LESSON 4

OPERATIONAL BUDGETING

TOPICS

1. Definition of Budgeting
2. Framework of Budgeting
3. Sub-parts of Operating Budgets.
4. Illustrative Examples

LEARNING OBJECTIVES:
After studying this lesson, you will be able to:
 Understand the definition of budgeting and its framework.
 Comprehend the sub-parts of operating budgets.
 Able to prepare Operating Budgets

TOPIC 1: DEFINITION OF BUDGET

Budget is a quantitative expression of objectives and goals of enterprise. This is used for
both planning and control. The robust of budgeting is showed in master budget. Master
budget is a comprehensive plan for overall activities of the enterprise. It composed of
operating budget, capital budget (capital expenditures budget) and cash budget (financial
budget). The master budget is a complete blueprint of the planned operations of the firm
for a period. It is also necessary to determine the budget period of the enterprise. Budget
period is the length of time for which a budget is to be prepared and implemented.

TOPIC 2: FRAMEWORK OF BUDGETING

A strong framework of budgeting is fall in a master budget consisting of operating

budgets, capital expenditure budgets and cash budgets.

Operating budgets – It encompasses the budget for revenues and expenses of the
company. It is also called as the budgeted income statement.

Capital budgets - It is mostly requests for large assets which create major demands on an
entity’s cash flow. Examples of these are spending for buildings, renovations,
automobiles, software system and furnitures. The purpose of capital budget is to allocate
funds, control risks in decision making and set priorities.

Cash budgets – It is an estimation of the cash inflows and outflows for a specific period
of time. Cash budgets are used to assess whether the entity has sufficient cash to fulfill
regular operations. This budget identifies whether too much cash is being left in
unproductive capacities.
These three budgets composed the budgeted income statement, statement of financial
position and cash flow statement.

The main purpose of budgeting is for planning, evaluating performance, coordinating and
control activities, implementing plans and communication and motivation.

Some of the advantages of budgeting are follows (1) It compels management planning.
(2) It provides a good framework for judging subsequent performance (3) It promotes
communication, coordination, and control. (4) It motivates members of the business
organization.

It found out that there are limitations associated with budgeting. Some restrictions are the
accuracy of the estimates, adverse reactions from employees, amount of work involved in
developing a good budget, once the budget is developed, it limits flexibility; and it is an
expensive tool and implementation is not automatic.

TOPIC 3: SUB-PARTS OF OPERATING BUDGETS

Again, Operating Budgets involves budget for revenues and expenses and this represents
the budgeted income statement. This budget has sub-parts and these are:

1. Sales forecast

2. Production budget

3. Material purchases and usage

a. Direct labor costs

b. Factory overhead costs

c. Inventory levels

4. Cost of goods sold budget

5. Selling and administrative expensive budget

6. Other expense related budgets

*Sales Forecast (Bishop 2019). It is prediction of future sales revenue. The basis of
forecast will be on its historical data, trends and status of current sales pipeline. It can be
made weekly, monthly, quarterly or annually based on the needs of the management that
will be help for decision making.

*Production Budget (Bragg, 2018). Based on Bragg article in Accounting Tools,

Production budget is the projection of the number of units that will be produced. It will
came from the combination of sales forecast and future ending inventory on hand. It is
simply computed as follows:

Forecasted unit sales XXX

Less: Proposed Ending Inventory XXX
Total Production Required XXX
 Less: Beginning Inventory XXX
Products to be manufactured XXX

Harina (2008) defined the following budgets:

*Direct material budget. Since the production budget was already determined, the next
step is to determine the direct material budget. This is the required materials necessary
for the production. It is the purchased of materials based on the expected usage of
materials and inventory levels to meet the production requirement.

*Direct labor Budget. Again the production requirements is the basis for the direct labor
budget. It can be computed by multiplying the expected production volume for each
period by the number of direct labor hours required to produce a single unit. The direct
labor hours required to meet production requirements is then multiplied by the direct
labor cost per hour to obtain the budgeted total direct labor cost.

*Factory overhead budget. Harina(2008) defined it as projection of all manufacturing

costs other than direct materials and direct labor. It also requires the development of a
predetermined overhead rate for the variable portion of the factory overhead. Those
accounts does not have cash outlay should be deducted from the total factory overhead in
preparing the cash budget.

* Ending inventory budget. The proposed ending inventory budget is needed for the
preparation of budgeted financial statements. It is needed in preparation of cost of goods
sold and ending materials and finished goods inventory.

*Cost of goods sold budget (Hayes, 2020). In article of Hayes in Investopedia, he defined
the cost of goods sold budget as a forecast for the direct costs of producing the goods sold
by a company. In this budget, it includes the cost of materials and labor directly used in
producing a product. It excludes period cost such as selling, general and administrative
costs.

*Selling and administrative budget (Carlson, 2020). It was defined as projected expenses
other than direct costs of producing a product. These are the projected operating
expenses of the company involving selling the products and needed expenses to manage
the business.

TOPIC 4: ILLUSTRATIVE EXAMPLE

The Scarborough Corporation manufactures and sells two products. Thingone and
Thingtwo. In July 2008, the Scarborough’s budget department gathered the following
information in order to project sales and budget requirements for 2009:

2009 Projected Sales

Products Units Price
Thingone 60,000 P70
Thingtwo 40,000 100
2009 Inventory in Units
Products Expected (01-01-09) Expected (12-31-09)
Thingone 20,000 25,000
Thingtwo 8,000 9,000

In order to produce one unit of Thingone and Thingtwo, the following raw materials are
used:

Materials Unit Amount used per unit

Thingone Thingtwo
A Kilos 4 5
B Kilos 2 3
C Each - 1

Projected data for 2009 with respect to materials is as follows:

Expected Purchase Expected Inventory Desired Inventory

Raw Material Price Jan. 1, 2009 Dec. 31, 2009
A P8.00 32,000 kilos 36,000 kilos
B 5.00 29,000 kilos 32,000 kilos
C 3.00 6,000 each 7,000 each

Projected direct labor requirements for 2009 and rates follow:

Products Hours/Unit Rate/Hour
Thingone 2 P3.00
Thingtwo 3 4.00

Overhead is applied at the rate of P2.00 per direct labor hour.

REQUIRED: Based on the above projections and budget requirements for 2009 for
Thingone and Thingtwo, prepare the following budgets for 2009:
1. Sales budget (in pesos)
2. Production budget (in units)
3. Raw materials usage budget (in quantities)
4. Raw materials purchase budget (in pesos)
5. Direct labor budget (in pesos)
6. Budgeted finished goods inventory at December 31, 2009 (in pesos)

SOLUTION:
1.
Scarborough Corporation
Sales Budget
For the Year 2009

Products Units Price Total

Thingone 60,000 P70 P4,200,000
Thingtwo 40,000 100 4,000,000
Projected Sales P8,200,000

2.
Production Budget
For the Year 2009
(In Units)
Thingone Thingtwo
Projected Sales 60,000 40,000
Desired Inventory, Dec. 31, 2009 25,000 9,000
Total 85,000 49,000
Expected Inventory, Jan. 1, 2009 20,000 8,000
Production Required 65,000 41,000

3.
Raw Materials Usage Budget
For the Year 2009
(In Quantities)

Product Production Material A Material B Material C

Thingone 65,000 260,000 130,000 -
Thingtwo 41,000 205,000 123,000 41,000
Production Requirement – Usage (3) 465,000 253,000 41,000
Add: Desired Inv. Dec. 31 36,000 32,000 7,000
Total Requirement 501,000 285,000 48,000
Less: Expected Inv. Jan. 01 32,000 29,000 6,000
Purchase Requirement 469,000 256,000 42,000

4.
Raw Materials Purchases Budget
For the Year 2009
Required Unit
Material Units Price Total
A 469,000 P8 P3,752,000
B 256,000 5 1,280,000
C 42,000 3 126,000
Raw Materials Purchases P5,158,000

5.
Direct Labor Budget
For the Year 2009
Products Total Hours Rate Amount
ThingOne (65,000 x 2) 130,000 P3 P390,000
Thingtwo (41,000 x 3) 123,000 4 492,000
Total Direct Labor Budget P882,000

6. Computation of Units Costs:

ThingOne Thingtwo
Items Rate/Price Units Cost Units Cost
Material A P8 4 P32 5 P40
Material B 5 2 10 3 15
Material C 3 - - 1 3
Labor P3/P4 2 6 3 12
Overhead P2 2 4 3 6
Budgeted Unit Costs P52 P76

Budgeted Finished Goods Inventory

For the Year 2009

Products Units Unit Cost Total

Thingone 25,000 P52 P1,300,000
Thingtwo 9,000 76 684,000
Total P1,984,000

Task/Activity : Quiz {Adopted from Management Advisory Service, Roque (2016)}

1. Edil Producers, Inc. will start its commercial operations on January 1, 200A. The
sales forecast per the sales manager’s estimates for its first year of operations is
50,000 units. However, the production manager estimated that only 80% of the sales
forecast can be produced with the available workforce and equipment. The product
will be sold for P20 per unit. The budgeted peso sales for Edil Producers, Inc. initial
year of operations is
a. P800,000 c. P50,000
b. P1,000,000 d. P40,000

2. Hershey Company has budgeted sales of 90,000 units in January, 120,000 units in
February; and 180,000 units in March. The company has 20,000 units on hand on
January 1. If Hershey Company requires an ending inventory of finished goods equal
to 20% of the following month’s sales, the budgeted production during February
should be
a. 96,000 c. 120,000
b. 108,000 d. 132,000

3. Tasyo Company has budgeted sales of 90,000 units in January 120,000 units in
February; and 180,000 in March. The company has 20,000 units of finished goods
and 35,000 pieces of materials on hand on January 1. Each unit of product requires 5
pieces of materials. The desired inventory of finished goods and materials at the end
of each month is as follows:
Finished goods – 20% of next month’s sales
Materials – 25% of next month’s production needs
How many pieces of materials should the company plan to purchase in January?
a. P600,000 c. P468,000
b. P567,000 d. P552,500

4. Nicely Wyn Corporation has the following budgeted production for four months:
April 50,000
May 40,000
June 45,000
July 60,000

Each unit of product requires 2 pieces of raw materials. The desired ending raw materials
inventory for each month is 130% of the following month’s production needs, plus 2,000
pieces. (The April 1 inventory meets this requirement.)
The product is processed in two departments (Dept. A and Dept. B) and the direct labor
standards are as follows:
Hours per Unit Rate per Hour Labor Cost per
unit
Dept. A 6 P30 P180
Dept. B 2 40 80

What is the budgeted purchases of raw materials in June?

a. 51,000 c. 120,000
b. 84,000 d. 129,000
5. Based on Number 4, what is the budgeted direct labor cost for the month of May?
a. P13,000,000 c. P10,400,000
b. P11,700,000 d. P7,200,000

6. Fame Company has the following budget formula for factory overhead costs:
FOH = P5,000,000 per month + P300 per unit of product
If the company plans to produce 50,000 units in January, how much is the budgeted
factory overhead cost?
a. P20,000,000 c. P5,000,000
b. P15,000,000 d. P5,050,000

7. For Number 7 to 10. Bags Inc. manufactures leather bags with 3 zipper-type pockets.
The company outsources the zippers at P8 per unit. Each bag requires 5 direct labor
hours to produce at a rate of P10 per hour. Budgeted sales of bags for the first quarter
of the year and the first month of the following quarter are as follows:
January 900 units
February 1,000 units
March 1,500 units
April 1,800 units

Inventory data are as follows:

January 1: Leather bags 360
Zipper 1,620
End of each month:
Leather bags – 40% of the following month’s budgeted sales
Zipper – 60% of the following month’s production requirement.

What is the budgeted production of leather bags for the first quarter?
a. 3,760 c. 4,400
b. 3,040 d. 3,400

8. What is the budgeted purchases of zipper for February?

a. 2,844 c. 4,356
b. 1,956 d. 3,600

9. What is the total budgeted zipper and labor costs for the month of March?
a. P55,080 c. P122,472
b. P29,160 d. P119,880

10. Assume that on the average, a full-time factory worker works 188 hours per month
and no overtime is allowed, how many full-time equivalent factory workers are
needed to produce the budgeted output of leather bags in January?
a. 5 c. 100
b. 25 d. 23.94

REFERENCES

BOOKS

Aliling, Leonardo E. & Anastacio, Ma. Flordeliza L. (2015). Management Accounting 1.

856 Nicanor Reyes, Sr. St. Sampaloc, Manila, Philippines. Rex Book Store,
Inc.
Cabrera, Ma. Elenita B. & Cabrera, Gilbert Anthony B. (2019). Strategic Cost
Management. 2017 C.M. Recto Ave., Sampaloc, Manila, Philippines. GIC
Enterprises & Co., Inc.
Harina, Ricardo M. (2008). Management Advisory Services. 2017 C.M. Recto Ave.,
Sampaloc, Manila, Philippines. GIC Enterprises & Co., Inc.
Mejorada, Nenita D. (2006). Management Advisory Services Part II. 393 Sen. Gil J.
Puyat Avenuue, Makati City, Philippines. Goodwill Trading Co., Inc.
Roque, Rodelio S. (2016). Management Advisory Services. 2017 C.M. Recto Ave.,
Sampaloc, Manila, Philippines. GIC Enterprises & Co., Inc.