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How Do You Deal With Rejected Items When Preparing Production Budgets?

Explanation of Production Budgets: Dealing with Rejected Items

In the AAT Level 4 Budgeting unit, there is normally a question on production budgets that includes working out production levels where there is % of production that is rejected. On the majority of progress tests, this bit is done incorrectly. Consistently incorrectly! This is caused by a mix of:

  • not being as comfortable with algebra as one should be and
  • the AAT layout of the production budget is less than helpful.

We have therefore produced an explanatory note to show how this question should be tackled.

Question: Complete the following production budget

  • Closing inventory is 25% of the next month’s sales
  • 5% of finished goods are rejected on quality grounds and scrapped
  • Sales in Period 4 are forecast at 26,000 units
Period 1 Period 2 Period 3
Sales 21,000 22,000 24,000
Opening inventory
Closing inventory
Production
Rejected units
Sub-total

Steps to deal with answer:

Stage 1:

  • Opening inventory in Period 1 is the same as closing inventory in the previous period = 25% of £21,000 = £5,250
  • Closing inventory in Period 1 = 25% of £22,000 = £5,500;
  • Closing inventory in Period 2 = 25% of £24,000 = £6,000;
  • Closing inventory in Period 3 = 25% of £26,000 = £6,500;

Let’s put these numbers in now, remembering that opening inventory in a period is = to the closing inventory in the previous period

Period 1 Period 2 Period 3
Sales 21,000 22,000 24,000
Opening inventory 5,250 5,500 6,000
Closing inventory 5,500 6,000 6,500
Production
Rejected units
Sub-total

Stage 2:

We have now got to work out the number of units that need to be produced each month and the amount of rejected units.

We have to work out how many “good” units need to be produced (i.e. after deducting rejected units from total production) in order to provide the closing stock needed – i.e. 25% of the next period’s sales.

This is not easy at all with the layout that is given as you have to do this calculation in your head – it is probably worth writing down a revised layout on your working papers.

Transferring the numbers from above: 

Period 1 Period 2 Period 3
Total Production
– Rejected units
= Good Production
+  opening inventory 5,000 5,500 6,000
= inventory available for sale
– Sales 21,000 22,000 24,000
= Closing inventory 5,500 6,000 6,500

Stage 3

You can then insert the Inventory available for sale by adding sales back to closing inventory:

Period 1 Period 2 Period 3
Total Production
– Rejected units
= Good Production
+  opening inventory 5,000 5,500 6,000
= inventory available for sale  26,500  28,000  30,500
– Sales 21,000 22,000 24,000
= Closing inventory 5,500 6,000 6,500

Stage 4

You can then do the same sort of thing to calculate “Good Production”

Period 1 Period 2 Period 3
Total Production
– Rejected units
= Good Production 21,500 22,500 24,500
+  opening inventory 5,000 5,500 6,000
= inventory available for sale  26,500  28,000  30,500
– Sales 21,000 22,000 24,000
= Closing inventory 5,500 6,000 6,500

Stage 5 

You have been told that 5% of finished goods are rejected, so the %s are as below:

Period 1
Total Production 100% To calculate this, divide £21,500 by 0.95 = £22,631.578
– Rejected units 5% for this multiply total production by 5%
= Good Production 95% 21,500

this gives you

Total Production 100% 22,632 You may be told to round up to the next whole number
– Rejected units 5% 1,132 ditto (as you will only deal in whole units)
= Good Production 95% 21,500

Do this for all periods

Period 1 Period 2 Period 3
Total Production 22,632 23,685 25,790
– Rejected units 1,132 1,185 1,290
= Good Production 21,500 22,500 24,500
+  opening inventory 5,000 5,500 6,000
= inventory available for sale  26,500  28,000  30,500
– Sales 21,000 22,000 24,000
= Closing inventory 5,500 6,000 6,500

Stage 6

Now put the numbers back into the horrible table format you were given in the question:

Period 1 Period 2 Period 3
Sales 21,000 22,000 24,000
Opening inventory 5,000 5,500 6,000
Closing inventory 5,500 6,000 6,500
Production 22,632 23,685 25,790
Rejected units 1,132 1,185 1,290
Sub-total 26,500 28,000 30,500

The subtotal is the amount of inventories available for sale each month (i.e. good production + opening inventory).

 

It is really hard to do this in your head and so I would recommend that you draft these notes on your working papers in the exam.

 

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