Master Budget

Production Budget

The production budget indicates how much product must be produced each period.

A large part of the operating budget is the production budget. The production budget provides a company with a plan for how much product must be manufactured or otherwise made available during a particular period. This budget shows not only the beginning inventory for the period, but also a goal for desired ending inventory. The idea behind carrying an ending inventory is to provide a safety stock that will be used to absorb any unexpected sales that may happen. This ending inventory then becomes beginning inventory for the next period.

An accountant prepares the production budget by following four steps:

1. Enter budgeted sales units from the sales budget.

2. Calculate budgeted ending inventory units for the period.

3. Add budgeted ending inventory units to budgeted sales units to determine the number of units required during the period.

4. Subtract beginning inventory units from required units to determine the budgeted production.

Production Budget Steps

The production budget determines how much product a company needs to produce based on its sales budget and considers its beginning and ending inventory.
Production Budget (Units)=Budgeted Sales (Units)+Budgeted Ending Finished Goods Inventory (Units)Beginning Finished Goods Inventory (Units){\begin{aligned}\text{Production Budget (Units)}=&\;\text{Budgeted Sales (Units)}+\text{Budgeted Ending Finished Goods Inventory (Units)}\\&-\text{Beginning Finished Goods Inventory (Units)}\end{aligned}}
For example, Heavenly Sleep Systems manufactures the leading bed comforter in the market, the Premium Down Comforter. Heavenly Sleep Systems' manufacturing manager plans the target finished goods inventory for the Premium Down Comforter numbers based on the previous year's inventory numbers. Finished goods inventory is the number and types of manufactured items that are ready for customers to buy; it contains the direct materials, direct labor, and overhead costs required to produce those units. For the first quarter of the year, Heavenly Sleep Systems' budgeted sales is 12,000 units, its budgeted ending inventory is 1,000 units, and its beginning inventory consists of 1,500 units. The total production budget for its first quarter is 11,500 units.
For the remainder of the year, Heavenly Sleep Systems expects its budgeted ending inventory units to equal its beginning inventory units, resulting in the two canceling each other out. Thus, the only remaining variable for Quarters 2 through 4 is Heavenly Sleep Systems' budgeted sales units. This means the production in only the first quarter will differ from sales.
Heavenly Sleep Systems
Production Budget
For Year Ended December 31, 2019
Quarter 1 Quarter 2 Quarter 3 Quarter 4
Budgeted Sales (Units) 12,000 10,000 12,050 14,000
+ Budgeted Ending Inventory (Units) 1,000 1,000 1,000 1,000
- Beginning Inventory (Units) 1,500 1,000 1,000 1,000
= Production Budget (Units) 11,500 10,000 12,050 14,000

Heavenly Sleep Systems' production budget for its leading product, the Premium Down Comforter, shows management how many units it expects to produce per quarter.

The production budget is then used to determine the specific components or parts of cost of goods manufactured (COGM), which is the amount spent to produce a product from start through completion and entry into finished goods inventory. Items that make up COGM include:

  • Direct materials: raw goods that can be traced directly to, or easily identified with, a specific product; for instance, fabric and wood are direct materials in furniture.
  • Direct labor: hours spent producing a product or providing a service that can easily be traced to the product or service
  • Manufacturing overhead: indirect, factory-related production costs that come from making an item but cannot be traced easily to a unit of product; examples include electricity and security guards' salaries.