WEEK 6 OPERATING BUDGETS (MANUFACTURING ORGANISATIONS) Case Study manufactures cardboard boxes which are used for transporting very special toys to toy stores all around Australia. You have already been given a tour of the factory where these boxes are made, now we need you to prepare the company s budgets for the coming year ending 30 June. The budgets that you need to prepare include: 1. Production budget 2a. Direct materials usage budget 2b. Direct materials purchases budget 3. Direct labour budget 4. Factory overhead budget 5. Ending inventory budget 6. COGS budget 7. Sales budget 8. Operating expenses budgets Then you need to prepare a BUDGETED INCOME STATEMENT. NOTE; 1. The process followed to prepare a CASH BUDGET and the BUDGETED FINANCIAL STATEMENTS for a manufacturing organisation and a merchandising organisation is the same so we are not going to look at these budgets again in this lesson. 2. In this lesson we are only going to focus on learning how to prepare the budgets which are used to prepare the BUDGETED INCOME STATEMENT of a manufacturing organisation. 3. CASH BUDGETS were covered in LESSON 4 and BUDGETED FINANCIAL STATEMENTS were covered in LESSON 5. 1
You are provided with the following information: Sales LPI estimates that it will sell 900,000 boxes at 0.80 each during the coming year. Direct materials Each box requires an average of 0.4 kilograms of cardboard at a cost of 0.60 per kilogram. Direct labour It takes one hour to produce 300 boxes. Factory workers are paid an average of 15 per hour. Factory overhead The following factory overhead items are anticipated for the year: Indirect materials 8,150 Indirect labour 43,500 Light and power 29,000 Rates 14,500 Factory insurances 17,500 Depreciation of factory equipment 21,000 * Factory overhead is applied on the basis of direct labour hours. * For the purposes of applying factory overhead to production, assume that LPI will use 185 direct labour hours in March and 250 direct labour hours in May next year. 2
Inventories Finished goods Actual beginning inventory 29,000 boxes valued at 15,950 Desired ending inventory 30 June 20,000 boxes Direct materials Actual beginning inventory 6,500 kg Desired ending inventory 30 June 5,000 kg Operating expenses Estimates for the year are as follows: Marketing Advertising 2% of sales Salaries paid to sales staff 58,000 Administration Clerical wages and salaries paid to 110,000 management Stationery, telephone, postage etc. 14,500 Depreciation of office equipment 9,500 Financial Bad debts 1% of sales Bank charges 5,000 3
1. Production budget Case Study SOLUTIONS (refer CHAPTER 4 WEEK 3 purchases budget in UNITS) Production budget for the year ending 30 June Boxes (UNITS) Sales Add: Desired ending inventory Total boxes needed Less: Actual beginning inventory Total boxes to be produced 900,000 20,000 920,000 29,000 891,000 4
2a. Direct materials usage budget The purpose of this budget is to show the volume of direct materials that will be used in budgeted production. It can also be used to show the value of direct materials that will be used in budgeted production. Direct materials usage budget for the year ending 30 June Total boxes to be produced 891,000 Kilos of cardboard required to make each box x 0.4 Total cardboard needed for production (kg) 356,400 Cost per kilo of cardboard x 0.60 Total cost of cardboard to be used in production 213,840 (from production budget) 2b. Direct materials purchases budget Direct materials purchases budget for the year ending 30 June Total cardboard needed for production (kg) 356,400 Add: Desired ending inventory (kg) 5,000 Total cardboard needed (kg) 361,400 Less: Actual beginning inventory (kg) 6,500 Total cardboard to be purchased (kg) 354,900 Price per kilo of cardboard x 0.60 Total cost of cardboard to be purchased 212,940 (from DM usage budget) 5
3. Direct labour budget To prepare this budget you need: VOLUME (no. direct labour hours required to manufacture budgeted production output) x COST (hourly rate) Direct labour budget for the year ending 30 June Total boxes to be produced (units) No. boxes produced per hour Total direct labour hours required for production (hours) Direct labour cost per hour Total direct labour cost 891,000 / 300 2,970 x 15.00 44,550 (from production budget) 6
4. Factory overhead budget STEP 1: Estimate total factory overhead expected to be incurred during the period Indirect materials 8,150 Indirect labour 43,500 Light and power 29,000 Rates 14,500 Factory insurances 17,500 Depreciation of factory equipment 21,000 Total 133,650 STEP 2: Establish an application rate. We are told that factory overhead is applied on the basis of direct labour hours (cost driver). Therefore, LPI s factory overhead application rate is calculated as follows: TOTAL budgeted factory overhead TOTAL budgeted direct labour hours required for production 133,650 2,970 (from direct labour budget) = 45 per direct labour hour STEP 3: Apply this predetermined rate to the total factory overhead Assuming that LPI will use 185 direct labour hours in March and 250 direct labour hours in May next year, how much factory overhead would be applied to production for those months? Factory overhead to be applied to production: For March is = 185 DL hours x 45 per DL hour = 8,325. For May is = 250 DL hours x 45 per DL hour = 11,250. 7
5. Ending inventory budget Recall: There are 3 basic types of inventories: 1. Finished goods (our focus) 2. Materials (our focus) 3. Work in progress (beyond the scope of this text) To calculate the finished goods inventory, we first have to work out how much it costs to produce one completed box. We know that; * Each box requires an average of 0.4 kilograms of cardboard at a cost of 0.60 per kilogram. * Each hour of direct labour produces 300 boxes at a cost of 15 for direct labour and 45 for factory overhead. Direct materials 0.4kg x 0.60 0.24 Direct labour 15 / 300 0.05 Factory overhead 45 / 300 0.15 Total production cost per box 0.44 Now we can prepare the ending inventory budget. Ending inventory budget as at 30 June Finished goods 20,000 boxes @ 0.44 per box 8,800 Direct materials 5,000 kg @ 0.60 per kg 3,000 Total ending inventories 11,800 8
6. COGS budget We already have all the information that we need to prepare the COGS budget. STEP 1: Calculate the TOTAL cost of production. Direct materials 213,840 Direct labour 44,550 Factory overhead 133,650 Total cost of production 392,040 STEP 2: Prepare the COGS budget. COGS budget for the year ending 30 June Beginning finished goods inventory Add: Cost of production Goods available for sale Less: Ending finished goods inventory COGS 7. Sales budget (refer CHAPTER 3 WEEK 2) Sales budget for the year ending 30 June 900,000 boxes 0.80 per box 720,000 15,950 392,040 407,990 8,800 399,190 (given) (see step 1 above) (from ending inventory budget) 9
8. Operating expenses budgets (refer CHAPTER 4 WEEK 3) Marketing expenses budget for the year ending 30 June Advertising (720,000 x 2%) 14,400 Salaries paid to sales staff 58,000 Total marketing expenses 72,400 Admin. expenses budget for the year ending 30 June Clerical wages and salaries paid to management 110,000 Stationery, telephone, postage etc. 14,500 Depreciation of office equipment 9,500 Total admin. expenses 134,000 Financial expenses budget for the year ending 30 June Bad debts (720,000 x 1%) 7,200 Bank charges 5,000 Total financial expenses 12,200 9. Budgeted Income Statement Budgeted Income Statement for the year ending 30 June Sales 720,000 Less: COGS 399,190 Gross profit 320,810 Less: Operating expenses Marketing expenses 72,400 Admin. expenses 134,000 Financial expenses 12,200 Total operating expenses 218,600 Net profit 102,210 10