Operating Budget – Manufacturing

Learning Outcomes

  • Prepare an operating budget for a manufacturing company

We now have the following pieces in place:

  • Sales Budget
  • Production Budget
  • Direct Materials Budget
  • Direct Labor Budget
  • Manufacturing Overhead Budget
  • Cost of Goods Sold Budget
  • Selling, General, and Administrative Expense Budget

And now, let’s review the entire operating budget as a whole.

A flowchart titled “Types of Budgets”. The entire area labeled operating budget is highlighted in yellow. At the top is the sales budget. The sales budget has two arrows pointing to the production budget and the SG&A budget. The production budget has three arrows pointing to the materials budget, labor budget, and manufacturing overhead budget. Those three budgets are all pointing to the cost of goods sold budget. The sales, production, materials, labor, manufacturing overhead, cost of goods sold, and SG&A budget boxes are all blue and there is a bracket labeling those as the operating budget. Below the operating budget is a horizontal line showing the capital expenditures budget in red on the left, and going to the right from there, an arrow pointing to the cash budget, with another arrow pointing to the budgeted income statement, and a final arrow pointing to the budgeted balance sheet. The cash budget, budgeted income statement, and budgeted balance sheet are all green and there is a bracket labeling those as the financial budget. There are also arrows pointing from the cost of goods sold budget and the SG&A budget to the cash budget.

The sales budget is the cornerstone and therefore the starting point:

GelSoft Sales Budget
Q1 Q2 Q3 Q4 Year
Sales in Units 40,000 42,000 44,100 46,305 172,405
Budgeted Price $34 $34 $34 $34
Sales in Dollars Single Line$1,360,000Double line Single Line$1,428,000Double line Single Line$1,499,400Double line Single Line$1,574,370Double line Single Line$5,861,770Double line

 

From the sales budget, we build the production budget/schedule:

GelSoft
Production Budget in Units
Q1 Q2 Q3 Q4 Year
Budgeted/Project sales, in units 40,000 42,000 44,100 46,305 172,405
Plus: ending inventory target 27,000 24,000 21,000 16,200 16,200
Total units needed to meet goals Single Line67,000 Single Line66,000 Single Line65,100 Single Line62,505 Single Line188,605
Less: units in beginning inventory 30,000 27,000 24,000 21,000 30,000
Units needed to be produced to meet goals Single Line37,000Double line Single Line39,000Double line Single Line41,100Double line Single Line41,505Double line Single Line158,605Double line

 

The production budget will then drive the direct materials budget, the direct labor budget, and the manufacturing overhead budget:

GelSoft
Direct Materials Budget
Q1 Q2 Q3 Q4 Year
Budgeted units to be produced 37,000 39,000 41,100 41,505 158,605
Direct materials needed per unit (Kg) 0.680 0.680 0.680 0.680
Total Kg direct materials needed Single Line25,160 Single Line26,520 Single Line27,948 Single Line28,223 Single Line107,851
Plus: desired DM in ending inventory (Kg) 8,800 9,300 9,400 11,200 11,200
Less: DM in beginning inventory (Kg) (25,000) (8,800) (9,300) (9,400) (25,000)
Budgeted purchase of direct materials Single Line8,960 Single Line27,020 Single Line28,048 Single Line30,023 Single Line94,051
Projected cost per Kg Single Line$11 Single Line$11 Single Line$11 Single Line$11
Budgeted cost of direct materials to be purchased Single Line$98,560Double line Single Line$297,220Double line Single Line$308,528Double line Single Line$330,253Double line Single Line$1,034,561Double line

 

GelSoft
Direct Labor Budget
Q1 Q2 Q3 Q4 Year
Budgeted units to be produced 37,000 39,000 41,100 41,505 158,605
Direct Labor per unit in hours 0.250 0.250 0.250 0.250
Total direct labor hours needed Single Line9,250 Single Line9,750 Single Line10,275 Single Line10,376 Single Line39,651
Projected labor cost per hour $40 $40 $40 $40
Budgeted cost of direct labor Single Line$370,000Double line Single Line$390,000Double line Single Line$411,000Double line Single Line$415,040Double line Single Line$1,586,040Double line

 

GelSoft
Manufacturing Overhead Budget
Q1 Q2 Q3 Q4 Year
Budgeted direct labor hours 9,250 9,750 10,275 10,376 39,651
Variable overhead cost per unit $20.00 $20.00 $20.00 $20.00
Budgeted manufacturing overhead costs Single Line$185,000Double line Single Line$195,000Double line Single Line$205,500Double line Single Line$207,520Double line Single Line$793,020Double line

 

The sales budget will drive the budget for cost of goods sold, which is informed by the production budget and the direct materials budget, the direct labor budget, and the manufacturing overhead budget.

We will use a FIFO inventory assumption and start with a beginning inventory of 30,000 units at a cost of $20 per unit. To that we add our direct materials purchases of $1,034,561 plus beginning materials, less ending materials inventory. That gives us the cost of direct materials used in production. To that we add the cost of direct labor incurred of $1,586,040 and our manufacturing overhead of $793,020 and we then have the cost of goods available for sale during the budget period:

Description Amount 1 Amount 2 Total
Cost of beginning Inventory $600,000
Subcategory, Direct Materials used in production
      Beginning inventory, at cost 275,000
      Purchases 1,034,561
      Less: ending inventory, at cost (123,200) 1,186,361
Direct Labor used in production Single Line 1,586,040
Rounding 19
Manufacturing overhead 793,020
Cost of goods produced during the period Single Line 3,565,440
Goods available for sale Single Line4,165,440
Less ending inventory, at cost (FIFO) (364,176)
      Cost of goods sold Single Line$3,801,264Double line

 

The FIFO assumption (First-In, First-Out) assumes that beginning inventory is sold first, so the units produced in December would be the units remaining in ending inventory to be the first units sold in January. Therefore, the total cost of goods produced during the period (adjusted for the slight accumulation of rounding errors that have occurred during the series of computations) can also be calculated as follows:

Description Units Cost/Unit Total Cost
Beginning inventory 30,000 $20.00 $600,000
Goods produced during the period 158,605 $22.48 $3,565,440
Goods available for sale Single Line188,605 Single Line$4,165,440
Less ending inventory 16,200 $22.48 $364,176
Cost of goods sold Single Line172,405Double line Single Line3,801,264Double line

 

The resulting Cost of Goods Sold budget would look something like this:

GelSoft Cost of Goods Sold Budget – FIFO
Q1 Q2 Q3 Q4 Year
Sales in Units 40,000 42,000 44,100 46,305 172,405
Less: Beginning inventory sold 30,000 30,000
Current product sold Single Line10,000Double line Single Line42,000Double line Single Line44,100Double line Single Line46,305Double line Single Line142,405Double line
Cost of beginning inventory sold @$20 $  600,000 $        – $        – $        – $  600,000
Cost of current product sold @$22.48 224,800 944,160 991,368 1,040,936 3,201,264
Single Line$  824,800Double line Single Line$  944,160Double line Single Line$  991,368Double line Single Line$1,040,936Double line Single Line$3,801,264Double line

 

A company could also choose to use a LIFO assumption (Last-In, First-Out) which would assign ending inventory the $20 costs to ending inventory because LIFO assumes that the first items sold would be the last ones produced. In addition, a company could choose a weighted average method or, in the case of unique items (job costing) the company could use specific identification, but for the sake of consistency and simplicity, we will use FIFO in these examples.

Once the Cost of Goods Sold budget is complete, the company prepares the SG&A budget and the components of the operating budget are complete.

GelSoft Cost of Goods Sold Budget – FIFO
Selling, General, and Administrative Budget
Description Q1 Q2 Q3 Q4 Year
Sales Salaries $  112,500 $  112,500 $  112,500 $  112,500 $  450,000
General and Administrative Salaries 237,500 237,500 237,500 237,500 950,000
Payroll Taxes and Benefits 30,000 30,000 30,000 30,000 120,000
Depreciation on Office Equipment 25,000 25,000 25,000 25,000 100,000
Rent and Property Taxes 37,500 37,500 37,500 37,500 150,000
Office Repairs and Maintenance 12,500 12,500 12,500 12,500 50,000
Miscellaneous Expenses 7,500 7,500 7,500 7,500 30,000
  Total Selling, General and Administrative Expenses Single Line$  462,500Double line Single Line$  462,500Double line Single Line$  462,500Double line Single Line$  462,500Double line Single Line$1,850,000Double line

 

The next step in the budgeting cycle is to prepare the projected financial reports, include a cash-flow budget, but before we move on to that, we’ll take a look at operating budgets for a merchandising operation and a service operation.

Now, check your understanding of compiling the operating budget from its component parts.

Practice Question