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
|Heavenly Sleep Systems
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|
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.