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: 

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. 

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: 

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. 

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: 

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. 

The general and administrative expenses budget details the variable and fixed operating expenses for the general and administrative areas of the company. The Pickup Trucks Company has no variable administrative expenses. Its fixed expenses include salaries of $60,000, rent expense of $15,000, and office supplies of $6,000.