To illustrate the preparation of the master budget, we use the fictitious company Smart Touch Learning. As you recall, the company manufactures its own brand of touch screen tablet computers that are preloaded with the company’s e-learning software. The master budget is for 2021, prepared by quarter. The balance sheet for December 31, 2020, as shown in Exhibit 22-3, provides some of the data we use in preparing the master budget.
Learning Objective 3 Prepare an operating budget for a
manufacturing company
Sales Budget
The first part of the operating budget involves preparing the sales budget. The sales budget estimates the amount of sales revenue and is the cornerstone of the master budget because the level of sales affects production expenses and almost all other elements of the master budget. Budgeted total sales for each product equal the sales price multiplied by the expected number of units sold. The sales and marketing teams at Smart Touch Learning project that the company will sell 500 tablet computers in the first quarter of 2021, with sales increasing by 50 tablets each quarter. The tablets sell for $500 each. Exhibit 22-4 shows the sales budget for Smart Touch Learning for 2021. The total sales for the year will be carried to the budgeted income statement.
Sales Budget
The budget that estimates the amount of sales revenue.
Exhibit22-3 | Balance Sheet
348,340
$ 368,340
$ 15,000 30,000 55,000 70,000
$ 170,000 SMART TOUCH LEARNING
Balance Sheet December 31, 2020
Assets Current Assets:
Total Current Assets
Property, Plant, and Equipment:
Total Assets
Current Liabilities:
Stockholders’ Equity Common Stock, no par
Retained Earnings Cash
Accounts Receivable Raw Materials Inventory Finished Goods Inventory
Equipment
Less: Accumulated Depreciation
Accounts Payable
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
210,340
48,340
$ 300,000
(12,000) 198,340
$ 368,340
$ 20,000 Liabilities
Exhibit22-4 | Sales Budget
First Second Third Fourth
SMART TOUCH LEARNING Sales Budget
For the Year Ended December 31, 2021
Production Budget
The production budget determines the number of tablets to be produced during the year to meet projected sales and is the basis for the production costs budgets: direct materials budget, direct labor budget, and manufacturing overhead budget. Additionally, the infor- mation is used to complete the cost of goods sold budget.
To calculate the number of tablets to be produced, start with the number of tablets projected to be sold. Add to this amount the desired number of tablets in ending inven- tory. This determines the total number of tablets needed. After determining the number of tablets needed, subtract the number of tablets in beginning inventory. The difference is the number of tablets to be produced. The calculation can be summarized as follows:
Production Budget The budget that determines the number of units to be produced to meet projected sales.
First Quarter: Second quarter’s sales * 20% = Desired ending inventory 550 tablets * 20% = 110 tablets
Second Quarter: Third quarter’s sales * 20% = Desired ending inventory 600 tablets * 20% = 120 tablets
Third Quarter: Fourth quarter’s sales * 20% = Desired ending inventory 650 tablets * 20% = 130 tablets
Fourth Quarter: First quarter’s sales (2022) * 20% = Desired ending inventory 700 tablets * 20% = 140 tablets
Budgeted tablets to be sold + Desired tablets in ending inventory
Total tablets needed
- Tablets in beginning inventory Budgeted tablets to be produced
Keep in mind that Smart Touch Learning does not want to end the period with zero inven- tory; it wants to have enough tablets on hand to begin the next period. The company should have the minimum amount of inventory to be sure the company balances providing adequate amounts of goods to customers with turning over the inventory efficiently. Keeping inventory at the minimum level that meets these needs helps reduce inventory storage costs, insurance costs, and warehousing costs, and it reduces the potential for inventory to become obsolete.
Smart Touch Learning desires to have an ending inventory each quarter equal to 20%
of the next quarter’s sales. Using this assumption, we can determine the desired ending inventory for each quarter by multiplying the following quarter’s sales by 20%. For the fourth quarter, we will need the forecasted sales for the first quarter of 2022. Assume the projected number of tablets to be sold during the first quarter of 2022 is 700, 50 more than fourth quarter 2021. Following are the calculations for desired ending inventory:
Once the calculations for desired ending inventory are determined, the company can determine the production for each quarter. Exhibit 22-5 illustrates the production budget for Smart Touch Learning. Notice that the desired ending inventory is added to the budgeted tablets to be sold to determine the total needed. The beginning inventory is then subtracted to determine the number of tablets to be produced each quarter. The beginning inventory for the first quarter is found on the December 31, 2020, balance sheet (Exhibit 22-3) which indicates the Finished Goods Inventory account has a balance of $55,000, consisting of 200 tablets at a cost of $275 each. The ending inventory of one quarter always becomes the beginning inventory of the following quarter.
Notice also in Exhibit 22-5 that the total column is not always equal to the sum of the numbers in a row. For example, both ending and beginning inventories are not totaled.
Instead, the number used in the total column for desired tablets in ending inventory is the ending inventory for the fourth quarter. The number used in the total column for tablets in beginning inventory is the beginning inventory for the first quarter. The beginning inventory and ending inventory in the total column are for the year, not the sum of the four quarters.
Budgeted tablets to be produced
* Direct materials (pounds) per tablet Direct materials needed for production
Exhibit22-5 | Production Budget
Budgeted tablets to be sold
First
Quarter Second
Quarter Third
Quarter Fourth
Quarter Total
Plus: Desired tablets in ending inventory Total tablets needed
Less: Tablets in beginning inventory
Budgeted tablets to be produced 560
110 120 130 200
610 660 2,240
500 550 600 650 2,300
410 200 110
610 670
120 130
730 790 2,440
140 140
SMART TOUCH LEARNING Production Budget
For the Year Ended December 31, 2021
Don’t forget that one period’s ending inventory becomes the next period’s beginning inventory.
Direct Materials Budget
Smart Touch Learning has determined the number of tablets to be produced each quarter in its production budget. The next step is to determine the product costs for the tablets, beginning with the direct materials budget. The direct materials budget estimates the amount of materials to purchase to meet the company’s production needs. The purchasing department has projected that each tablet requires 3 pounds of direct materials and the expected cost of direct materials is $50 per pound. The company now needs to determine the amount of materials to purchase each quarter. The amount of indirect materials needed for the production of tablet computers has been determined to be insignificant and will therefore not be considered in the calculation. That means that the amount of materials in the Raw Materials Inventory account is assumed to be only direct materials.
Just as the Finished Goods Inventory account must be considered when calculating the amount of tablets to produce, the Raw Materials Inventory account must be considered when calculating the amount of materials to be purchased. The formula is:
Direct Materials Budget The budget that estimates the amount of materials to purchase to meet the company’s production needs.
The December 31, 2020, balance shown in Exhibit 22-3 places the Raw Materials Inventory balance at $30,000 or 600 pounds ($30,000 / $50 per pound = 600 pounds).
The company desires the ending balance in Raw Materials Inventory to be 40% of the next quarter’s budgeted direct materials needed for production. The desired ending balance for the fourth quarter is 852 pounds. Following are the calculations for desired ending inventory:
First Quarter: 2nd quarter>s production * 3 pounds per tablet * 40% = Desired ending inventory 560 tablets* 3 pounds per tablet * 40% = 672 pounds
Second Quarter: 3rd quarter>s production * 3 pounds per tablet * 40% = Desired ending inventory 610 tablets* 3 pounds per tablet * 40% = 732 pounds
Third Quarter: 4th quarter>s production * 3 pounds per tablet * 40% = Desired ending inventory 660 tablets* 3 pounds per tablet * 40% = 792 pounds
Fourth Quarter: Amount given Desired ending inventory
852 pounds
Exhibit 22-6 illustrates the direct materials budget for Smart Touch Learning.
Exhibit22-6 | Direct Materials Budget
Budgeted tablets to be produced
First
Quarter Second
Quarter Third
Quarter Fourth
Quarter Total
Direct materials (pounds) per tablet Direct materials needed for production
Plus: Desired direct materials in ending inventory (pounds) Total direct materials needed
Less: Direct materials in beginning inventory (pounds) Budgeted purchases of direct materials
410 560 610 660 2,240
SMART TOUCH LEARNING Direct Materials Budget For the Year Ended December 31, 2021
Direct materials cost per pound
Budgeted cost of direct materials purchases
× $50 × $50 × $50 × $50 × $50
$ 65,100 $ 87,000 $ 94,500 $ 102,000 $ 348,600
× 3 × 3 × 3 × 3 × 3
1,230 1,680 1,830 1,980 6,720
732 792 852 852
672
1,902 2,412 2,622 2,832 7,572
600 672 732 792 600
1,740 1,890 2,040 6,972
1,302
Notice again that in the total column, the amount for ending inventory and beginning inventory is not totaled. Instead, the ending inventory is the amount of ending inventory for the fourth quarter and the beginning inventory is the amount
of beginning inventory for the first quarter. The beginning inventory and ending inventory in the total column are for the year, not the sum of each quarter.
Direct Labor Budget
The next product cost to consider is direct labor. The direct labor budget estimates the direct labor hours and related cost needed to support the production budget. The pro- duction manager projects that each tablet computer will require three hours of direct labor. The personnel manager projects direct labor costs to average $25 per hour. To
Direct Labor Budget The budget that estimates the direct labor hours and related cost needed to meet the company’s production needs.
calculate the direct labor cost, multiply the number of tablets to be produced by the number of projected direct labor hours. Then multiply that total by the average direct labor cost per hour. Exhibit 22-7 shows the direct labor budget for Smart Touch Learning for 2021.
Exhibit22-7 | Direct Labor Budget
Budgeted tablets to be produced
First
Quarter Second
Quarter Third
Quarter Fourth
Quarter Total
Direct labor hours per unit
Direct labor hours needed for production Direct labor cost per hour
Budgeted direct labor cost $ 42,000
× $25 × $25 × $25 × $25
$ 45,750 $ 49,500 $ 168,000
410 560 610 660 2,240
$ 30,750
× $25
× 3
1,230 1,680
× 3 × 3
1,830 1,980 6,720
× 3 × 3 SMART TOUCH LEARNING
Direct Labor Budget
For the Year Ended December 31, 2021
The various units used in budgeting can be confusing.
Notice that the direct labor budget includes tablets produced, direct labor hours per tablet, and direct labor cost per hour.
It is important to not confuse dollars (direct labor cost per hour) with the quantity of an input (direct labor hours) and
units of output (budgeted tablets).
Manufacturing Overhead Budget
The last product cost to consider is manufacturing overhead. The manufacturing overhead budget estimates the variable and fixed manufacturing overhead needed to meet the company’s production needs. The production manager worked with the cost accountant to project the variable manufacturing cost at $20 per tablet. Additionally, they project that fixed costs are $12,000 per quarter for depreciation on the manufacturing equipment and $15,440 per quarter for other fixed costs, such as utilities, insurance, and property taxes on the manufacturing facility. The manufacturing overhead budget calcu- lates the budgeted overhead cost for the year and also the predetermined overhead allo- cation rate for the year. The predetermined overhead allocation rate is used to allocate the indirect overhead costs to the tablets produced. Smart Touch Learning uses direct labor hours (which is taken from the direct labor budget) as the allocation base to allo- cate overhead costs. As a reminder, the formula to calculate the predetermined overhead allocation rate is:
Manufacturing Overhead Budget The budget that estimates the variable and fixed manufacturing overhead needed to meet the company’s production needs.
Cost of Goods Sold Budget
Now that the product costs have been determined, Smart Touch Learning’s managers can use them to complete the cost of goods sold budget which estimates the cost of goods sold based on the company’s projected sales. The cost of goods sold budget starts by calcu- lating the projected cost to produce each tablet in 2021. The total projected manufacturing cost to produce each tablet in 2021 is $294, which is calculated as follows:
Direct materials cost per tablet (3 pounds per tablet : $50 per pound) $ 150 Direct labor cost per tablet (3 DLHr per tablet : $25 per DLHr) 75 Manufacturing overhead cost per tablet (3 DLHr per tablet : $23 per DLHr) 69 Total projected manufacturing cost per tablet for 2021 $ 294
Smart Touch Learning uses the first-in, first-out (FIFO) inventory costing method.
The production budget illustrated in Exhibit 22-5 shows that the company starts 2021 with 200 tablets in Finished Goods Inventory, and the balance sheet in Exhibit 22-3 shows the beginning Finished Goods Inventory has a total cost of $55,000, which is $275 per tablet, the actual cost to produce the tablets in the prior period. Therefore, the first 200 tablets sold in 2021 will have a cost of $275. All other tablets sold in 2021 will assume the budgeted production cost of $294 per tablet, as calculated above.
Referring to the sales budget in Exhibit 22-4, the company projected sales of 500 tablets in the first quarter. Therefore, the company must use the appropriate inventory costing method, FIFO, to determine the cost of each tablet sold. 200 tablets will be assigned the beginning inventory costs of $55,000 ($275 per tablet) and the remaining 300 tablets will be assigned the cost of $294 per tablet. The cost of goods sold budget for Smart Touch Learning for 2021 is shown in Exhibit 22-9.
Cost of Goods Sold Budget The budget that estimates the cost of goods sold based on the company’s projected sales.
How do inventory costing methods affect the budgeting process?
Exhibit22-8 | Manufacturing Overhead Budget
Budgeted tablets to be produced
First
Quarter Second
Quarter Third
Quarter Fourth
Quarter Total
VOH* cost per tablet Budgeted VOH Budgeted FOH**
Depreciation
Utilities, insurance, property taxes Total budgeted FOH
Budgeted manufacturing overhead costs Direct labor hours (DLHr)
*VOH – Variable Manufacturing Overhead
**FOH – Fixed Manufacturing Overhead
1,680 1,830 1,980 6,720
$ 23/DLHr
410 560 610 660 2,240
1,230
× $20
$ 8,200
12,000 15,440 27,440
$ 35,640
$ 11,200
12,000 12,000 12,000 48,000
15,440 15,440 15,440 61,760
27,440 27,440
$ 39,640 $ 40,640
27,440 109,760
$ 154,560
$ 38,640
× $20 × $20
$ 12,200 $ 13,200 $ 44,800
× $20 × $20 SMART TOUCH LEARNING
Manufacturing Overhead Budget For the Year Ended December 31, 2021
Predetermined overhead allocation rate ($154,560 / 6,720 DLHr)
Selling and Administrative Expense Budget
The cost accountant works with the office and sales managers to develop the selling and administrative expense budget. The selling and administrative expense budget estimates the selling and administrative expenses needed to meet the company’s projected sales. Cost behavior is also considered for this budget, with costs designated as variable or fixed. Smart Touch Learning projects the following selling and administrative costs for 2021:
Salaries Expense, fixed $ 30,000 per quarter Rent Expense, fixed 25,000 per quarter Insurance Expense, fixed 2,500 per quarter Depreciation Expense, fixed 1,500 per quarter Supplies Expense, variable 1% of Sales Revenue
To calculate the projected Supplies Expense, multiply the Sales Revenue for each quarter, as calculated in the sales budget in Exhibit 22-4, by 1%.
Quarter Sales Revenue Supplies Expense
First $ 250,000 $ 2,500
Second 275,000 2,750
Third 300,000 3,000
Fourth 325,000 3,250
The selling and administrative expense budget for Smart Touch Learning for 2021 is shown in Exhibit 22-10 (on the next page).
Selling and Administrative Expense Budget
The budget that estimates the selling and administrative expenses needed to meet the company’s projected sales.
Exhibit22-9 | Cost of Goods Sold Budget
Beginning inventory, 200 tablets
First
Quarter Second
Quarter Third
Quarter Fourth
Quarter Total
Tablets produced and sold in 2021 @ $294 each (300, 550, 600, 650 tablets per quarter)
Total budgeted cost of goods sold $ 161,700 $ 176,400 $ 191,100 $ 672,400
$ 55,000 $ 55,000
$ 143,200
88,200 $ 161,700 $ 176,400 $ 191,100 617,400 SMART TOUCH LEARNING
Cost of Goods Sold Budget For the Year Ended December 31, 2021