Accounting Principles II: Operating Budgets

The operating budgets include the budgets for sales, manufacturing costs (materials, labor, and overhead) or merchandise purchases, selling expenses, and general and administrative expenses.

Sales budget

The sales budget is the starting point in putting together a comprehensive budget for a business. It includes the number of units to be sold and the selling price per unit. It is important to agree to the sales budget first because many other budgets are based on this data. Although its components are simple, getting a management team to agree on the number of units to be sold and the selling price per unit, the two items needed to prepare the budget, is often difficult and time- consuming. The Pickup Trucks Company, which makes toy trucks, has just completed its budgeting process for next year. Total expected sales are 100,000 toy trucks at a price of $15.00 each. Its sales budget has been prepared on a quarterly basis as follows:

The Pickup Trucks Company Sales Budget For the Year Ended December 31, 20X1

	*Quarter 1*	*Quarter 2*	*Quarter 3*	*Quarter 4*	*Total*
Units	15,000	17,000	28,000	40,000	100,000
Selling Price	$15	$15	$15	$15	$15
Total Sales	$225,000	$255,000	$420,000	$600,000	$1,500,000

In addition to annual and quarterly sales budgets, monthly budgets are often prepared so sales can be tracked against expectations more frequently than once every three months.

Manufacturing costs

Before preparing the direct materials, direct labor, and manufacturing overhead budgets, the production budget must be completed.

Production budget. The production budget shows the number of units that must be produced. To budget for annual production, three things must be known: the number of units to be sold, the required level of inventory at the end of the year, and the number of units, if any, in the beginning inventory. If quarterly budgets are required, this same information is needed on a quarterly basis. Using the Pickup Trucks Company's quarterly sales budget and given that 15% of the next quarter's sales volume must be on hand before the quarter begins, the production budget by quarter can be prepared. Further assumptions are a 10% increase in sales in quarter one of next year compared to the current year's quarter-one sales, and 2,250 units in inventory at the beginning of the year.

Pickup Trucks Company Production Budget in Units for 20X1


Sales	15,000	17,000	28,000	40,000	100,000
Required Ending Ivnentory ( ¹ )	2,550( ² )	4,200( ² )	6,000( ² )	2,475( ⁴ )	2,475( ⁵ )
Units Required	17,550	21,200	34,000	42,475	102,475
Beginning Inventory	(2,250)( ³ )	(2,550)( ² )	(4,200)( ² )	(6,000)( ² )	(2,250)( ⁶ )
Units to be Produced	15,300	18,650	29,800	36,475	100,225

Direct materials budget. The direct materials budget determines the number of units of raw materials to be purchased. It uses the number of units to be produced from the production budget, the required level of ending inventory for raw materials, and the number of units in beginning inventory. Once the number of units to be purchased is determined, it is multiplied by the cost per unit to determine the budgeted amount for raw materials purchases. The Pickup Trucks Company requires 10% of next quarter's production requirement for raw materials to be in its ending inventory. For example, because it takes five tires to make the special toy pickup truck (four plus the spare tire mounted on the side), at a cost of $0.50 per tire, the raw materials purchases budget calculates 501,890 tires required at a cost of $250,945. The units in the production budget are adjusted for units in ending and beginning inventories, multiplied by five (number of tires per pick up) to determine total tires to be purchased and then multiplied by $0.50 to determine the cost of the tires needed. As a reminder, the production budget showed the following units for 20X1:

	Units
Quarter 1	15,300
Quarter 2	18,650
Quarter 3	29,800
Quarter 4	36,475
Total	100,225

Pickup Trucks Company Raw Materials Budget For the Year 20X1

	*Quarter 1*	*Quarter 2*	*Quarter 3*	*Quarter 4*	*Total*
Units to be produced ( ¹ )	15,300	18,650	29,800	36,475	100,225
Number of tires per unit ( ² )	×5	×5	×5	×5	×5
	76,500	93,250	149,000	182,375	501,125
Required ending inventory ( ³ )	9,325	14,900	18,238	8,415 ( ⁴ )	8,415
Total units required	85,825	108,150	167,238	190,790	509,540
Beginning inventory ( ³ ) ( ⁵ )	(7,650)	(9,325)	(14,900)	(18,238)	(7,650)
Units to purchase	78,175	98,825	152,338	172,552	501,890
Cost per unit ( ⁶ )	×$0.15	×$0.15	×$0.15	×$0.15	×$0.15
Cost of raw materials purchases *	$11,726	$ 14,824	$ 22,851	$ 25,883	$ 75,284

This process is repeated for all the other raw material components used in producing a toy pickup truck.

Direct labor budget. The direct labor budget shows the number of direct labor hours and the cost of the labor to determine the total cost of direct labor. Assume it takes one-half hour of labor to put together one pickup truck and each labor hour costs $14.00. The total direct labor budget is for 50,113 (100,225 units × .5 hours per unit) hours at a cost of $701,575 ($14.00 per hour × 50,113 hours). The break out by quarter is shown in the following table.

Pickup Trucks Company Direct Labor Budget For the Year 20X1

	*Quarter 1*	*Quarter 2*	*Quarter 3*	*Quarter 4*	*Total*
Units to be produced	15,300	18,650	29,800	36,475	100,225
Direct labor hours per unit	× .5	× .5	× .5	× .5	× .5
Total direct labor hours	7,650	9,325	14,900	18,237.5	50,112.5
Cost per hour	×$14.00	×$14.00	×$14.00	×$14.00	×$14.00
Cost of direct labor	$107,100	$130,550	$208,600	$255,325	$701,575

Manufacturing overhead. The manufacturing overhead budget identifies the expected variable and fixed overhead costs for the year (or other period) being budgeted. The separation between fixed and variable costs is important because the Pickup Trucks Company uses a predetermined overhead rate for applying overhead to units produced. In preparing its budget, the Pickup Trucks Company has identified the following variable and fixed costs: indirect materials $0.50 per unit, indirect labor $1.00 per unit, maintenance $0.75 per unit, annual depreciation $12,000, supervisory salaries $24,000, and property taxes and insurance $21,000. The budget by quarter is:

Pickup Trucks Company Manufacturing Overhead Budget For the Year 20X1

	*Quarter 1*	*Quarter 2*	*Quarter 3*	*Quarter 4*	*Total*
Variable Costs
Indirect Materials	$ 7,650	$ 9,325	$14,900	$18,238	$ 50,113
Indirect Labor	15,300	18,650	29,800	36,475	100,225
Maintenance	11,475	13,988	22,350	27,356	75,169
Total Variable Costs	34,425	41,963	67,050	82,069	225,507
Fixed Costs
Supervisory Salaries	3,000	3,000	3,000	5,700	14,700
Property Taxes and Insurance	6,000	6,000	6,000	6,000	24,000
Depreciation	5,250	5,250	5,250	5,250	21,000
Total Fixed Costs	14,250	14,250	14,250	16,950	59,700
Total Manufacturing Overhead	$48,675	$56,213	$81,300	$99,019	$285,207
Total Direct Labor Hours *	7,650	9,325	14,900	18,238	50,113
Predetermined Overhead Rate					$5.70

Selling expenses budget

The budget for selling expenses includes the variable and fixed selling expenses. The variable expenses in the selling expenses budget are usually based on sales dollars. Assume the Pickup Trucks Company's variable expenses are sales commissions and delivery expense. Sales commissions are 4% of sales dollars, and delivery expense, also called freight out by some companies, is $0.10 per unit sold. The company also has fixed sales salaries of $50,000. The calculations for sales commissions and delivery expense, followed by the selling expenses budget, are shown in the following tables.

Pickup Trucks CompanySales Commission and Delivery Expenses Budget CalculationsFor the Year 20X1


Sales Commission Expense
Sales	$225,000	$255,000	$420,000	$600,000	$1,500,000
Commission Rate	4%	4%	4%	4%

Operating Budgets

Related Topics:

Operating Budgets

Sales budget

Manufacturing costs

Selling expenses budget