Week 6 – Chapter 5
OPERATING BUDGETS
(manufacturing)
FNSACC503A
Manage 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 statement
MERCHANDISING
Sales
Purchases >> COGS
Marketing expenses
Admin. expenses
Financial expenses
PROFESSIONAL SERVICES*
MANUFACTURING
Budget income statement
Fees income
Sales
Professional and support
Production + Ending Inventories
labour costs
e.g. dentist + dental
* direct materials (usage + purchases)
* direct labour
assistant
* factory overhead
>> COGS
Marketing expenses
Marketing expenses
Admin. expenses
Admin. expenses
Financial expenses
Financial expenses
Cash budget
Budgeted balance sheet
* sells expertise and knowledge
Capital expenditure budget
1. Examples of manufacturing
companies in Australia
Company
This company manufactures
CSR
Aluminium and building products
Tontine Group (part of Pacific Brands)
Pillows
Bristol Paints
Decorating supplies
Malvern Star
Bicycles
2. Manufacturing Organisations
KEY CONCEPTS
1. Cost classification
1.
2.
Product versus Period costs
Direct versus Indirect costs
2. The manufacturing process
3. Types of inventories
1.
2.
3.
Finished goods
WIP
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 PRODUCT
costs 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 expenses
2. Admin. expenses
3. Financial expenses
The Manufacturing Process
Is about converting raw materials
into finished goods with the use of
direct labour and factory
overhead.
The Manufacturing Process
The Manufacturing Process
MATERIALS
WORK IN
PROGRESS
FINISHED GOODS
LABOUR
OVERHEADS
DIRECT versus INDIRECT costs
INDIRECT COSTS
Costs that cannot be traced very
easily to a particular product.
All factory overhead.
DIRECT COSTS
Major items of cost
that can be traced
quite easily to a
particular product
Direct labour
Direct materials
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 overhead
Manufacturing 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 overhead
To apply factory overhead to individual units of
production you have to:
a. Estimate total factory overhead expected to be
incurred during the period
b. 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 inventories
 Materials 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 Study
LITTLE 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 Study
LITTLE 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 A
Manufacturing 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 A
Manufacturing 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 goods
2. 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
MANUFACTURING
Beginning inventory
xx Beginning inventory
xx
Add: Planned purchases
xx Add: Cost of production
xx
Total available for sale
xx Total available for sale
xx
Less: Ending inventory
xx Less: Ending inventory
xx
COGS
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 Study
LITTLE 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 8
Flexible Budgets
Performance Reports
This week’s homework
 Read Chapter 5 – Operating Budgets
(manufacturing)
 Complete homework questions (chapter 5)
(ref. STUDENT ONLINE STUDY GUIDE)