Direct Materials Budget

Learning Outcomes

  • Prepare a direct materials budget

A flowchart titled “Types of Budgets”. The materials 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 operating budget. There are also arrows pointing from the cost of goods sold budget and the SG&A budget to the cash budget.
The direct materials budget (or materials purchases budget) is used to plan how much raw materials we need to have available to meet budgeted production. This budget is prepared similarly to the production budget as the company must decide how much raw materials inventory they want to have on hand at the end of each quarter. This is typically determined as a percent of next quarter’s material needs. In a materials budget, we will deal with units first and then add the budgeted cost near the end. We also need to know how much direct materials are needed for each unit.

The direct materials budget is dependent upon the sales budget and the production budget, reproduced here:

GelSoft
Sales Budget in Units
Quarter Units (rounded)
Q1 40,000
Q2 42,000
Q3 44,100
Q4 46,305
Total Projected Sales Single Line172,405Double line

 

GelSoft
Production Budget in Units
Description Amount
Budgeted/Projected sales, in units     172,405
Plus: ending inventory target         16,200
Total units needed to meet goals Single Line188,605
Less: units in beginning inventory         30,000
Units needed to be produced to meet goals Single Line158,605Double line

 

GelSoft’s standard cost for raw materials is $11 per kilogram (Kg). The standard quantity per seat is 0.68 Kg (about a pound and a half). Beginning raw materials inventory is projected to be 25,000 pounds but management wants to reduce that to the equivalent of one month’s production rounded to the nearest hundred Kg.

GelSoft
Direct Materials Budget in Units
Description Amount
Budgeted units to be produced 158,605
Direct materials needed per unit (kilograms) 0.680
Total Kg direct materials needed Single Line107,851
Plus: desired DM in ending inventory (Kg) (see below) 11,200
Less: DM in beginning inventory (Kg) (25,000)
Budgeted purchase of direct materials Single Line94,051
Projected cost per Kg $11
Budgeted cost of direct materials to be purchased Single Line$1,034,561Double line

 

Ending Raw Materials Inventory

Ending raw materials inventory can be estimated in a number of ways, but let’s assume that GelSoft is using a rolling (continuous) budget and therefore is using a fairly sophisticated method of determining ending raw materials inventory sufficient to cover the first month of the next quarter’s production. In this case, if the company extended projected sales to Q1 and Q2 of the next budget year, they would come up with the following:

GelSoft
Production Budget in Units
Q1 YR 2 Q2 YR 2
Budgeted/Project sales, in units 48,620 51,051
Plus: ending inventory target 17,000
Total units needed to meet goals Single Line65,620
Less: units in beginning inventory 16,200
Units needed to be produced to meet goals Single Line49,420Double line

 

Budgeted sales for the first quarter of the next budget cycle is Q4 estimated sales times 105% and budgeted sales for the second quarter of the next budget cycle is the prior quarter’s estimated sales times 105%. One-third of 51,051 units is 17,017 which we will round to 17,000 for budgeting purposes. Our ending inventory from the budget we are creating is 16,200 (based on 48,620/3 rounded to the nearest hundred) so our production needs for the first quarter of the next budget cycle is 49,420 units. One-third of that amount (approximating one month’s production) is 16,473.33 units. Multiplying that amount by our standard raw materials usage of 0.68 Kg gives us a target ending raw materials inventory of 11,200 Kg (rounded to the nearest hundred).

GelSoft is creating these budgets on a quarterly basis, but could create them monthly, semi-annually, or annually. Below is the production budget and the resultant raw materials budget for the year, broken down by quarter:

GelSoft
Production Budget in Units
Description Q1 Q2 Q3 Q4 Year
Budgeted/Project sales, in units 40,000 42,000 44,100 46,305   172,405
Plus: ending inventory target 14,000 14,700 15,400 16,200 16,200
Total units needed to meet goals Single Line54,000 Single Line56,700 Single Line59,500 Single Line62,505 Single Line188,605
Less: units in beginning inventory 30,000 14,000 14,700 15,400 30,000
Units needed to be produced to meet goals Single Line24,000Double line Single Line42,700Double line Single Line44,800Double line Single Line47,105Double line Single Line158,605Double line

 

GelSoft
Direct Materials Budget
Description Q1 Q2 Q3 Q4 Year
Budgeted units to be produced 24,000 42,700 44,800 47,105 158,605
Direct materials needed per unit (Kg) 0.680 0.680 0.680 0.680
Total Kg direct materials needed Single Line16,320 Single Line29,036 Single Line30,464 Single Line32,031 Single Line107,851
Plus: desired DM in ending inventory (Kg) 9,700 10,200 10,700 11,200 11,200
Less: DM in beginning inventory (Kg) (25,000) (9,700) (10,200) (10,700) (25,000)
Budgeted purchase of direct materials Single Line1,020 Single Line29,536 Single Line30,964 Single Line32,531 Single Line94,051
Projected cost per Kg $11 $11 $11 $11
Budgeted cost of direct materials to be purchased Single Line$11,220Double line Single Line$324,896Double line Single Line$340,604Double line Single Line$357,841Double line Single Line$1,034,561Double line

 

Notice that purchases during Q1 are scheduled to be significantly lower than the following quarters as beginning inventory is used up before new materials are purchased, thus reducing the amount on hand and moving the company toward a more Just-in-time inventory system.

Also, the ending raw materials inventory for each quarter is equal to the next quarter’s production divided by three multiplied by the DM need for each unit. For instance, ending RM inventory for Q1 (Jan-Feb-Mar) needs to be enough to cover April production of approximately 14,233 units (42,700/3) at 0.68 kg per unit, which is 9,678.44 kg which for purposes of this budget we will round to 9,700 kg.

Here is a video review of how to prepare a direct materials budget:

You can view the transcript for “Direct Materials Budget, Part 1” here (opens in new window).

Practice Question