BUDGETING

A
Group Presentation
OPERATING BUDGETS

Group Members
Umair A. Rather
Waqas Nawaz
Rashid Khawaj
 Master Budget

• A budget covering all aspects of a firm’s

working.
• The comprehensible budget plan
encompassing all the individual budgets
related to sales, cost of goods sold,
operating expenses, capital.
• Also known as performance plan/
comprehensive budget.
Components of Master budget

Master Budget

Operating Financial
Budget Budget
 Operating Budgets

• Budgets about routine activities that lists the

amount of non-capital goods and services a
firm is authorized by management to expend
during the operating period.

• It includes Sales budget, Production Budget,

Material Purchased Budget, Material Used
Budget, COGS Budget, Labor Budget, FOH
budget & Budgeted Revenue Statement.
 Role of Operating Budgets in an
Organization
• Compels managers to think ahead.
• Managers can be given incentives not
only to achieve budgetary projections but
also to provide accurate projections.
• Aids managers in coordinating different
operating activities.
• Provides definite expectations that are
the best framework to evaluate
performance.
 Operating Budgets for Different
Industries

Operating
Budgets

Service
Manufacturing Merchandising
Industry
 Manufacturing

• Sales Budget

• Production Budget

• Direct Material Budgets

• Direct Labor Budget

• Factory Overhead Budget
• Operating Expense Budget
 Merchandising

• Sales Budget
• Purchase Budget
• Operating Expense Budget (Selling &
Admin expenses etc)

Service industry
• Operating Expense Budget
Relationship between Operating
Budgets of a Manufacturing Firm
• The Sales forecast or budget for the forthcoming
(budget) year is usually the starting point of the
budgetary exercise. Production, materials, labor, etc.,
are related to the level of sales.

Sales Budget

Production
Budget

Direct Materials Factory Overhead

Budget Budget
Sales Budget for a Manufacturing
Firm
• The sales budget is an estimate of future
sales, often broken down into both units
and price. It is used to create company
sales goals.
• Sales volume of units helps in making
production budget according to that sales
requirement.
 Sales Forecasting

In preparing the sales forecast, the following

factors should be considered:
● The outlook of the industry and economy.
● Past behavior and emerging trends in sales.
● Governmental regulations and controls affecting
the industry.
● Consumer attitudes, dispositions, tastes, and
preferences.
● The nature and the extent of competition.
● Sales promotion effort of the firm.
Formula

Sales in units
x Selling price
per unit

Total sales
 Example

Kerry Industrial Products Company

Sales Budget
For the First Quarter Ended June 30, 2007

Sale
Forecast

Sales in units 20,000 25,000 35,000 80,000

Selling price
per unit x $30 x $30 x $30 x $30
Total sales $600,000 $750,000 $1,050,000 $2,400,000
 Production Budget for a
Manufacturing Firm
• A schedule for expected units to be
produced. It sets forth the units expected
to be manufactured to satisfy budgeted
sales and inventory requirements.
• Expected production volume is
determined by adding desired ending
inventory to planned sales and then
subtracting beginning inventory.
 Considerations in preparing the
production budget are as follows:
● Assess the productive capacity of the firm.
● Specify the finished goods inventory policy of
the firm.
● Estimate the total quantity of each product to be
manufactured during the budget period on the
basis of sales forecast and finished goods
inventory policy.
● Schedule the production during the budget
period, taking into account the pattern of sales,
the finished goods inventory policy, and the
productive capacity.
 Factors Affecting Production
Budget
A well balanced production plan is
required to ensure economical
manufacturing. The factors that
influence the plan of production are:
i. The volume and timing of sales
ii. Inventory of sales and
iii. Productive capacity
 Reasons for Variation between
Sales and Production Budget
Goods flow from production line largely is in
conformity with the needs of sales. There
may , however be significant divergence
between the pattern of sales and pattern of
production. This happens under two
conditions:
i. There is a pronounced seasonal variation in sales
whereas production is planned in a stable
manner.
ii. Production necessarily has to be carried out
during a certain period of the year, whereas sales
occur round the year though there may be some
seasonal variation.
 Formula

Determining the budgeted units of production:

Budgeted Budgeted Desired Beginning
= + –
Production Sales Ending Inventory
(in units) (in units) Inventory (in units)
(in units)
 Example

Kerry Industrial Products Company

Production Budget
For the Quarter Ended June 30,2007
April May June Quarter
Budgeted sales in units 20,000 25,000 35,000 80,000
Desired ending inventory 7,500 10,500
Units needed 27,500 35,500 30% of June’s
Beginning inventory 5,000 7,500 budgeted sales
Budgeted production 22,500 28,000
 Material Budgets for a
Manufacturing Firm
Materials used in a manufacturing unit are
traditionally classified as:
• Direct Material
Direct materials are materials which are directly
identified with the product and are visibly incorporated
init.
• Indirect Material
Indirect materials cannot be traced directly to the
product.
The material budget generally is concerned only with
Direct materials. Indirect materials and supplies are
covered by the Manufacturing Overhead budget.
 Direct Material Usage Budget

• A direct materials usage budget shows the

direct materials required for production and
their budgeted cost.

• The information in the production budget

becomes the basis for preparing several
manufacturing-related budgets.
 Formula

Budgeted Production
x Direct Material
per unit

Total
Direct Material
used
 Example
Assume that each unit produced requires 3 pounds of alloy and
budgeted production for June is 36500.
Direct Material Purchases Budget

• Direct Material Purchases budget

provides an estimate of the amount of
the direct materials to be purchased in
the next period.
• Once the Direct Material Purchase
Budget has been completed, a Schedule
of Expected Cash Disbursements can be
prepared.
 This DM purchase budget shows:
a) The quantities of each type of raw material

to be purchased,

b) The schedule of purchases, and

c) The estimated cost of purchases.

 Considerations in developing the
purchase budget:
i. The quantities specified in the materials
budget.
ii. The planned changes in material
inventories.
iii. Re-order levels of various inventory
items, and
iv. Economic order quantities of various
inventory items.
 Formula

Total D.M Total D.M Desired Beginning

Purchase = Used + Ending – Inventory
(pounds) Inventory (pounds)
(pounds)

Then multiply the DM purchase quantity with

per unit price
 Example
Assume alloy cost at $2.45, $2.50 and $2.60 per pound for April, Kay
and June respectively. Kerry expects to manufacture 36,000 units in
July. On April 1, 7,000 pounds of alloy were in inventory.
Desired ending inventory is 10 % of the next period’s production
needs.
Labor Budget for a Manufacturing
Firm
Labor is generally classified as:
Direct Labor
Direct labor cost represents the Wages paid to workers
employed directly in the manufacturing activity.
Indirect Labor
Indirect labor cost represents all other labor costs , such
as supervisory salaries, wages paid to storekeepers,
maintenance personnel, janitors, etc.
The budget for labor cost normally includes the cost of
direct labor only. Indirect labor costs are covered by
the Manufacturing Overhead budget.
 Direct Labor Budget

• The direct labor budget enables the personnel

department to plan for hiring and repositioning
of employees.
• A good labor budget helps the firm to avoid
emergency hiring, prevent labor shortages, and
reduce or eliminate the need to lay off workers.
• Firms usually prepare labor budget for each type
of labors. For example, for each skill
requirement.
 Formula
• To prepare the direct labor budget, a company
would use its production budget,

Units produced
x Direct labor-hours/unit

Total direct labor-hours

x Rate/hour
Total budget @ rate/hour
 Example

• Each unit of output requires .5 hours of semi-skilled

labor at an average cost of $8.00 per hour, and .2 hours
of skilled labor at an average cost of $12.00 per hour.
Kerry Industrial Production Company
Direct Labor Budget
For the Quarter Ended June 30, 2007
April May June Quarter
Budgeted production 22,500 28,000 36,500 87,000
Semi-skilled labor costs $ 90,000 $ 112,000 $ 146,000 $ 348,000
Skilled labor costs 54,000 67,200 87,600 208,800
Total labor costs $ 144,000 $ 179,200 $ 233,600 $ 556,800

22,500 × .5 × $8.00 = $90,000 22,500 × .2 × $12.00 = $54,000

 Factory Overhead Budget for a
Manufacturing Firm
• A factory overhead budget often includes all
production costs other than direct materials
and direct labor.

• Manufacturing overhead consists of:

i. Indirect material
ii. Indirect labor
iii. Miscellaneous factory expense items, such as
depreciation, utilities, supplies, repairs,
maintenance, insurance, tax, and etc.
To construct the manufacturing overhead
budget, expense budgets for all the
departments in the factory – production
as well as service departments – have to
be drawn up and aggregated. For this
purpose, the expected volume of the
work to be done in each department has
to be determined in terms of an indicator
appropriate to its activity.
Some measures of activity are given below:
1. For producing departments
* units of output
* Direct labor hours
* Direct machine hours

2. For service departments

* Repair and maintenance: direct repair hours or the
number of machines to be maintained.
* Purchase department: total purchases in monetary term
or the purchases order to be placed.
* General factory administration: number of employees
in the plant or total direct labor hours.
Given the activity level of each department
in terms of a suitable measure,
departmental budgets are drawn up in
terms of two basic components: the
variable cost (the cost that changes as the
level of output changes) and fixed cost
(the cost that remains constant as the
level of output changes).
 Formula

Total Variable Overhead

+ Total Fixed Overhead
Total Factory Overhead
 Example

The variable overhead rate is $4.40 per direct labor hour. Fixed factor
overhead is $44,300 during April and May, and $54,300 in June .
Kerry Industrial Production Company
Factory Overhead Budget
For the Quarter Ended June 30, 2007
April May June Quarter
Production
Budgeted production 22,500 28,000 36,500 87,000
Budget
Semi-skilled hours required 11,250 14,000 18,250 43,500
Labor Skilled labor hours required 4,500 5,600 7,300 17,400
Budget Total direct labor hours 15,750 19,600 25,550 60,900
Variable factory overhead
($4.40 per hour) $ 69,300 $ 86,240 $ 112,420 $ 267,960
Fixed factory overhead 44,300 44,300 54,300 142,900

113600 130540 166720 410860

 Budgeted Revenue Statement
for a Manufacturing Firm
• The budgeted income statement estimates the
expected operating income from the budgeted
operations.
• A budgeted income statement allows
management a glimpse of the likely operating
result upon completion of the budgeted
operation.
• Once the budget income statement has been
approved, it becomes the benchmark against
which the performance of the period is
evaluated.
 Example

Sales revenue $600,000

Less: Cost of goods sold 450,000
Gross margin $150,000
Other expenses:
Selling, general and
administrative expenses $75,000
Uncollectible accounts
expense 12,000
Interest expense 6,250
Total other expenses 93,250
Net income $56,750
Limitations of Operating Budgets

• Many cost objects such as defects, reworks,

over processing, and poor managerial costs in
the aspects of quality, efficiency, risk and etc
out of consideration in the operating budget
leading to variances in actual and budgeted
activities.
• The operating budgets are strongly
interdependent. One error in any budget can
lead to mistakes in all other budgets.
Queries???