Now we're moving from the overview and some quote, "The theoretical discussion of that to an example." And this will be as always, a simplified example but not a grossly simplified example, so we will be able to see some of the challenges that people face when they prepare operating budgets. So our first two episodes will be devoted to the data and requirements. So this is operating budget data and this is part one. So we talk about the company called BGW incorporated, just an artificial name, that makes two kinds of spare parts for special equipment, one is called regular the other is heavy-duty. So we can imagine that maybe the second part requires more resources, and maybe is more costly, and maybe is more expensive in sales, we will see all that. So we have the regular part and the heavy-duty. So these are two of our products. Now on this page, I will provide some important inputs for preparing. And inputs plus assumptions, if you will, these assumptions will be simplifying for us. Now first of all, we can say that revenues they are equal to all the sales of R and HD. So we ignore all other minor revenues, any potential interest revenue, any miscellaneous revenue, whatever. That's for simplicity. It's not very difficult to incorporate in this plan, but that will really distract our attention, so we ignore that. Now, another very important thing is that we ignore work in progress inventory. Well, this is a little bit more difficult to make up for, but again, that makes the preparation more cumbersome but does not provide any special insight. So we believe that we have all the raw materials inventory and finished goods inventory. Now, the next thing is that we use the FIFO assumption, costs for assumptions for direct materials and finished goods inventory. That means that if we use some of the materials let's say, direct materials in production. So if we have something at the beginning of the period in our inventory, we take that from the inventory. Well, in this example, we will ignore the change in prices but I will show how we could easily make up for that. But that would still be important to keep in mind whether it's a FIFO or it's a LIFO assumption. Again, for a LIFO assumption there is nothing very much more difficult to do, but we will stick to that. Now another simplifying assumption is that unit costs of inventories stays constant over the period of this budget. Again, this period will cover a year, whatever the year is. So that's a simplifying assumption. For example, if that would not be true, then we would going back to this FIFO, we would have taken the inventories, the beginning levels at their costs as they were purchased before. And then if we were purchasing something over the course of the year then we would use other costs for that. Now that again, makes the preparation a little bit more cumbersome, but there is nothing very difficult in that. So here, we talk about primary direct materials and finished goods inventories. So we have to make some assumptions about costs. And we say that variable manufacturing costs via variable with respect to direct labor, so we're talking about labor hours. Now, the next thing that variable non-manufacturing, this is variable with respect to revenue dollars. So we will have to properly calculate the corresponding cost allocation rates. And then finally, the seventh thing is that a uniform cost allocation rate. Cost allocation base which is direct labour, is used. Well, I put these assumptions here, just with the idea of keeping that consistent with what we will do later, but some of those are quite important. You can see that we ignore additional revenues, we ignore work in progress, we use FIFO, we ignore the changes in costs, in prices of raw materials for example here, and we make some simplifying assumptions about the allocation of overhead. And now we start some data. So here, we will start with forecasting of direct cost inputs. So these is all data. Well, here we have D1, this is direct materials. So this company uses two kinds of direct materials, thus for simplicity I will put one and two, like this. And we know the costs for one it's $8 per one kilogram and for two this is $10 for one kilogram. And we know that these don't change because of our fourth assumption on the previous page. Then we also know that there is direct labor and that costs $30 per hour. So, that is the first panel here. Now this is not it, because these are costs. But we also would like to know the content, how many of these kilograms of material one and material two go to the manufacturing of our two products? So here we have content, we have regular and we have heavy-duty. And this will be panel D2. I am circling those because later on I will be referring to them, because we cannot go back and forth these flip chart pages, but I will just put references here. So see what we have here, we have material one, material two. So for a regular part we use 11 kilograms and for this 12 kilograms. Of material two we use here five kilograms and here we use eight. And with respect to direct labor we use three hours here, and four hours here. So that wraps up our first two panels of forecasts, but that's not it. We proceed with other two panels. And that will be first of all, panel D3, and here, we have forecasts of sales and target inventories. So this is R, this is heavy-duty. Now, we have expected sales and this is in units, so for R this is 6,000, for HD this is 1,200. Now, we have price of U, also unit here that will be 500, here it will be $700 a piece. Then we proceed with target and finished goods inventory in units, and we'll say that this is 1,100 of R and 50 of HD. You can see that heavy-duty has a more narrowed demand and for that we do not keep that many of them in our warehouse. Then also this is beginning balance of FGI that we absorb. This is 100 now and this is 50 that we have. So here we would like to enhance our finished goods inventory for the regular part. And then another important thing here, is that the beginning inventory we also have it in dollar prices and this is $34,800, so I'll put a star here because later we will see when does this number come from, and here, $22,800. We're almost done. We have only to complete that the panel D4, and panel D4 deals with direct materials inventory. Direct materials. So this is one, this is two. And we have beginning inventory, here we have 8,000, this is in kilograms, and here we have 6,000. And then target end, also in kilograms. Here we'll have 9,000, and here just 3,000. So, that wraps up our first four panels. And so far, we dealt with only direct materials and direct labor. Now we have to have some inputs with respect to our other costs of indirect costs because remember that, indirect costs are important in any problem dealing majorly in accounting. In the next episode, we will talk about some information of these costs.
