06/04/2011 13:42

Production Budget:

Learning Objective of the article:

1. Define and explain production budget.
2. Prepare a production budget.

Definition and Explanation of Production Budget:

The production budget is prepared after the sales budget. The production budget lists the number of units that must be produced during each budget period to meet sales needs and to provide for the desired ending inventory. Production needs can be determined as follows.

 Budgeted sales in units------------------- Add desired ending inventory------------ Total need--------------------------------------- less beginning inventory-------------------- Required production-------------------------- XXXX XXXX -------- XXXX XXXX -------- XXXX =====

Production requirements for a period are influenced by the desired level of ending inventory. Inventories should be carefully planned. Excessive inventories tie up funds and create storage problems. Insufficient inventories can lead to lost sales or crash production efforts in the following period.

Example of a Production Budget:

Following is the production budget of Hampton Freeze Inc. (See explanation of this production budget)

 Hampton Freeze, Inc. Production Budget For the Year Ended December 31, 2009 Quarter 1 2 3 4 Year Budgeted sales (see sales budget) 10,000 30,000 40,000 20,000 100,000 Add desired ending inventory of finished goods* 6,000 8,000 4,000 3,000 3,000 ------------ ------------ ------------ ----------- ----------- Total needs 16,000 38,000 44,000 23,000 103,000 Less Beginning inventory of finished goods** 2,000 6,000 8,000 4,000 2,000 ------------ ------------ ------------ ------------ ------------ Required production 14,000 32,000 36,000 19,000 101,000 ====== ====== ====== ====== ====== *Twenty percent of the next quarters sales. The ending inventory of 3,000 cases is assumed **The beginning inventory in each quarter is the same as the prior quarter's ending inventory

Explanation of Production Budget of Hampton Freeze Inc.

At Hampton Freeze, management believes that an ending inventory equal to 20% of the next quarter's sales strikes the appropriate balance. Example contains the production budget for Hampton Freeze. The first row in the production budget contains the budgeted sales, which have been taken directly from the sales budget (see sales budget page). The total needs for the first quarter are determined by adding together the budgeted sales of 10,000 cases for the quarter and the desired ending inventory of 6,000 cases. The ending inventory is intended to provide some cushion in case problems develop in production or sales increase unexpectedly. Since the budgeted sales for the second quarter are 30,000 cases and management would like the ending inventory in each quarter to 20% of the following quarter's sales, the desired ending inventory is 6,000 cases (20% of 30,000 cases). Consequently, the total needs for the first quarter are 16,000 cases. However, since the company already has 2,000 cases in beginning inventory, only 14,000 cases need to be produced in first quarter.

Pay particular attention to the year column to the right of the production budget in the example. In some cases (e.g., budgeted sales, total needs, and required production), the amount listed for the year is the sum of the quarterly amounts for the item. In other cases (e.g., desired inventory of finished goods and beginning inventory of finished goods), the amount listed for the year is not simply the sum of the quarterly amounts. From the standpoint of the entire year, the beginning inventory of finished goods is the same as the beginning inventory of finished goods for the first quarter--it is not the sum of the beginning inventories of the finished goods for all quarters. Similarly, from the standpoint of the entire year, the ending inventory of finished goods is the same as the ending inventory of finished goods for the fourth quarter--it is not the sum of the ending inventories of finished goods for all four quarters.