) to be used
8/9/2019 L3 - Operating Budget
16/44
Direct Material Purchases Budget
Quantity of DM to be used for production
+ Target DM ending inventory
= Total quantity of DM needed
- DM beginning inventory
= Quantity of DM to purchase
x Cost of direct material per (its) unit
= Total direct material (DM) cost
Purchasing managers prepare this budget to know theamount of purchases in each period.
8/9/2019 L3 - Operating Budget
17/44
Example 1b: Production Budget
(revisited) Let us expand this table:
April May June July August
Budgeted Sales (in units) 10000 20000 30000 35000 40000
ADD: Desired Ending Inv. 4000 6000 7000 8000
Total Needs 14000 26000 37000 43000
LESS: Beginning Inv. 2000 4000 6000 7000 8000
Required Production 12000 22000 31000 36000
REMINDER:
Additions to Inv. = WithdrawalsEI + BITo be Purchase = To be Sold + Desired EIBI
= 35000 + 80007000= 36000
8/9/2019 L3 - Operating Budget
18/44
Example 1c: DM Purchases Budget
(c)At XYZ company, 5 Kg of materials are required per unit ofproduct. Management wants materials on hand at the end ofeach month equal to 10% of the following months production.
On March 31, 10000 Kg of material are on hand. Material cost
is0.50 per Kg. Prepare the Direct Materials Purchasesbudget for the quarter.
What do we need?
- Amount of Production (from production budget)
- Material needed per unit of production ( = 5 Kg)- Cost of raw material per unit ( =0.50)
8/9/2019 L3 - Operating Budget
19/44
Example 1c: DM Purchases Budget (cont.)The DM needs for July: 36000units * 5 Kg/unit = 180000 KgJunes ending inventory is equal to 10% of this, or 18000 Kg.
April May June Quarter
Production(in units)
Material needs (Kg per unit)ProductionNeeds (of DM, in Kg) 60000 110000 155000 325000
Cost (per Kg)
12000 22000 31000 65000
5 5 5 5
0.50 0.50 0.50 0.50
DM Usage Cost () 30000 55000 77500 162500
TargetEnding Inv. of DM (in Kg) 11000 15500 18000 18000
Total Material Needed (Kg) 71000 125500 173000 343000
Beginning Inv. of DM (in Kg) 10000 11000 15500 10000
Materials to be Purchased (Kg) 61000 114500 157500 333000
Direct Material PurchasesCost () 30500 57250 78750 166500
x
=
x
=
-
=
x
=
8/9/2019 L3 - Operating Budget
20/44
Example 3
Marina company makes and sells dresses. Three metersof silk are needed to make one dress. Budgetedproductions for the next four months are as follow:
The company wants to maintain monthly endinginventories of material equal to 20% of the following
months production needs. On March 31, this requirementwas not met since only 2500 meters of silk were on hand.
The cost of silk is0.60 per meter.
April May June JulyProduction in units 14000 14500 15500 12600
8/9/2019 L3 - Operating Budget
21/44
Example 3 (cont.)
(a)What is the desired ending inv. of material for May?
We have to calculate Junes needs for materials.
Production for June 15500
Material Needed per unit 3 meters
Total Material Required 46500 meters
20% Ending Inv. 9300 meters
The desired ending inventory of material for May is equal to 20%of total material required in May:
46500 * 20% = 9300
8/9/2019 L3 - Operating Budget
22/44
Example 3 (cont.)
(b) What is the total cost of material to be purchased inApril?
April May
Production (units) 14000 14500Materials (per unit) (meters) 3 3
Production Needs 42000 43500
ADD: Targeted Ending Inv. 8700
Total Material Needed 50700
LESS: Beginning Inv. 2500
Mater ials to be purch ased (meters) 48200
Cost per meter 0.60
Material Cost 28920
8/9/2019 L3 - Operating Budget
23/44
Example 3 (cont.)
(b) What is the total cost of material to be purchased inApril?
SECOND APPROACH (without using the table):
We can directly use the formula to solve for the material neededand then multiply it by the cost per unit of use the statementmethod.
Additions to Inv. = WithdrawalsEI + BI
Purchases of materials = Needed for production + Desired EIBI
= (14000 units * 3 meters) + 8700 2500
= 42000 8700 + 2500 = 28920
8/9/2019 L3 - Operating Budget
24/44
Direct (Manufacturing) Labor budget
A detailed plan that estimates the direct labor hours needed in anaccounting period and its associated cost.
Production Managers use estimated direct labor hours to plan:
How many employees will be required during the period?
How many hours each employee will work.
Accountantsuse estimated direct labor cost to plan:
Cash Payments to workers
HR managers use information on direct labor budget to:
Decide whether or not to hire new employees.
Reduce the existing work force (if necessary).
Train employees.
Prepare schedules of employee fringe benefits.
8/9/2019 L3 - Operating Budget
25/44
Direct Manufacturing Labor Budget
Required production
x Direct labor hours per unit of production
= Total direct labor hours needed
x Cost of direct labor per hour
= Total direct labor (DL) costs
8/9/2019 L3 - Operating Budget
26/44
Example 1d: DL Budget
(d)At XYZ company, each unit of product requires 0.05 hours(3 minutes) of direct labor. The company pays an hourly rate of10. Prepare the Direct Labor budgetfor the quarter.
What do we need?
- Number of hours the labor works each month- Per hour rate of payment to labor (to get the cost of labor for thequarter in Euros)
April May June Quarter
600 1100 1550 3250
12000 22000 3100065000
0.05 0.05 0.05 0.05
10 10 10 10
Production(in units)Direct Labor Hours (perunit)
Total Hours Required
Hourly Wage Rate (per hour)
Total Labor Costs () 6000 11000 15500 32500
x
=
x
=
8/9/2019 L3 - Operating Budget
27/44
Example 4
Lubriderm corporation (specialized in daily skin careproducts) goes through two department in the productionprocess. Each bottle requires two direct labor hours indept. A and one hour in dept. B. Labor cost is20 perhour in dept. A and15 per hour in dept. B. (a)Assumingthe amount budgeted to be produced in January is 30000
units, what is the budgeted direct labor cost for January?(b) The labor capacity for a normal 8-hour shift for a
month is 50000 direct labor hours for each of the depts.Overtime is paid at time and a half. What would be thebudgeted direct labor cost for January, assuming abudgeted production of 30000 units?
8/9/2019 L3 - Operating Budget
28/44
Example 4 (cont.)
(a) Production units: 30000
Dept. A Dept. B Total
Production in units 30000 30000Direct Labor Hours per unit 2 1
Total Hours Required 60000 30000
Hourly Wage Rate 20 15
Total Labor Costs 1200000 450000 1650000
8/9/2019 L3 - Operating Budget
29/44
Example 4 (cont.)
(b) Labor Capacity : 50000
Dept. A Dept. B Total
Production in units 30000 30000Direct Labor Hours per unit 2 1
Total Hours Required 60000 30000
Hourly Wage Rate 20 15
Regular Labor Costs 1000000 450000 1450000
Overtime (10000 hrs @ 30) 300000 - 300000
Total Labor Costs 1300000 450000 1750000
8/9/2019 L3 - Operating Budget
30/44
Manufacturing Overhead (Costs) Budget
The manufacturing overhead budget contains all manufacturingcosts other than the costs of direct materials and direct labor.
The total of all costs in this overhead budget are converted into aper-unit overhead allocation, which is used to derive the cost of
ending finished goods inventory, and which in turn is listed on thebudgeted balance sheet.
It may also be divided into fixed and variable (and maybe evenmixed) groups.
Examples: indirect materials (e.g. lubricants for machinery),
indirect labor (e.g. administrative salaries: wages paid tomanufacturing supervisors, the purchasing staff, production clerks,and logistics planning staff), rent, utilities (e.g. electricity and heat),factory insurance, factory taxes, etc.
8/9/2019 L3 - Operating Budget
31/44
Example 1e: MOH Budget
(e)At XYZ company, manufacturing overhead is applied tounits of products on the basis of direct labor hours. The variablemanufacturing overhead is20 per direct labor hour. The fixedmanufacturing overhead is30000 per month. Prepare XYZs
Manufacturing Overhead budget for the quarter.
What should we do?
Here, the variable MOH is only on the basis of direct labor hours, so:- We need the number of hours worked each month (from DL budget)
- We should multiply it by variable rate to get total variable OH costs.- Finally, we should add fixed MOH to the result of previousmultiplication to get total MOH costs.
8/9/2019 L3 - Operating Budget
32/44
Example 1e: MOH Budget (cont.)
April May June Quarter
LaborNeeded (hours) 600 1100 1550 3250
Variable MOH Rate (per hour) 02 20 20 20Variable MOH Costs () 12000 22000 31000 65000
Fixed MOH Costs () 30000 30000 30000 90000
TotalMOH Costs () 42000 52000 61000 155000
x
=
+
=
8/9/2019 L3 - Operating Budget
33/44
Ending Inventory Budget
A detailed plan that estimates the cost of goods(direct material, incomplete good, & finished good)that are planned to be in the inventory at the end of
the period.
Can be prepared for any (or all) of the inventoriesthe company posses.
We do not consider the Ending Work-in-Processinventory.
8/9/2019 L3 - Operating Budget
34/44
Ending DM Inventory Budget
For Ending DM inventory, it is easy! Just write theamount of direct materials that are planned to be onhand at the end of the period along with their costs.
At the end, the (cost of) EI of all direct materials shouldbe added together!
Target DM ending inventory
x Cost of direct material per (its) unit= Total EI of direct materials
8/9/2019 L3 - Operating Budget
35/44
Ending FG Inventory Budget
The ending finished goods inventory budgetcalculates the cost of the finished goodsinventory at the end of each budget period.
The ending finished goods inventory budgetcontains per unit values of three main costs that
are required to be included in the inventoryasset: direct material, direct labor, & overhead.
8/9/2019 L3 - Operating Budget
36/44
Ending FG Inventory Budget
For DM part, multiply the cost of direct material by thequantity of direct material needed for the production ofone unit of FG.
For DL part, multiply the cost of DL (per hour) by thenumber of hours needed for production of one unit ofFG.
For MOH, it depends on the thing the cost is associatedwith (we will see an example). NOTE:total MOH costs divided by the required amount of
production gives the per unit MOH cost.
8/9/2019 L3 - Operating Budget
37/44
Example 1f: Ending (FG) Inv. Budget
Production Costs
(perunit)Quantity of
Input (per unit)Cost of Input
(per unit)Total
Direct Materials 5 Kg 0.50 (per Kg) 2.50
Direct Labor 0.05 hrs 10 (per hour) 0.50TotalMOH Costs 0.05 hrs 47.69 (per hour) 2.385
PerUnit Production Cost 5.385
Ending Inv.(in units) 7000
Total Ending FG Inv. Costs 37695
Input
from MOH budget:
Cost per unit of input = Total MOH
costs / Total labor hours needed
=155000 / 3250 hrs = 47.69
from production budget
(EI at the quarter)
8/9/2019 L3 - Operating Budget
38/44
Cost of Goods Sold (CGS) Budget
Summary of companys expected costs of production
for the goods sold
Combines information from DM, DL, MOH and Ending
Inv. Budgets For a CGS statement, we need:
Beginning FG inventory
Cost per unit of Beginning FG Inv.
Quantity of Units produced Product cost per unit
Quantity of units in Ending inv. (its per unit cost is equalto the FG cost)
8/9/2019 L3 - Operating Budget
39/44
Cost of Goods Sold (CGS) Budget
DM cost + DL cost + MOH cost = Cost of goods manufactured
Cost of Beginning FG inventory
x Per unit cost of beginning FG inv.
= Beginning finished goods inventory cost
+ Cost of goods manufactured
= Cost of goods available for sale
- Ending finished goods inventory cost
= Cost of Goods Sold (CGS)
8/9/2019 L3 - Operating Budget
40/44
Example 1g: Cost of Goods Sold Budget
Suppose the cost of beginning inventory at XYZ company is5.00per unit. Prepare the Cost of Goods Sold Budget for the quarter.
Units Rate (/unit) Total ()
Beginning Inv. 5.00 10000
ADD: Cost ofGoods Manufactured
Direct Materials Used 2.50 162500
Direct Labor 0.50 32500
TotalMOH Costs 2.385 155000
Cost of Goods A vai lab lefor Sale 360000
LESS: Cost of Ending Inv.
2000
65000
65000
65000
7000 5.385 37.695
Cost of Goods Sold 322.305
8/9/2019 L3 - Operating Budget
41/44
Operating Expenses
Includes all non-manufacturing costs (for example,R&D costs, design costs, marketing costs, distributioncosts, customer service costs, labor costs of sales floorpersonnel, distribution costs: costs of shipping productsto customers)
For service companies, this includes all costs that arenot directly related to the service offered
Similar to MOH, this cost can also have fixed andvariable parts (we will see an example!)
8/9/2019 L3 - Operating Budget
42/44
Example 1h: Operating ExpensesApril May June Quarter
Budgeted Unit Sales (in units) 10000 20000 30000 60000
VARIABLE OPERATING EXPENSES
Sales Commission Exp.(0.5/unit sold) 5000 10000 15000 30000
Shipping Expenses (0.40/unit sold) 4000 8000 1200024000
Bad-creditCustomers (1% *10) 1000 2000 3000 6000
Total Variable Operating Expenses 10000 20000 30000 60000
FIXED OPERATING EXPENSES
Office Rent 10000 10000 10000 30000
Advertising 5000 5000 5000 15000
Non-manufacturing Staff Salaries 35000 35000 35000 105000
Total Fixed Operat ing Expenses 50000 50000 50000 150000
Total Operating Expenses 60000 70000 80000 210000
8/9/2019 L3 - Operating Budget
43/44
Income Statement
Sales Revenue
- Cost of Goods Sold (CGS)
= Gross Prof i t
- Operating Expenses= Operat ing Pro f i t
- Depreciation & Amortization
= Trading Prof i t
- Interest & Tax expenses
= Net Profit
8/9/2019 L3 - Operating Budget
44/44
Example 1i: Budgeted Income Statement
Total Sales Revenue 600000
LESS: Cost of Goods Sold 322305Gross Margin (Gross Profit) 277695
LESS: Operating Expenses 210000
Operating Income (Operating Profit) 67695