Budget preparation - Sales, production, materials, labour, a...

Learning Outcomes

By studying this article, you will understand the preparation of sales, production, materials usage and purchases, labour, and overhead budgets. You will be able to explain the sequence of budgeting, link each functional budget to business planning, and produce accurate quantitative calculations for each budget type. You will also recognise the principal budget factor in the process, understand interconnection between budgets, and identify common pitfalls in budget preparation.

ACCA Management Accounting (MA) Syllabus

For ACCA Management Accounting (MA), you are required to understand the budget preparation process for internal planning and control. This article addresses the following key syllabus points:

• Describe the sequence of preparing budgets within an organisation.
• Explain the principal budget factor and its effect on budget preparation.
• Prepare a sales budget.
• Prepare functional budgets: production, raw materials usage and purchases, labour, and overheads.
• Identify how functional budgets link together in an overall budget.
• Calculate budgeted figures for quantities and costs.
• Recognise common errors and challenges in functional budget preparation.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is usually the first budget prepared, and why?
2. How is budgeted production determined from sales and inventory levels?
3. The standard direct labour hours per unit is 4. If 1,500 units are budgeted for production, how many hours are required?
4. If budgeted material usage is 20,000 kg, opening inventory is 2,500 kg and closing inventory is 3,000 kg, what is the quantity to be purchased?

Introduction

Budgets are detailed plans that set out expected sales, production and resource requirements for a future period. Preparing specific functional budgets—sales, production, materials, labour, and overheads—allows each area of a business to plan, coordinate, and control its activities.

Functional budgets are interdependent, starting with the principal budget factor—commonly sales demand—which drives the preparation of the remaining supporting budgets. These budgets provide the basis for the overall budget and cash flow forecasting, essential for business operations and effective management control.

Understanding the correct sequence and methods for functional budget preparation is essential for effective planning and for ACCA exam questions on budgeting.

THE BUDGET PREPARATION SEQUENCE

Budget preparation follows a logical sequence, as each budget relies on information from the previous stage.

1. Identify the Principal Budget Factor: The resource that limits activity (often sales demand but could also be production capacity, materials, or labour).
2. Prepare the Sales Budget: Estimate quantities and revenue.
3. Prepare the Production Budget: Determine output needed to meet sales, considering inventory policies.
4. Prepare the Materials Usage and Purchases Budgets: Calculate material requirements for planned production.
5. Prepare the Labour Budget: Estimate required labour hours and costs.
6. Prepare the Overhead Budgets: Forecast variable and fixed overheads based on activity levels.

Key Term: Principal Budget Factor
The resource or constraint that restricts an organisation’s activity level in the budget period and determines the order in which budgets are prepared.

SALES BUDGET

The sales budget forecasts the quantity and value of units expected to be sold during the period.

• Estimate sales volume by product, period, and location.
• Multiply by planned selling prices to obtain revenue.

Key Term: Sales Budget
A detailed estimate of expected sales, measured in both units and revenue, usually by product and period.

Worked Example 1.1

A business plans to sell 3,500 units of Product A at £50 each and 2,000 units of Product B at £80 each. Prepare the sales budget.

Answer:
Product A: 3,500 × £50 = £175,000
Product B: 2,000 × £80 = £160,000
Total sales budget: £335,000

PRODUCTION BUDGET

The production budget calculates the number of units to be manufactured.

• Use the formula:

  Budgeted Production = Forecast Sales

  • Closing Inventory of Finished Goods
    – Opening Inventory of Finished Goods

• Adjust production to account for changes in inventory.

Key Term: Production Budget
The plan for the number of units to be produced in the period to meet forecast sales and inventory requirements.

Worked Example 1.2

If forecast sales are 8,000 units, desired closing inventory is 1,500 units, and opening inventory is 1,200 units, what is the budgeted production?

Answer:
8,000 + 1,500 – 1,200 = 8,300 units

MATERIALS USAGE AND PURCHASES BUDGETS

The materials usage budget determines the amount of raw material needed for planned production.

• Usage per unit × Budgeted production = Total material required

The purchases budget adjusts for inventory movements:

Material to purchase =
Budgeted material usage

• Closing inventory of raw material
  – Opening inventory of raw material

Key Term: Materials Usage Budget
A plan showing the quantity of each material required for production in the period.

Key Term: Materials Purchases Budget
A plan showing the amount of each material to order, adjusted for inventory changes, to meet production needs.

Worked Example 1.3

A company plans to produce 5,000 units requiring 3 kg of Material X per unit. Opening inventory is 2,000 kg, closing inventory should be 2,500 kg. Calculate the materials usage and purchases budgets.

Answer:
Usage: 5,000 × 3 kg = 15,000 kg
Purchases: 15,000 + 2,500 – 2,000 = 15,500 kg

LABOUR BUDGET

The labour budget calculates the number of direct labour hours and cost required for budgeted output.

• Calculate total hours:
  Budgeted production × Standard hours per unit = Total hours needed
• Labour cost:
  Total hours × Wage rate

Key Term: Labour Budget
A forecast of the direct labour hours and cost required to achieve the production budget, usually per department.

Worked Example 1.4

Budgeted production is 2,500 units. Each unit requires 2.4 hours of labour. The wage rate is £12 per hour. What are the total hours and total labour cost?

Answer:
Hours: 2,500 × 2.4 = 6,000 hours
Labour cost: 6,000 × £12 = £72,000

OVERHEAD BUDGETS

Overhead budgets estimate both variable and fixed indirect costs for the period.

• Variable Overheads: Typically absorb based on activity (e.g., machine hours, labour hours).
• Fixed Overheads: Costs that remain unchanged within the relevant activity range.

Key Term: Overhead Budget
A plan of all indirect costs (variable and fixed) allocated to production, based on expected activity levels.

Worked Example 1.5

A factory expects 4,000 machine hours. Variable overheads are recovered at £4 per machine hour, and fixed production overheads are £20,000 per period. Calculate the total overhead budget.

Answer:
Variable: 4,000 × £4 = £16,000
Fixed: £20,000
Total overheads: £16,000 + £20,000 = £36,000

LINKAGE OF FUNCTIONAL BUDGETS

Functional budgets are interconnected. For example, an upward revision of sales increases production, materials, and labour budgets.

• Always adjust dependent budgets if initial assumptions change.
• Budget reviews often reveal inconsistencies or constraints that require iterations.

Exam Warning

Take care to maintain logical connections across budgets. Adjust inventory targets in each step. A change in one budget—especially the principal budget factor—will impact the others. Errors in linkage or double counting will lead to incorrect totals.

COMMON CHALLENGES AND ERRORS

• Not starting with the principal budget factor, causing budget inconsistencies.
• Forgetting to adjust for inventory changes in production or purchases budgets.
• Failing to account for unavoidable non-productive time in labour budgets.
• Overlooking required supporting calculations for multi-product scenarios.

Revision Tip

For each budget, use clear formulas and double-check that inventory adjustments have not been omitted or reversed.

Summary

Successful budget preparation requires a logical sequence, beginning with the principal limiting factor—usually sales—and building coherent supporting budgets for production, materials, labour, and overheads. Each budget relies on the correct preparation of the preceding one, with inventory movements thoroughly accounted for. Clear, accurate calculations and understanding interdependencies ensure robust budgets, supporting effective business planning and control.

Key Point Checklist

This article has covered the following key knowledge points:

• Distinguish the role of the principal budget factor in the budgeting process
• Prepare a sales budget and understand its impact on other budgets
• Calculate production budgets adjusting for opening and closing inventory
• Produce materials usage and purchases budgets using standard formulas
• Prepare labour budgets based on standard hours and rates
• Calculate overhead budgets for both variable and fixed production overheads
• Recognise the interrelationships and dependencies between all functional budgets
• Avoid common calculation and sequencing errors in budget preparation

Key Terms and Concepts

• Principal Budget Factor
• Sales Budget
• Production Budget
• Materials Usage Budget
• Materials Purchases Budget
• Labour Budget
• Overhead Budget