Direct Materials Budget
Before a company can begin manufacturing products to meet its production budget, it must acquire the required direct materials. The direct materials budget will itemize the direct materials that the company needs to meet planned production levels. Careful planning will help minimize the resources invested in inventory without running short of inventory. This will then allow a company to meet customer demands in a timely manner.
Once the production budget has been completed, preparing the direct materials budget is rather straightforward. The logic here is similar to that of the production budget. The key inputs are the budgeted production and the direct materials standards for each product.
A separate direct materials budget must be completed for every direct material type that goes into each product. Next, the accountant figures out the budgeted dollar amounts for direct materials purchases by multiplying the required purchases of direct materials by the standard cost per unit.
If sales patterns are uncertain, a company may tend to use a greater cushion in production and inventory levels. If sales are higher than expected, meaning more units need to be produced, then managers can monitor the inventory balances and know when they need to order more materials.
To prepare the direct materials budget, an accountant follows these steps:
1. Enter budgeted production from the production budget.
2. Multiply the budgeted production by the cost of the direct material per unit to reach the total direct material cost.
3. Add budgeted ending direct material inventory to the total direct material cost. Next, subtract the beginning inventory cost for that period to reach the total cost of direct material.| Heavenly Sleep Systems Direct Materials Budget For Year Ended December 31, 2019 |
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|---|---|---|---|---|
| Quarter 1 | Quarter 2 | Quarter 3 | Quarter 4 | |
| Budgeted Production (Units) | 11,500 | 10,000 | 12,050 | 14,000 |
| × Cotton Cost (Per Unit) | $5.00 | $5.00 | $5.00 | $5.00 |
| = Total Direct Material Cost | $57,500 | $50,000 | $60,250 | $70,000 |
| + Budgeted Ending Cotton Inventory | 10,000 | 10,000 | 10,000 | 10,000 |
| - Beginning Cotton Inventory Balance | 5,000 | 5,000 | 5,000 | 5,000 |
| = Total Cost of Cotton | $62,500 | $55,000 | $65,250 | $75,000 |
Heavenly Sleep Systems' direct materials budget demonstrates how much it expects to pay for its most expensive direct material, cotton, by considering its budgeted sales units, cost of cotton per unit, its budgeted ending cotton inventory, and its beginning cotton inventory balance for that period.
Direct Labor Budget
The next step is to create the direct labor budget. Direct labor refers to the hours spent producing a product or providing a service that can easily be traced to the product or service.
The direct labor budget calculates the number of direct labor hours required to meet the budgeted level of production. An accountant uses the following steps to prepare it:
1. Enter budgeted production from the production budget.
2. Calculate the number of direct labor hours needed to meet the production schedule by multiplying the number of units to be produced during the period by the standard number of direct labor hours for one unit.
3. Calculate the total budgeted direct labor payroll by multiplying the total required direct labor hours by the standard average wage rate for the period.Direct Labor Budget Steps
| Heavenly Sleep Systems Direct Labor Budget For Year Ended December 31, 2019 |
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|---|---|---|---|---|
| Quarter 1 | Quarter 2 | Quarter 3 | Quarter 4 | |
| Budgeted Production (Units) | 11,500 | 10,000 | 12,050 | 14,000 |
| × Direct Labor (Hours) | 0.5 | 0.5 | 0.5 | 0.5 |
| = Total Direct Labor (Hours) | 5,750 | 5,000 | 6,025 | 7,000 |
| × Direct Labor Cost (Per Hour) | $20 | $20 | $20 | $20 |
| = Direct Labor Budget | $115,000 | $100,000 | $120,500 | $140,000 |
Heavenly Sleep Systems' direct labor budget demonstrates how much it should expect to pay for direct labor for its budgeted sales.
Manufacturing Overhead Budget
Just about every business has overhead—operating costs such as rent, utilities, and other expenses that must be paid regularly. Overhead costs are required to operate a manufacturing plant, but they cannot be classified as direct materials or direct labor.
Expected overhead costs for the period are shown in the manufacturing overhead budget, which is the next component of the operations budget. If management knows its fixed and variable overhead costs, a manufacturing overhead budget can be created. For example, in Quarter 1, Heavenly Sleep Systems has the following fixed overhead costs: $500,000 in administrative salaries, $20,000 in depreciation, $5,000 in insurance, $10,000 for its mortgage payment, $1,250 for its property taxes, and $12,500 for its utilities. Depreciation is the gradual loss of an asset's value due to normal wear and tear over time. All of these fixed overhead costs are added together to reach its total fixed overhead costs. Thus, Heavenly Sleep Systems' total fixed overhead cost is $548,750. Management also knows the company's variable overhead costs consist of $5,000 in advertising, $9,000 in freight, $5,000 in packaging, and $6,500 in supplies. After totaling these variable overhead costs, management discovers that it has a total variable overhead cost of $25,500. Last, management adds the total fixed overhead cost to the total variable overhead cost to reach its total manufacturing overhead. For Quarter 1, Heavenly Sleep Systems has a total manufacturing overhead of $574,250.| Heavenly Sleep Systems Manufacturing Overhead Budget For Year Ended December 31, 2019 |
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|---|---|---|---|---|
| Quarter 1 | Quarter 2 | Quarter 3 | Quarter 4 | |
| Fixed Overhead Costs | ||||
| Administrative Salaries | $500,000 | $500,000 | $500,000 | $590,000 |
| Depreciation | $20,000 | $20,000 | $20,000 | $20,000 |
| Insurance | $5,000 | $5,000 | $5,000 | $5,000 |
| Mortgage | $10,000 | $10,000 | $10,000 | $10,000 |
| Property Taxes | $1,250 | $1,250 | $1,250 | $1,250 |
| Utilities | $12,500 | $12,500 | $12,500 | $16,000 |
| = Total Fixed Overhead Cost | $548,750 | $548,750 | $548,750 | $642,250 |
| Variable Overhead Costs | ||||
| Advertising | $5,000 | $5,000 | $6,000 | $8,000 |
| Freight | $9,000 | $9,000 | $9,000 | $15,000 |
| Packaging | $5,000 | $5,000 | $6,000 | $9,000 |
| Supplies | $6,500 | $6,500 | $8,000 | $11,000 |
| = Total Variable Overhead Cost | $25,500 | $25,500 | $29,000 | $43,000 |
| = Total Manufacturing Overhead | $574,250 | $574,250 | $577,750 | $685,250 |
Heavenly Sleep Systems' total manufacturing overhead costs are calculated by adding its total overhead fixed costs to its total overhead variable costs. Costs that fall within manufacturing overhead greatly vary, as it serves as a catchall for items that cannot be categorized as either direct labor or direct materials.
Total budgeted manufacturing overhead costs flow to the ending inventory and cost of goods sold (COGS) budget.
Similar to the process used with the selling and administrative expense budget, the accountant subtracts noncash items from total budgeted manufacturing overhead to arrive at total cash costs. This amount flows to the cash budget. Once a company has prepared these three manufacturing cost budgets, it can prepare the cost of goods sold budget.