Operating Budget
M.Sc. Elham Safari
[email protected] Based on the lecture slides by Senior Lecturer Jukka Sirkiä
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
Basic Operating Budget Steps 1. 2. 3.
4.
5.
Prepare the revenues budget. Prepare the production budget (in units). Prepare the direct materials (usage and purchases) budget. Prepare the direct manufacturing labor budget. Prepare the manufacturing overhead costs budget.
Basic Operating Budget Steps 6. 7. 8. 9.
Prepare the ending inventories budget. Prepare the cost of goods sold budget. Prepare the operating expense budget. Prepare the budgeted income statement.
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 to output products (e.g. wages and benefits paid to assembly-line workers who convert direct materials to finished goods) Manufacturing Overhead / Indirect Manufacturing Costs All manufacturing costs that are indirectly related 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)
Remark2: Types of Inventory Manufacturing-sector companies usually have one or more of the following types of inventories: Finished Goods (FG) Inventory includes products that are ready to be sold (but not sold yet).
Direct Materials (DM) Inventory includes direct materials that will later be used in production. Work-in-Process / Work-in-Progress (WIP) Inventory includes goods that are not complete yet (for example, mobile phones that are at different stages of completion, but are not finished yet).
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 of resources needed for the operations – When this estimation is done, other budgets can be developed based on it.
Sales Budget / Revenues Budget
x =
Number of units to be sold Sales price per unit Total Sales Revenue
Example 1: XYZ company XYZ company is preparing budgets for the quarter ending in June 30, 2014. (a) The budgeted sales for the months April to August are as follows: 10’000, 20’000, 30’000, 35’000, and 40’000 (all in units) respectively. Prepare a Sales Budget. Selling price is10€/unit. April Budgeted Sales (in units) Selling Price (€ per unit) Total Budgeted Sales (€)
10’000
May
+
20’000
June
+
30’000
Quarter
=
60’000
x
x
x
x
10
10
10
10
=
=
=
=
100’000
200’000
300’000
600’000
Production Budget • A detailed plan which shows the number of units a company must produce to meet budgeted sales and budgeted inventory levels • Expressed in terms of units • Production managers use this information to plan for the materials and human resources that production activities will requires • 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 the budget year
Production Budget • In inventory accounts, there are two items on the debit side, and two items on the credit side Beginning Inventory
+
Additions to Inventory (To be produced)
=
Additions to Inventory
Withdrawals (To be sold)
=
Withdrawals
+
Ending Inventory (EI)
+
-
(Desired) Ending Inventory Beginning Inventory (BI)
Production Budget
+ = =
Units needed for sales Desired ending inventory Total units needed Beginning inventory Required Production (or: To Be Produced)
Example 1b: Production Budget (b) Suppose that the management of XYZ company wants the ending inventory to be equal to 20% of the following month’s budgeted sales in units. Prepare a Production budget. On March 31, 2000 units were on hand. April Budgeted Sales (in units) ADD: Desired Ending Inv.
10’000 4’000
May
+
20’000 6’000
June
+
30’000
Quarter
=
60’000
+
7’000
7’000
Total Needs
14’000
26’000
37’000
= 67’000 -
LESS: Beginning Inv.
2,000
4’000
6’000
2’000
Required Production
12’000
22’000
31’000
65’000
=
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 budgeted production as well as inventory needs, and the costs associated 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
Direct Material Usage Budget
x = x =
Quantity of Finished Goods Production Quantity of Materials needed per unit of FG Quantity of DM to be used for production Cost of direct material per (its) unit Total cost of (DM) to be used
Direct Material Purchases Budget
+ = = x =
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 Cost of direct material per (its) unit Total direct material (DM) cost
Purchasing managers prepare this budget to know the amount of purchases in each period.
Example 1b: Production Budget (revisited) • Let us expand this table: April
May
June
July
August
Budgeted Sales (in units)
10’000
20’000
30’000
35’000
40’000
ADD: Desired Ending Inv.
4’000
6’000
7’000
8’000
Total Needs
14’000
26’000
37’000
43’000
LESS: Beginning Inv.
2’000
4’000
6’000
7’000
Required Production
12’000
22’000
31’000
36’000
REMINDER: Additions to Inv. = Withdrawals – EI + BI To be Purchase = To be Sold + Desired EI – BI = 35’000 + 8’000 – 7’000 = 36’000
8’000
Example 1c: DM Purchases Budget (c) At XYZ company, 5 Kg of materials are required per unit of product. Management wants materials on hand at the end of each month equal to 10% of the following month’s production. On March 31, 10’000 Kg of material are on hand. Material cost is €0.50 per Kg. Prepare the Direct Materials Purchases budget 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)
Example 1c: DM Purchases Budget (cont.) The DM needs for July: 36’000units * 5 Kg/unit = 180’000 Kg June’s ending inventory is equal to 10% of this, or 18’000 Kg. April
May
June
Quarter
12’000
22’000
31’000
65’000
5
5
5
5
60’000
110’000
155’000
325’000
0.50
0.50
0.50
0.50
DM Usage Cost (€ )
30’000
55’000
77’500
162’500
Target Ending Inv. of DM (in Kg)
11’000
15’500
18’000
18’000
Total Material Needed (Kg)
71’000 x
125’500
173’000
343’000
11’000
15’500
10’000
61’000
114’500
157’500
333’000
30’500
57’250
78’750
166’500
Production (in units ) Material needs (Kg per unit ) Production Needs (of DM, in Kg) Cost (€ per Kg)
Beginning Inv. of DM (in Kg) Materials to be Purchased (Kg) Direct Material Purchases Cost (€)
x
= x =
10’000 = =
Example 3 Marina company makes and sells dresses. Three meters of silk are needed to make one dress. Budgeted productions for the next four months are as follow: Production in units
April
May
June
July
14’000
14’500
15’500
12’600
The company wants to maintain monthly ending inventories of material equal to 20% of the following month’s production needs. On March 31, this requirement was not met since only 2’500 meters of silk were on hand. The cost of silk is €0.60 per meter.
Example 3 (cont.) (a) What is the desired ending inv. of material for May? We have to calculate June’s needs for materials. 15’500
Production for June Material Needed per unit
3 meters
Total Material Required
46’500 meters
20% Ending Inv.
9’300 meters
The desired ending inventory of material for May is equal to 20% of total material required in May: 46’500 * 20% = 9’300
Example 3 (cont.) (b) What is the total cost of material to be purchased in April? April
May
14’000
14’500
3
3
Production Needs
42’000
43’500
ADD: Targeted Ending Inv.
8’700
Total Material Needed
50’700
LESS: Beginning Inv.
2’500
Materials to be purchased (meters)
48’200
Cost per meter
€0.60
Production (units) Materials (per unit) (meters)
Material Cost
€28’920
Example 3 (cont.) (b) What is the total cost of material to be purchased in April? SECOND APPROACH (without using the table): We can directly use the formula to solve for the material needed and then multiply it by the cost per unit of use the statement method. Additions to Inv. = Withdrawals – EI + BI Purchases of materials = Needed for production + Desired EI – BI = (14’000 units * 3 meters) + 8’700 – 2’500 = 42’000 – 8’700 + 2’500 = 28’920
Direct (Manufacturing) Labor budget • A detailed plan that estimates the direct labor hours needed in an accounting 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.
• Accountants use 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.
Direct Manufacturing Labor Budget
x = x =
Required production Direct labor hours per unit of production Total direct labor hours needed Cost of direct labor per hour Total direct labor (DL) costs
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 of €10. Prepare the Direct Labor budget for 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 the quarter in Euros) April
May
June
Quarter
12’000
22’000
31’000
65’000
Direct Labor Hours (per unit)
0.05
0.05
0.05
0.05
Total Hours Required
600
1’100
1’550
3’250
Hourly Wage Rate (€ per hour)
10
10
10
10
=
11’000
15’500
32’500
Production (in units )
Total Labor Costs (€)
x
= x
6’000
Example 4 Lubriderm corporation (specialized in daily skin care products) goes through two department in the production process. Each bottle requires two direct labor hours in dept. A and one hour in dept. B. Labor cost is €20 per hour in dept. A and €15 per hour in dept. B. (a) Assuming the amount budgeted to be produced in January is 30’000 units, what is the budgeted direct labor cost for January? (b) The labor capacity for a normal 8-hour shift for a month is 50’000 direct labor hours for each of the depts. Overtime is paid at time and a half. What would be the budgeted direct labor cost for January, assuming a budgeted production of 30’000 units?
Example 4 (cont.) (a) Production units: 30’000 Dept. A
Dept. B
30’000
30’000
2
1
60’000
30’000
Hourly Wage Rate
€20
€15
Total Labor Costs
€1’200’000
€450’000
Production in units Direct Labor Hours per unit Total Hours Required
Total
€1’650’000
Example 4 (cont.) (b) Labor Capacity : 50’000
Production in units Direct Labor Hours per unit Total Hours Required
Hourly Wage Rate Regular Labor Costs Overtime (10’000 hrs @ €30) Total Labor Costs
Dept. A
Dept. B
Total
30’000
30’000
2
1
60’000
30’000
€20
€15
€1’000’000
€450’000
€1’450’000
€300’000
-
€300’000
€1’300’000
€450’000
€1’750’000
Manufacturing Overhead (Costs) Budget • The manufacturing overhead budget contains all manufacturing costs other than the costs of direct materials and direct labor. • The total of all costs in this overhead budget are converted into a per-unit overhead allocation, which is used to derive the cost of ending finished goods inventory, and which in turn is listed on the budgeted balance sheet. • It may also be divided into fixed and variable (and maybe even mixed) groups. • Examples: indirect materials (e.g. lubricants for machinery), indirect labor (e.g. administrative salaries: wages paid to manufacturing supervisors, the purchasing staff, production clerks, and logistics planning staff), rent, utilities (e.g. electricity and heat), factory insurance, factory taxes, etc.
Example 1e: MOH Budget (e) At XYZ company, manufacturing overhead is applied to units of products on the basis of direct labor hours. The variable manufacturing overhead is €20 per direct labor hour. The fixed manufacturing overhead is €30’000 per month. Prepare XYZ’s 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 previous multiplication to get total MOH costs.
Example 1e: MOH Budget (cont.) April
May
June
Quarter
Labor Needed (hours)
600
1’100
1’550
3’250
Variable MOH Rate (€ per hour)
20
20
20
20
Variable MOH Costs ( €)
12’000
22’000
31’000
65’000
Fixed MOH Costs (€)
30’000
30’000
30’000
90’000
Total MOH Costs (€)
42’000
=
52’000
61’000
155’000
x
=
+
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 inventories the company posses.
• We do not consider the Ending Work-in-Process inventory.
Ending DM Inventory Budget • For Ending DM inventory, it is easy! Just write the amount of direct materials that are planned to be on hand at the end of the period along with their costs. • At the end, the (cost of) EI of all direct materials should be added together!
x =
Target DM ending inventory Cost of direct material per (its) unit Total EI of direct materials
Ending FG Inventory Budget • The ending finished goods inventory budget calculates the cost of the finished goods inventory at the end of each budget period.
• The ending finished goods inventory budget contains per unit values of three main costs that are required to be included in the inventory asset: direct material, direct labor, & overhead.
Ending FG Inventory Budget • For DM part, multiply the cost of direct material by the quantity of direct material needed for the production of one unit of FG. • For DL part, multiply the cost of DL (per hour) by the number of hours needed for production of one unit of FG. • For MOH, it depends on the thing the cost is associated with (we will see an example). – NOTE: total MOH costs divided by the required amount of production gives the per unit MOH cost.
Example 1f: Ending (FG) Inv. Budget Production Costs (per unit)
Quantity of Input (per unit)
Cost of Input (per unit)
Total
5 Kg
€0.50 (per Kg)
€2.50
0.05 hrs
€10 (per hour)
€0.50
0.05 hrs
€47.69 (per hour)
€2.385
Direct Materials Direct Labor
Input
Total MOH Costs Per Unit Production Cost
€5.385
Ending Inv. (in units)
7’000
Total Ending FG Inv. Costs from MOH budget: Cost per unit of input = Total MOH costs / Total labor hours needed = €155’000 / 3’250 hrs = €47.69
€37’695 from production budget (EI at the quarter)
Cost of Goods Sold (CGS) Budget • Summary of company’s 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 equal to the FG cost)
Cost of Goods Sold (CGS) Budget DM cost + DL cost + MOH cost = Cost of goods manufactured
x = + = =
Cost of Beginning FG inventory 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)
Example 1g: Cost of Goods Sold Budget Suppose the cost of beginning inventory at XYZ company is €5.00 per unit. Prepare the Cost of Goods Sold Budget for the quarter. Units
Rate (€/unit)
Total (€)
2’000
€5.00
€10’000
Direct Materials Used
65’000
€2.50
€162’500
Direct Labor
65’000
€0.50
€32’500
Total MOH Costs
65’000
€2.385
€155’000
Beginning Inv. ADD: Cost of Goods Manufactured
€360’000
Cost of Goods Available for Sale LESS: Cost of Ending Inv. Cost of Goods Sold
7’000
€5.385
€37.695 €322.305
Operating Expenses • Includes all non-manufacturing costs (for example, R&D costs, design costs, marketing costs, distribution costs, customer service costs, labor costs of sales floor personnel, distribution costs: costs of shipping products to customers) • For service companies, this includes all costs that are not directly related to the service offered • Similar to MOH, this cost can also have fixed and variable parts (we will see an example!)
Example 1h: Operating Expenses April
May
June
Quarter
10’000
20’000
30’000
60’000
Sales Commission Exp.(€0.5/unit sold) 5’000
10’000
15’000
30’000
Shipping Expenses (€0.40/unit sold)
4’000
8’000
12’000
24’000
Bad-credit Customers (1% * €10)
1’000
2’000
3’000
6’000
10’000
20’000
30’000
60’000
Office Rent
10’000
10’000
10’000
30’000
Advertising
5’000
5’000
5’000
15’000
Non-manufacturing Staff Salaries
35’000
35’000
35’000
105’000
Total Fixed Operating Expenses
50’000
50’000
50’000
150’000
Total Operating Expenses
60’000
70’000
80’000
210’000
Budgeted Unit Sales (in units) VARIABLE OPERATING EXPENSES
Total Variable Operating Expenses FIXED OPERATING EXPENSES
Income Statement = = = =
Sales Revenue Cost of Goods Sold (CGS) Gross Profit Operating Expenses Operating Profit Depreciation & Amortization Trading Profit Interest & Tax expenses Net Profit
Example 1i: Budgeted Income Statement
Total Sales Revenue
600’000
LESS: Cost of Goods Sold
322’305
Gross Margin (Gross Profit)
277’695
LESS: Operating Expenses
210’000
Operating Income (Operating Profit)
67’695
