Budgeting
Forecasts must be as dynamic as the business environment. That means it is not set in stone but will be routinely evaluated for necessary corrections. These sections will explain the importance of budgets and forecasting to the business. This material will enable you to explain the budgeting and forecasting process and discuss its benefits to the company.
7.2 Prepare Operating Budgets
Direct Materials Budget
From the production budget, management knows how many units need to be produced in each budget period. Management is already aware of how much material it needs to produce each unit and can combine the direct material per unit with the production budget to compute the direct materials budget. This information is used to ensure the correct quantity of materials is ordered and the correct amount is budgeted for those materials.
Similar to the production budget, management wants to have an ending inventory available to ensure there are enough materials on hand. The direct materials budget illustrates how much material needs to be ordered and how much that material costs. The calculation is similar to that used in the production budget, with the addition of the cost per unit.
If Big Bad Bikes uses 3.2 pounds of material for each trainer it manufactures and each pound of material costs $1.25, we can create a direct materials budget. Management's goal is to have 20% of the next quarter's material needs on hand as the desired ending materials inventory. Therefore, the determination of each quarter's material needs is partially dependent on the following quarter's production requirements. The desired ending inventory of material is readily determined for quarters 1 through 3 as those needs are based on the production requirements for quarters 2 through 4. To compute the desired ending materials inventory for quarter 4, we need the production requirements for quarter 1 of year 2. Recall that the number of units to be produced during the first quarter of year 2 is 3,800. Thus, quarter 4 materials ending inventory requirement is 20% of 3,800. That information is used to compute the direct materials budget shown in Figure 7.9.
| BIG BAD BIKES Direct Materials Budget For the Year Ended December 31, 2019 |
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| Quarter 1 |
Quarter 2 | Quarter 3 | Quarter 4 | Total | |
| Units to be Produced | 1,300 | 1,150 | 1,800 | 2,800 | 7,050 |
| Direct Material per Unit | 3.20 | 3.20 | 3.20 | 3.20 | 3.20 |
| Total Pounds Needed for Production | 4,160 | 3,680 | 5,760 | 8,960 | 22,560 |
| + Desired Ending Inventory | 736 | 1,152 | 1,792 | 2,432 | 2,432 |
| Total Material Required | 4,896 | 4832 | 7,552 | 11,392 | 24,992 |
| - Beginning Inventory | 0 | 736 | 1,152 | 1,792 | 0 |
| Pounds of Direct Material Required | 4,896 | 4,096 | 6,400 | 9,600 | 24,992 |
| Cost per Pound | $1.25 | $1.25 | $1.25 | $1.25 | $1.25 |
| Total Cost of Direct Material Purchase | $6,120 | $5,120 | $8,000 | $12,000 | $31,240 |
Figure 7.9 Direct Materials Budget for Big Bad Bikes.
Management knows how much the materials will cost and integrates this information into the schedule of expected cash disbursements, which will be shown in Prepare Financial Budgets. This information will also be used in the budgeted income statement
and on the budgeted balance sheet. With 6,000 units estimated for sale, 3.2 pounds of material per unit, and $1.25 per pound, the direct materials used represent $24,000 of the cost of goods sold. The remaining $7,240 is included in ending inventory
as units completed and raw material.