Chapter 20: Operating Budgets

Preparing the Operating Budgets of a Master Budget for a Manufacturing Company The master budget is a comprehensive plan for a company's financial activities. It includes interconnected budgets for sales, production, direct materials, direct labor, factory overhead, selling expenses, and general administrative expenses. Below are the key steps and components for preparing the operating budgets of a master budget for a manufacturing company like Toronto Sticks Company (TSC). 1. Sales Budget The sales budget is the starting point of the master budget. It projects the units to be sold and the sales revenue based on forecasted sales. The forecast considers market conditions, production capacity, and advertising plans. For TSC: • • • Unit selling price: $60 Sales in September: 700 units Forecasted sales for the next three months (October, November, and December) Example: Month Unit Sales Price/Unit Total Sales ($) October 750 $60 $45,000 November 800 $60 $48,000 December 900 $60 $54,000 2. Production Budget The production budget calculates how many units need to be produced to meet the sales demand and maintain a desired level of ending inventory. Formula: Total Required Units=Budgeted Sales Units+Desired Ending Inventory =Total Required Units−Beginning Inventory For TSC, the desired ending inventory equals 90% of the next month’s sales. Example: Budgeted Desired Ending Sales Inventory (90%) October 750 720 November 800 810 Month Total Required Beginning Units Inventory 1,470 675 1,610 720 Units to Produce 795 890 3. Direct Materials Budget The direct materials budget outlines the amount and cost of raw materials required to meet production needs. Formula: Materials Needed for Production=Units to Produce×Materials per Unit Inventory Total Materials Required=Materials Needed for Production+Desired Ending Mater ials Inventory Materials to Purchase=Total Materials Required−Beginning Materials Inventory For TSC: • • • 0.5 pounds of wood per unit Desired ending materials inventory: 50% of next month's material needs Materials cost per pound: $20 Example: Month Units to Produce October 795 Materials per Unit 0.5 Materials Needed 398 lbs Desired Beginning Materials to Cost Ending Inventory Purchase ($) Inventory 355 lbs 178 lbs 575 lbs $11,500 4. Direct Labor Budget The direct labor budget projects the number of labor hours and the labor cost necessary to meet production. Formula: Direct Labor Hours Required=Units to Produce×Labor Hours per Unit For TSC: • • 0.25 hours of labor per unit Labor cost per hour: $12 Example: Units to Produce October 795 Month Labor Hours per Total Labor Labor Cost per Total Labor Unit Hours Hour Cost ($) 0.25 198.75 $12 $2,385 5. Factory Overhead Budget The factory overhead budget estimates variable and fixed overhead costs to support production. Overhead costs include indirect labor, utilities, and depreciation. For TSC: • • Variable overhead: $10 per direct labor hour Fixed overhead: $1,500 per month Example: Direct Labor Variable Variable Hours Overhead Rate Overhead ($) October 198.75 $10 $1,987.50 Month Fixed Total Overhead ($) Overhead ($) $1,500 $3,487.50 6. Cost of Goods Sold Budget Once the direct materials, direct labor, and overhead budgets are prepared, the cost of goods sold (COGS) budget can be calculated. For TSC: • • • • Direct materials cost: $10 per unit Direct labor cost: $3 per unit Variable overhead: $2.50 per unit Fixed overhead: $1.50 per unit Total product cost per unit = $17.00 Example: Month Units Sold Product Cost per Unit Total COGS ($) October 750 $17.00 7. Selling Expense Budget $12,750 The selling expense budget projects the costs associated with selling the product, including commissions, salaries, and advertising. For TSC: • • Sales commissions: 10% of sales Sales manager salary: $2,000 per month Example: Sales Commission Sales Commission Sales Manager ($) Rate ($) Salary ($) October $45,000 10% $4,500 $2,000 Month Total Selling Expense ($) $6,500 8. General and Administrative Expense Budget This budget covers expenses such as administrative salaries, insurance, office expenses, and depreciation. For TSC: • Administrative salaries: $4,500 per month Example: Month Admin Salaries ($) Office Expenses ($) Total General Admin Expense ($) October $4,500 $500 $5,000 These steps form the operating budgets of a master budget for a manufacturing company like TSC. Each component feeds into the next, ensuring that the company has a comprehensive plan for production, expenses, and sales.