How to Prepare a Direct Materials Purchases Budget
A direct materials budget allows you to calculate your materials needs for a given time period, which might be either monthly or quarterly. Because the direct materials budget can be a significant portion of all costs, both direct and indirect, careful preparation of this budget is essential for the success of your company. Otherwise, a carelessly prepared or improperly calculated direct materials purchases budget can lead you to overestimate or underestimate your costs.
Either mistake can lead to serious cash-flow problems.
Real Life Example Background Information
Using a small pottery business, ArtCraft Pottery, materials budget as our example, we will use the following information to develop a direct materials purchases budget:
These budgeted units of pottery are to be produced in each of the following four quarters: 1,060, 1,260, 1,600, and 1,800. To calculate your direct materials purchases budget, you begin by assessing and recording your unit costs. In the ArtCraft Potter example, plain pottery is $3 per unit and the material used to color the pottery -- here abbreviated to "color" -- is $0.20 per ounce. On a per-unit basis, the factory needs one pound of clay and five ounces of color to produce the final piece.
ArtCraft Pottery's policy is to have 10 percent of the following quarter's production needs in ending inventory. This policy changes your materials needs because this 10 percent ending inventory must be taken into account in the budget.
The factory has 58 pounds of clay and 390 ounces of color on hand on January 1. At the end of the year, the desired ending inventory is 106 pounds of clay and 530 ounces of color.
Calculating the Ending Inventory for Clay and Color for Quarters 2 and 3
The first step in preparing the direct materials budget is to use this information to calculate the ending inventory of clay and color for quarters 2 and 3.
The second step is to prepare the direct materials purchases budget for both clay and color.
- Ending Inventory clay, Quarter 2 = 0.10 (1,600 units X 1 unit clay) = 160
- Ending Inventory clay, Quarter 3 = 0.10 (1,800 units X 1 unit clay) = 190
- Ending Inventory color, Quarter 2 = 0.10 (1,600 units X 5 ounces) = 800
- Ending Inventory color, Quarter 3 = 0.10 (1,800 units X 5 ounces) = 900
You now have the units of each component to manufacture the pottery that you need. You can see, however, that if a product was more complicated and needed a lot of different raw materials, this calculation would be massive. In this simple example, we have the information to calculate the direct materials purchases budgets, which is presented below in tabular form.
ArtCraft Pottery Direct Material Purchases Budget*
The table was developed from two simple accounting equations you may be familiar with:
1. Raw Materials Required for Production + Ending Inventory = Total Raw Materials Required
2. Total Raw Materials Required - Beginning Raw Materials Inventory = Raw Materials to Be Purchased
|Quarter 1||Quarter 2||Quarter 3||Quarter 4||Year|
|Units to be Produced||1,060||1,260||1,600||1,800||5,720|
|Direct Materials Per Unit||x1||x1||x1||x1||x1|
|Desired Ending Inventory||126||160||180||106||106|
|Less: Beginning Inventory||(58)||(126)||(160)||(180)||(58)|
|Direct Materials to be Purchased||1,128||1,294||1,620||1,726||5,768|
|Cost of clay||x$3||x$3||x$3||x$3||x$3|
|Total Purchase Cost of Clay||$3,384||$3,882||$4,860||$5.178||$17,304|
*Table Developed Compliments of Cornerstones of Managerial Accounting, 3rd ed.