# Cost of Goods Manufactured (COGM) Budget

### Direct Materials Budget

A company needs to identify its direct materials costs in order to create a 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.
{\begin{aligned}\text{Raw Materials Inventory Budget}=&\;\text{Budgeted Sales (Units)}\times\text{Unit Cost of Raw Material}\\&+\;\text{Budgeted Ending Raw Material Inventory}-\text{Beginning Raw Material Inventory}\end{aligned}}
The resulting budgeted ending direct materials inventory balance will also be reported on the pro forma balance sheet. For instance, Heavenly Sleep Systems' management wants to calculate the cost of cotton, its largest direct material cost. Heavenly Sleep Systems budgeted production for Quarter 1 as 11,500 units. Historically, Heavenly Sleep Systems' uses $5 of cotton per unit and prefers to budget its ending cotton inventory at$10,000 and its beginning cotton inventory balance at $5,000. Heavenly Sleep Systems' total cost of cotton for Quarter 1 is$62,500.
$\62{,}500=(11{,}500{\text { Units}}\times \5) +\10{,}000-\5{,}000$
Heavenly Sleep Systems
Direct Materials Budget
For Year Ended December 31, 2019
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

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 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

${\text{Direct Labor Budget}=\text{Budgeted Production (Units)}\times\text{Direct Labor (Hours)}\times\text{Labor Cost (per Hour)}}$
For example, Heavenly Sleep Systems' manufacturing manager wants to create a direct labor budget based on the previous year's direct labor reports. Heavenly Sleep Systems' management budgeted sales is 11,500 units in Quarter 1. Management also expects each unit to take 30 minutes on average to produce, and their employees cost $20 per hour. For the first quarter, Heavenly Sleep Systems' direct labor budget is $\115{,}000\;((11{,}500\;\text{units}\times0.5\;\text{hours})\times\20\;\text{per}\;\text{hour}=\115{,}000$). Heavenly Sleep Systems Direct Labor Budget For Year Ended December 31, 2019 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. If the company pays a wide range of direct labor wage rates, then the direct labor budget will be more accurate if direct labor hours are calculated separately for each pay level. The same process is required for each product line or category the company offers. ### Manufacturing Overhead Budget To create a budget, a company must identify its manufacturing overhead costs. 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.
$\574{,}250=\548{,}750 + \25{,}500$
Heavenly Sleep Systems
For Year Ended December 31, 2019
Quarter 1 Quarter 2 Quarter 3 Quarter 4
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
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