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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