This chapter covers the next group of operating budgets for manufacturing companies: direct labor  budget, manufacturing overhead budget, the selling and administrative expense budget, and the capital expenditures budget. Some companies prepare budgets in additional to those presented in this text, however, the budgets covered are the primary budgets of most manufacturing companies.

Direct Labor Budget

Because direct labor is a cost of production, the direct labor budget begins with the number of units to be produced. The goal of the direct labor budget is to determine the budgeted direct labor cost for the budget period. Budgeted direct labor cost consists of units to be produced multiplied by the direct labor hours per unit times the labor rate per hour.

Because hours are the denomination in which employees' wage rates are quoted, you must always convert minutes to hours. For example, 6 minutes divided by 60 minutes (in an hour) results in 0.10 direct labor hours per unit.

Walk Through Problem - Direct Labor Budget

Saran, Inc.’s budgeted sales are 66,000 widgets for January, 59,000 for February, and 65,000 widgets for March. Its budgeted production units are 65,300 for January, 59,600 for February, and 64,500 widgets for March. The company’s policy requires maintaining units on hand at the end of each month equal to 10% of next month's budgeted unit sales, and to maintain materials at the end of each month equal to 8% of the next month's production needs.  Each widget requires 3 pounds of material and 12 minutes of direct labor to produce. Employees are paid \$12 per hour. Manufacturing overhead is applied at \$3.20 per direct labor hour. Prepare a direct labor budget for the month of February.

Solution

Step 1: Begin with the finished goods units to be produced which is calculated in the production budget. Why begin with units to be produced? Labor efforts are used to produce units, not sell units.

Step 2: Determine the number of direct labor hours needed for each finished good item, in this case, for each widget. Because employees are not accumulated in inventory, you will ignore any inventory changes in this budget. To convert the minutes to hours, divide the 12 minutes by 60 minutes to get 0.20 hours per widget. Multiplying the number of labor hours per widget times the number of widgets to be produced determines the total labor hours need for production:

 Finished units to be produced 59,600 Direct labor hours to complete one widget 0.20 Direct labor hours needed for production 11,920

Step 3: The next line item of the direct labor budget displays the budgeted labor cost per hour. Any fringe benefits are included as part of the direct labor hourly rate.

Step 4: Multiply the labor cost per hour by the number of direct labor hours to determine the budgeted direct labor cost.

 Saran, Inc. Direct Labor Budget Month Ending February 28, 2018 Finished units to be produced 59,600 Direct labor hours to complete one unit 0.20 Direct labor hours needed for production 11,920 Budgeted labor cost per hour \$    12.00 Budgeted direct labor cost \$143,040

The manufacturing overhead (MOH) budget has two formats depending on if the company uses actual or normal costing. An actual costing overhead budget separates overhead into variable and fixed components and lists the indirect costs item by item. Variable overhead is the variable cost per unit times the number of units produced. Fixed overhead is the same total dollar amount no matter how many widgets are budgeted during each period. Only product overhead costs are part of this budget.

Budgeted MOH = [Unit variable MOH cost x Units to be produced] + [Total fixed MOH]

Companies that use normal costing apply overhead based on one of four activity bases: direct labor hours, direct labor cost, number of machine hours, or number of units produced. This format provides for a very short budget which contains two components and a total.

Budgeted MOH = MOH rate x Number of activity units

Walk Through Problem 1 - Manufacturing Overhead Budget with Actual Costing

During March, Bisbee, Inc.'s production budget showed 2,500 units to be produced, and its sales budget showed 2,800 wagons to be sold. Budgeted manufacturing costs for March appear below:

 Indirect labor \$3.00 per wagon Supplies \$4.80 per wagon Factory depreciation \$26,000 Factory supervisory salaries 20,000 Fixed factory occupancy 34,000

Prepare a manufacturing overhead budget for March.

Solution

Step 1: The variable cost section of the overhead budget begins with units to be produced from the production budget. Multiply each unit variable cost by the number of wagons to be produced, 2,500.

Indirect labor = \$3.00 X 2,500 = \$7,500

Supplies = \$4.80 X 2,500 = \$12,000

 Variable overhead: Indirect labor \$      7,500 Supplies 12,000 Total variable overhead costs \$19,500

Step 2: Prepare the fixed costs section of the overhead budget. Because fixed costs are the same in total regardless of activity level, we use the amounts given for the fixed cost section:

 Fixed overhead: Factory depreciation \$26,000 Factory supervisory salaries 20,000 Fixed factory occupancy 34,000 Total fixed overhead costs \$80,000

 Bisbee, Inc. Manufacturing Overhead Budget Month Ending March 31, 2018 Variable overhead: Indirect labor \$  7,500 Supplies 12,000 Total variable overhead costs \$19,500 Fixed overhead: Factory depreciation 26,000 Factory supervisory salaries 20,000 Fixed factory occupancy 34,000 Total fixed overhead costs 80,000 Total budgeted overhead costs \$99,500

Walk Through Problem - Manufacturing Overhead Budget with Normal Costing

During March, Dinker, Inc.'s production budget showed 2,000 widgets to be produced, and its sales budget showed 2,200 widgets to be sold. Budgeted direct labor costs are \$15,000. Dinker applies manufacturing overhead at the rate of \$1.50 per direct labor dollar.

Solution

Step 1: Begin with the budgeted direct labor costs, because that is the basis on which manufacturing overhead is applied.

Step 2: Multiple the budgeted direct labor costs by the manufacturing overhead rate to determine the budgeted manufacturing overhead for the period.

 Dinker, Inc. Manufacturing Overhead Budget Month Ending March 31, 2018 Budgeted direct labor costs \$15,000 Manufacturing overhead rate 1.50 Budgeted manufacturing overhead costs \$22,500

The selling and administrative expense budget includes only operating expenses, i.e., period costs. It is usually divided into variable and fixed components. Variable operating costs are calculated as the variable cost per unit times the number of units sold, because selling costs and other non-manufacturing costs are generated as units are sold. Fixed selling and administrative costs are the same no matter how many units are budgeted for sale during each period.

Walk Through Problem - Selling and Administrative Expense Budget

During March, Dinker, Inc.'s production budget showed 2,000 units to be produced, and its sales budget showed 2,200 units to be sold. The following selling and administrative expenses were budgeted for March, 2018:

 Corporate depreciation \$14,000 Corporate insurance \$21,000 Office salaries \$17,000 Customer delivery costs \$8,000 Variable administrative supplies \$1.50 per unit Corporate rent \$23,000

Prepare a selling and administrative expense budget for April.

Solution

Step 1: Identify the behavior of  each cost. Multiply the variable unit costs by the units to be sold whenever unit variable costs are provided.

Variable administrative supplies = \$1.50 x 2,200 = \$3,300

Display any variable costs given as total amounts as separate line items on the budget.

Step 2: List the fixed cost amounts. Because fixed costs are the same in total regardless of activity level, use the amounts given.

Step 3: Add the variable and fixed amounts together to obtain the total budgeted selling and administrative expenses for March.

 Dinker, Inc. Selling and Administrative Expense Budget Month Ending March 31, 2018 Variable expenses: Variable administrative supplies \$  3,300 Customer delivery costs 8,000 Total variable expenses 11,300 Fixed expenses: Corporate depreciation \$14,000 Corporate insurance 21,000 Office salaries 17,000 Corporate rent 23,000 Total fixed expenses 75,000 Total budgeted selling & administrative expenses \$86,300

Capital Expenditures Budget

The capital expenditures budget is based on planned acquisitions of property, plant, and equipment. It differs from capital budgeting whose goal is to determine if a proposed investment will generate a decent return. The capital expenditures budget includes only those acquisitions which have already been approved for purchase. Only the expected acquisition cost is part of the capital expenditures budget. Budgeted revenues and costs that are expected to occur related to the capital acquisition are reported on the budgets they are expected to impact, such as the sales and expense budgets.

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