Week 6 – Chapter 5OPERATING BUDGETS

(manufacturing)

FNSACC503AManage Budgets and Forecasts

By the end of this lesson, you will be able to…

1. Give some examples of manufacturing organisations in Australia.2.1 Explain some cost classification concepts relevant to manufacturing organisations.2.2 Describe the manufacturing process.3. Prepare all budgets for a manufacturing organisation (sales, production, direct materials, direct labour, factory overhead, ending inventory, COGS and operating expenses budgets).4. Prepare a budgeted income statement, cash budget and budgeted balance sheet for a manufacturing organisation.

MASTER BUDGETS (chapter 1 : budgeting fundamentals)

Budget income statementMERCHANDISING PROFESSIONAL SERVICES*

Sales Fees income Sales

Purchases >> COGS Professional and support labour costse.g. dentist + dentalassistant * direct labour

>> COGSMarketing expenses Marketing expensesAdmin. expenses Admin. expenses Admin. expensesFinancial expenses Financial expenses

Cash budget Capital expenditure budget

Budgeted balance sheet* sells expertise and knowledge

MANUFACTURINGBudget income statement

Marketing expenses

Financial expenses

Production + Ending Inventories

* direct materials (usage + purchases)

* factory overhead

1. Examples of manufacturing companies in Australia

Company This company manufacturesCSR Aluminium and building productsTontine Group (part of Pacific Brands) PillowsBristol Paints Decorating suppliesMalvern Star Bicycles

2. Manufacturing OrganisationsKEY CONCEPTS

1. Cost classification1. Product versus Period costs2. Direct versus Indirect costs

2. The manufacturing process3. Types of inventories

1. Finished goods2. WIP3. Materials

Cost Classification(PRODUCT vs. PERIOD costs)

Product costs are costs of converting raw materials into a finished product e.g. packaging boxes

MANUFACTURING or PRODUCTcosts include:(1) Direct materials e.g. cardboard(2) Direct labour (3) Factory overhead

Cost Classification(PRODUCT vs. PERIOD costs)

Period costs are all other costs associated with the business (i.e. expired costs).

1. Marketing expenses2. Admin. expenses3. Financial expenses

The Manufacturing Process

Is about converting raw materialsinto finished goods with the use of

direct labour and factory overhead.

The Manufacturing Process

The Manufacturing Process

WORK IN PROGRESS

MATERIALS

LABOUR

OVERHEADS

FINISHED GOODS

DIRECT versus INDIRECT costs

DIRECT COSTS

Direct labour Direct materials

Costs that cannot be traced very easily to a particular product.

All factory overhead.

INDIRECT COSTS

Major items of cost that can be traced quite easily to a

particular product

FACTORY OVERHEAD:All indirect costs of

running a factory e.g. indirect materials

and labour; factory insurance; light and power used by the factory

Cost Classification Summary

What is factory overhead? Includes all factory costs other than direct

materials and direct labour. Is also referred to as indirect manufacturing

costs.Cannot be traced or are not worthwhile

tracing (cost vs. benefit) to individual units of production.

Examples: * Factory insurance * Factory supervisor’s salary* Factory light & power

What is factory overhead? Although factory overhead costs cannot be

traced (or are not worthwhile tracing) to individual units of production, the TOTAL FACTORY OVERHEAD COST incurred must be allocated to individual units of production REGARDLESS.

This means that each product has to be charged with an estimated amount of factory overhead which is expected to cover the actual TOTAL cost incurred.

How do we do this?

Applying factory overheadManufacturing overhead costs incurred during a period

are allocated to units of production based on a predetermined overhead rate.

This overhead rate is based on the budgeted overhead costs for the period

and the estimated level of activity

(e.g. no. of units produced, direct labour hours etc.)

Applying factory overheadTo apply factory overhead to individual units of production you have to:a. Estimate total factory overhead expected to be incurred during the periodb. Establish an application rate (based on the relevant cost driver e.g. no. units; direct labour hours; machine hours etc.c. Apply this predetermined rate to the total factory overhead to arrive at an estimate of the cost to be allocated/charged to each individual unit of production.

Types of inventoriesMaterials includes stocks of raw material and

factory supplies e.g. lubricating oils for machinery.

Work-in-progress are partly completed goods that will be completed in the future e.g. cardboard pieces cut out and ready to be glued.

Finished goods are fully completed products ready for sale e.g. toy boxes.

Clip

* STUDENT ACTIVITY *Copy and paste the following URL into your Internet browser and watch

this YouTube Clip which takes you for a tour of the Ferrari Factory in Maranello, Italy. See if you can identify and name at least one example of DIRECT MATERIAL, DIRECT LABOUR and FACTORY OVERHEAD.

http://www.youtube.com/watch?v=La73Oy9ZGVw

Case StudyLITTLE PEOPLE INC.

You are now going to learn how to prepare the different types of budgets for the manufacturing

industry using this case study.

Case StudyLITTLE PEOPLE INC.

Little People Inc. manufactures cardboard boxes which are used for transporting very special toys to

toy stores all around Australia. We need you to prepare the company’s budgets for the

coming year ending 30 June.

3. BUDGETS FOR AManufacturing Organisation

To work out an estimate for the cost of production you need to prepare the following budgets:1.Production budget (LESSON 3 – PURCHASES BUDGET)2a. Direct materials usage budget (NEW)2b. Direct materials purchases budget (NEW)3. Direct labour budget (NEW)4. Factory overhead budget (NEW)5. Ending inventory budget (NEW)These budgets are used to prepare the COGS budget.

3. BUDGETS FOR AManufacturing Organisation

You also need to prepare the

SALES BUDGET (LESSON 2)and

OPERATING EXPENSES BUDGETS (LESSON 3)

before preparing the

BUDGETED INCOME STATEMENT.

Ending inventory budget(budget 5 in case study)

Recall: There are 3 basic types of inventories:1. Finished goods2. Materials 3. Work in progress (beyond the scope of this text)

Before we can prepare the ending inventory budget, we need work out how much it costs to produce one completed unit e.g. box.

COGS budget (budget 6 in case study)

MERCHANDISING MANUFACTURINGBeginning inventory xx Beginning inventory xxAdd: Planned purchases xx Add: Cost of production xxTotal available for sale xx Total available for sale xxLess: Ending inventory xx Less: Ending inventory xxCOGS xx COGS xx

Major difference : Manufacturing firm’s COGS budget:COST OF PRODUCTION of finished goods replaces the PURCHASES of finished goods.Therefore;Step 1: Calculate the total cost of production.Step 2: Prepare the COGS budget.

Case StudyLITTLE PEOPLE INC.

Please refer to the following document which will take you through the case study:

You are now ready to start the FINAL lesson on:

Chapter 8Flexible Budgets

Performance Reports

This week’s homework Read Chapter 5 – Operating Budgets

(manufacturing) Complete homework questions (chapter 5)

(ref. STUDENT ONLINE STUDY GUIDE)