CHAPTER 27

Budgeting and Budgetary Control

Introduction Budgeting has come to be accepted as an efficient method of short-term planning and control. It is employed, no doubt, in large business houses, but even the small businesses are using it at least in some informal manner. Through the budgets, a business wants to know clearly as to what it proposes to do during an accounting period or a part thereof. The technique of budgeting is an important application of Management Accounting. Probably, the greatest aid to good management that has ever been devised is the use of budgets and budgetary control. It is a versatile tool and has helped managers cope with many problems including inflation.

DEFINITION OF BUDGET
The Chartered Institute of Management Accountants, England, defines a 'budget' as under: " A financial and/or quantitative statement, prepared and approved prior to define period of time, of the policy to be persued during that period for the purpose of attaining a given objective." According to Brown and Howard of Management Accountant "a budget is a predetermined statement of managerial policy during the given period which provides a standard for comparison with the results actually achieved." Essentials of a Budget An analysis of the above said definitions reveal the following essentials of a budget:
(1)

It is prepared for a definite future period.

(2) (3) (4)

It is a statement prepared prior to a defined period of time. The Budget is monetary and I or quantitative statement of policy. The Budget is a predetermined statement and its purpose is to attain a given objective.

A budget, therefore, be taken as a document which is closely related to both the managerial as well as accounting functions of an organization.

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Forecast Vs Budget Forecast is mainly concerned with an assessment of probable future events. Budget is a planned result that an enterprise aims to attain. Forecasting precedes preparation of a budget as it is an important part of the budgeting process. It is said that the budgetary process is more a test of forecasting skill than anything else. A budget is both a mechanism for profit planning and technique of operating cost control. In order to establish a budget it is essential to forecast various important variables like sales, selling prices, availability of materials, prices of materials, wage rates etc. Difference between Forecast and Budget Both budgets and forecasts refer to the anticipated actions and events. But still there are wide differences between budgets and forecasts as given below:
Forecasts
(1) Forecasts is mainly concerned with anticipated or

Budgets
(1) Budget is related to planned events

(2) (3) (4) (5) (6) (7)

probable events Forecasts may cover for longer period or years Forecast is only a tentative estimate Forecast results in planning The function of forecast ends with the forecast of likely events Forecast usually covers a specific business function Forecasting does not act as a tool of controlling measurement.

Budget is planned or prepared for a shorter period Budget is a target fixed for a periOd. Result of planning is budgeting The process of budget starts where forecast ends and converts it into a budget (6) Budget is prepared for the business as a whole (7) Purpose of budget is not merely a planning device but also a controlling tool.

(2) (3) (4) (5)

BUDGETARY CONTROL
Budgetary Control is the process of establishment of budgets relating to various activities and comparing the budgeted figures with the actual performance for arriving at deviations, if any. Accordingly, there cannot be budgetary control without budgets. Budgetary Control is a system which uses budgets as a means of planning and controlling. According to I.C.M.A. England Budgetary control is defined by Terminology as the establishment of budgets relating to the responsibilities of executives to the requirements of a policy and the continuous comparison of actual with the budgeted results, either to secure by individual actions the objectives of that policy or to provide a basis for its revision. Brown and Howard defines budgetary control is "a system of controlling costs which includes the preparation of budgets, co-ordinating the department and establishing responsibilities, comparing actual performance with the budgeted and acting upon results to achieve maximum profitability." The above definitions reveal the following essentials of budgetary control: (1) (2) (3) (4) Establishment of objectives for each function and section of the organization. Comparison of actual performance with budget. Ascertainment of the causes for such deviations of actual from the budgeted performance. Taking suitable corrective action from different available alternatives to achieve the desired objectives.

Objectives of Budgetary Control Budgetary Control is planned to assist the management for policy formulation, planning, controlling and co-ordinating the general objectives of budgetary control and can be stated in the following ways:

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563

(1)

Planning: A budget is a plan of action. Budgeting ensures a detailed plan of action for a
business over a period of time.

(2) (3)

Co-ordination: Budgetary control co-ordinates the various activities of the entity or organization and secure co-operation of all concerned towards the common goal.

Control: Control is necessary to ensure that plans and objectives are being achieved. Control
follows planning and co-ordination. No control performance is possible without predetermined standards. Thus, budgetary control makes control possible by continuous measures against predetermined targets. If there is any variation between the budgeted performance and the actual performance, the same is subject to analysis and corrective action.

Scope and Techniques of Standard Costing and Budgetary Control

Scope:
(1)

Budgets are prepared for different functions of business such as production, sales etc. Actual results are compared with the budgets and control is exercised. Standards on the other hand are complied by classifying, recording and allocation of the expenses to cost units. Actual costs are compared with standard costs.

(2) (3)

Budgets have a wide range of coverage of the entire organization. Each operation or process is divided into number of elements and standards are set for each such element. Budgetary control is concerned with origin of expenditure at functional levels. Standard costing is concerned with the requirements of each element of cost.

(4)

Budget is a projection of financial accounts whereas standard costing projects the cost accounts.

Technique:
(1)

Budgetary control is exercised by putting budgets and actuals side by side. Variances are not normally revealed in the accounts. Standard costing variances are revealed through accounts.

(2) (3)

Budgetary control system can be operated in parts. For example, Advertisement Budgets, Research and Development Budgets, etc. Standard costing is not put into operation in parts. Budgetary control of expenses is broad in nature whereas standard costing system is a far more technically improved system by means of which the variances are analysed in detail.

Requisites for Effective Budgetary Control The following are the requisites for effective budgetary control :
(1)

Clear cut objectives and goals should be well defined. The ultimate objective of realising maximum benefits should always be kept uppermost. There should be a budget manual which contains all details regarding plan and procedures for its execution. It should also specify the time table for budget preparation for approval, details about responsibility, cost centers etc. Budget committee should be set up for budget preparation and efficient execution of the plan. A budget should always be related to a specified time period.

(2) (3)

(4) (5)

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A TeXlbook of Financial Cost and Management Accounting

(6) (7) (8) (9) (10) (11) (12)

Support of top management is necessary in order to get the full support and co-operation of the system of budgetary control. To make budgetary control successful, there should be a proper delegation of authority and responsibility. Adequate accounting system is essential to make the budgeting successful. The employees should be properly educated about the benefits of budgeting system. The budgeting system should not cost more to operate than it is worth. Key factor or limiting factor, if any, should consider before preparation of budget. For budgetary control to be effective, proper periodic reporting system should be introduced.

Organization for Budgetary Control In order to introduce budgetary control system, the following are essential to be considered for a sound and efficient organization. The important aspects to be considered are :
1.

Organisation Chart Budget Center Budget Officer Budget Committee Budget Manual Budget Period Key Factor

2.
3.

4.

5.
6.
7.

(1) Organisation Chart: For the purpose of effective budgetary control, it is imperative on the part of each entity to have definite "plan of organization." This plan of organization is embodied in the organization chart. The organization chart explaining clearly the position of each executive's authority and responsibility of the firm. All the functional heads are entrusted with the responsibility of ensuring proper implementation of their respective departmental budgets. An organization chart for budgetary control is given showing clearly the type of budgets to be prepared by the functional heads.

Organization Chart

I Chairman I
~
Budget Officer

Purchase Manager (Purchase & Material Budget)

Production Manager (Production Budget Plant Utilization Budget)

Sales Manager (Sales Budget Advertising Budget & Cost Budget)

Personnel Manager (Labour Budget)

Finance Manager (Cash Budget & Income & Expenditure Budget)

Accounts Manager (Cost Budget)

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565

From the above chart we can observe that the chairman of the company is the overall in charge of the functions of the Budgeted Committee. A Budget Officer is the convener of the budget committee, who helps in co-ordination. The Purchase Manager, Production Manager, Sales Manager, Personnel Manager, Finance Manager and Account Manager are made responsible to prepare their budgets. (2) Budget Center: A Budget Center is defined by the terminology as "a section of the organization of an undertaking defined for the purpose of budgetary control." For effective budgetary control budget centre or departments should be established for each of which budget will be set with the help of the head of the department concerned. (3) Budget Officer: Budget Officer is usually some senior member of the accounting staff who controls the budgetary process. He does not prepare the budget himself, but facilitates and co-ordinates the budgeting activity. He assists the individual departmental heads and the budget committee, and ensures that their decisions are communicated to the appropriate people. (4) Budget Committee: Budget Committee comprising of the Managing Director, the Production Manager, Sales Manager and Accountant. The main objectives of this committee is to agree on all departmental budgets, normal standard hours and allocations. In small concerns, the Budget Officer may co-ordinate the work for preparation and implementation of budgets. In large-scale concern a budget committee is setup for preparation of budgets and execution of budgetary control. (5) Budget Manual: A Budget Manual has been defined as "a document which set out the responsibilities of persons engaged in the routine of and the forms and records required for budgetary control." It contains all details regarding the plan and procedures for its execution. It also specifies the time table for budget preparation to approval, details about responsibility, cost centers, constitution and organization of budget committee, duties and responsibilities of budget officer. (6) Budget Period: A budget is always related to specified time period. The budget period is the length of time for which a budget is prepared and employed. The period may depend upon the type of budget. There is no specific period as such. However, for the sake of convenience, the budget period may be fixed depending upon the following factors: (a) Types of Business (b) Types of Budget (c) Nature of the demand of the product (d) Length of trade cycle (e) Economic factors
(f) Ava!lability of accounting period

(g) Availability of finance (h) Control operation

Key Factor
Key Factor is also called as "Limiting Factor" or Governing Factor. While preparing the budget, it is necessary to consider key factor for successful budgetary control. The influence of the Key Factor which dominates the business operations in order to ensure that the functional budgets are reasonably capable of fulfilment. The Key Factors include.
(1)

Raw materials may be in. short supply. Non-availability of skilled labours.

(2)

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(3) (4) (5) (6) (7) (8) (9)

Government restrictions. Limited sales due to insufficient sales promotion. Shortage of power. Underutilization of plant capacity. Shortage of efficient executives. Management policies regarding lack of capital. Insufficient research into new product development.

(10) , Insufficiency due to shortage of space.

Advantages of Budgetary Control

The advantages of budgetary control may be summarized as follows :
(1)

It facilitates reduction of cost. Budgetary control guides the management in planning and formulation of policies. Budgetary control facilitates effective co-ordination of activities of the various departments and functions by setting their limits and goals. It ensures maximization of profits through cost control and optimum utilization of resources.
It evaluates for the continuous review of performance of different budget centers.

(2) (3) (4) (5) (6) (7) (8) (9) (10)

It helps to the management efficient and economic production control. It facilitates corrective actions, whenever there is inefficiencies and weaknesses comparing actual performance with budget. It guides management in research and development.
It ensures economy in working.

It helps to adopt the principles of standard costing.

Limitations of Budgetary Control

Budgetary Control is an effective tool for management control. However, it has certain important limitations which are identified below: (1) The budget plan is based on estimates and forecasting. Forecasting cannot be considered to be an exact science. If the budget plans are made on the basis of inaccurate forecasts then the budget progamme may not be accurate and ineffective. For reasons of uncertainty about future, and changing circumstances which may develop later on, budget may prove short or excess of actual requirements. Effective implementation of budgetary control depends upon willingness, co-operation and understanding among people reasonable for execution. Lack of co-operation leads to inefficient performance. The system does not substitute for management. It is mere like a management tool. Budgeting may be cumbersome and time consuming process.

(2) (3)

(4) (5)

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567

Types of Budgets As budgets serve different purposes, different types of budgets have been developed. The following are the different classification of budgets developed on the basis of time, functions, and flexibility or capacity.

(A)

Classification on the basis of Time:

1.
2. 3. Long-Term Budgets Short-Term Budgets Current Budgets

(B)

Classification according to Functions:

1.

Functional or Subsidiary Budgets Master Budgets

2.

(C) Classification on the basis of Capacity :

1.
2. Fixed Budgets Flexible Budgets

The following chart can explain this more: Types of Budget

Long-Term Budget

Short-Term Budget

Current Budget

Functional Budget

Master
Budget Fixed Budget Flexible Budget

(A) Classification on the Basis of Time 1. Long-Term Budgets: Long-term budgets are prepared for a longer period varies between five to ten years. It is usually developed by the top level management. These budgets summarise the general plan of operations and its expected consequences. Long-Term Budgets are prepared for important activities like composition of its capital expenditure, new product development and research, long-term finance etc. 2. Short-Term Budgets: These budgets are usually prepared for a period of one year. Sometimes they may be prepared for shorter period as for quarterly or half yearly. The scope of budgeting activity may vary considerably among different organization. 3. Current Budgets: Current budgets are prepared for the current operations of the business. The planning period of a budget generally in months or weeks. As per ICMA London, "Current budget is a budget which is established for use over a short period of time and related to current conditions." (B) Classification on the Basis of Function 1. Functional Budget: The functional budget is one which relates to any of the functions of an organization. The number of functional budgets depend upon the size and nature of business. The following are the commonly used:

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A Textbook of Financial Cost and Management Accounting

(1)

Sales Budget Purchase Budget Production Budget Selling and Distribution Cost Budget Labour Cost Budget Cash Budget Capital Expenditure Budget

(2)
(3)
(4)

(5) (6) (7)

2. Master Budget: The Master Budget is a summary budget. This budget encompasses all the functional activities into one harmonious unit. The ICMA England defines a Master Budget as the summary budget incorporating its functional budgets, which is finally approved, adopted and employed.
(C) Classification on the Basis of Capacity

1. Fixed Budget: A fixed budget is designed to remain unchanged irrespective of the level of activity actually attained. 2. Flexible Budget: A flexible budget is a budget which is designed to change in accordance with the various level of activity actually attained. The flexible budget also called as Variable Budget or Sliding Scale Budget, takes both fixed, variable and semi fixed manufacturing costs into account. Control Ratios Ratios are used by the management to determine whether performance of its activities is going on as per estimates or not. If the ratio is 100 % or more, the performance is considered as favourable and if the ratio is less than 100% the performance is considered as unsatisfactory. The following are the ratios generally calculated for performance evaluation. 1. Capacity Ratio: This ratio indicates the extent to which budgeted hours of activity is actually utilised. Capacity Ratio

Actual Hours Worked Production

x 100

Budget Hours

2. Activity Ratio: This ratio is used to measure the level of activity attained during the budget period. Activity Ratio

Standard Hours for Actual Production Budgeted Hours

x 100

3. Efficiency Ratio: This ratio shows the level of efficiency attained during the budget period Efficiency Ratio

Standard Hours for Actual Production Actual Hours Worked

x 100

4. Calendar Ratio: This ratio is used to measure the proportion of actual working days to budgeted working days in a budget period. Calendar Ratio
=

------------------------------x 100 Budgeted Working Days for the Period

Number of Actual Working Days in a Period

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Illustration: 1

A company produces two articles A and B. Each unit takes 4 hours for A and 10 hours for B as production time respectively. The budgeted production for April, 2003 is 400 units of A and 800 units for B. The actual production at the end of the months was 320 units of A and 850 units of B. Actual hours spent on this production was 200. Find out the Capacity, Activity, and Efficiency Ratios for April 2003. Also find out the Calendar Ratio if the actual working days during the month be 28 corresponding to 26 days in the budget.
Solution:
Standard Budgeted Hours: A-400+ 4 B-800+10

100 hours 80 hours 180 hours

Standard Hours for Actual Production: A - 320 + 4 B-850+1O =

80 hours 85 hours 165 hours

(1)

Capacity Ratio

=
= =

Actual Hours worked x 100 Budgeted Hours 200

- - x 100
180

111.1%
Standard Hours for Actual Production Budgeted Standard Hours 165 180 91.66% Standard Hours for Actual Production Actual Hours Worked 165 200 82.5% Number of Actual Working Days in a Period Number of Working Days in a Budget Period 28 26
x 100 x 100 x 100 x 100

(2)

Activity Ratio

= =
=

(3)

Efficiency Ratio

= =
=

(4)

Calendar Ratio

= = =

x 100

x 100

107.69%

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A Textbook of Financial Cost and Management Accounting

Illustration: 2

From the given below information you are required to calculate Capacity Ratio, Activity Ratio and Efficiency Ratio:
Actual Hours worked Budgeted Hours 3,600 4,000

Standard Hours for Actual Production 5,600 (Actual Production converted into Standard Hours) 6,000 Budgeted Standard Hours (Budgeted Production Converted into Standard Hours )

Solution:
( 1) Capacity Ratio

= =

Actual Hours Worked

x 100

Budgeted Hours 3,600 4,000 90%

x 100

(2)

Activity Ratio

= =
=

Standard Hours for Actual Production Budgeted Standard Hours 5,600 6,000 93.33% Standard Hours for Actual Production Actual Hours Worked 5,600
x 100 x 100

x 100

(3)

Efficiency Ratio

x 100

3,600 155.55%

=
Illustration: 3

Product A takes 4 hours to make and B requires 8 hours. In a month 27 effective days of 8 hours a day. 500 units of A and 300 units, of Y were produced. The company employ 25 workers in the production department. The budgeted hours are 60,000 for the year. Calculate Capacity Ratio, Activity Ratio and Effective Ratio.
Solution:
Standard Hours for Actual Production Product A : 500 x 4 Product B : 300 x 8 Std. Hours for Actual Production Budgeted Hours for the month

=
=

2,000 hours 2,400 hours 4,400 hours 60,000 12 5,000 hours 5,400 hours

=
=

Actual Hours Worked = 25 x 27 x 8

=
=

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571

( 1)

Capacity Ratio

= = =

Actual Hours Worked Budgeted Hours 5,400 5,000 108%

x 100

x 100

(2)

Activity Ratio

= =

Standard Hour for Actual Production Budgeted Hours 4,400 5,000 88 % Standard Hours for Actual Production Actual Hours Worked 4,400 5,400 81.48 %

x 100

x 100

(3) Efficiency Ratio

= =

x 100

x 100

Illustration: 4 A Manufacturing company submits the following figures:

Budgeted Production 44 units Actual Production 40 units Standard Hours Per unit 8 Actual work Hours 500 You are required to calculate (a) Capacity Ratio (b) Activity Ratio and (c) Efficiency Ratio.

Solution:
Standard hours for actual period Budgeted hours

= = = =

Standard hours per unit x Actual Production 8 x 40 = 320 hours Standard hour per unit x Budgeted Production 8 x 44 = 352 hours Actual Hours worked Budgeted Hours 500 352

( 1)

Capacity Ratio

= = =

x 100

x 100

142.04% Standard hours for actual production Budgeted Hours 320 352 90.90% Standard hours for actual Production Actual Hours worked 320 500 64% x 100

(2)

Activity Ratio

= = =

x 100

x 100

(3)

Efficiency Ratio

= = =

x 100

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Performance of Budgeting Perfonnance of Budget has been defined as a "budget based on functions, activities and projects." Perfonnance of Budgeting may be described as "the budgeting system in which input costs are related to the perfonnance, i.e., end results." According to National Institute of Bank Management, Perfonnance Budgeting is, "the Process of analyzing, identifying, simplifying and crystallizing specific perfonnance objectives of a job to be achieved over a period, in the framework of the organizational objectives, the purpose and objectives of the job." From the above definitions, it is clear that budgetary perfonnance involves the following: (1) (2) (3) (4) (5) Establishment of well defined centers of responsibilities: Establishment for each responsibility centre physical units. a programme of target perfonnance is -

Forecasting the amount of expenditure required to meet the physical plan laid down. Comparison of the actual perfonnance with the budgets, i.e., evaluation of perfonnance. Undertaking periodic review of the programme with a view to make modifications as required.

SOME IMPORTANT BUDGETS

Sales Budget Sales Budget is one of the important functional budget. Sales estimate is the commencement of budgeting may be made in quantitative terms. Sales budget is primarily concerned with forecasting of what products will be sold in what quantities and at what prices during the budget period. Sales budget is prepared by the sales executives taking into account number of relevant and influencing factors such as : (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) ( 11 ) (12) Analysis of past sales (Product wise; Territory wise, Quote wise). Key Factors. Market Conditions. Production Capacity. Government Restrictions. Competitor's Strength and Weakness. Advertisement, Publicity and Sales Promotion. Pricing Policy. Consumer Behaviour. Nature of Business. Types of Product. Company Objectives.

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(13)
(14) (15)

Salesmen's Report. Marketing Research's Reports. Product Life Cycle.

Illustration: 5
Thomas Engineering Co. Ltd. Manufactures two articles X and Y. Its sales department has three divisions: West, South and East. Preliminary sales budgets for the year ending 3151 December 2003. based on the assessments of the divisional executives:
Product X : West 40,000 units: South 1,00,000 units and East 20,000 units Product Y : West 60,000 units: South 8,00,000 units and East Nil Sales Price X Rs. 2 and Y Rs. 3 in all areas. Arrangements are made for the extensive advertising of product X and Y and it is estimated that West division sales will increase by 20,000 units. Arrangements are also made to advertise and distribute product Y in the Eastern area in the second half of 2003 when sales are expected to be 1,00,000 units. Since the estimated sales of the South division represented an unsatisfactory target, it is agreed to increase both the estimates by 10 %. Prepare a sales budget for the year to 31" December 2003.

Solution: Sales Budget for the year 2003

Product X Division Qty. Price Rs. Value Rs. Qty. Rs. Product Y Price Rs. Value Rs. Total Rs.

West South East Total

60,000 1,10,000 20,000 1,90,000

2 2 2

1,20,000 2,20,000 40,000 3,80,000

80,000 88,000 1,00,000 2,68.000

3 3 3

2,40,000 2,64,000 3,00,000 8.04,000

3,60,000 4,84,000 3,40,000 11,84,000

Illustration: 6
Two articles A and B are manufactured in a department. Sales for the year 2003 were planned as follows:
Product 1st Quaner Units 2nd Quarter Units 3rd Quaner Units 4th Quarter Units

Product A Product B

5,000 2,500

6,000 2,250

6,500 2,000

"7,500 1,900

Selling price were Rs. 10 per unit for A and Rs. 20 per unit for B respectively. Average sales return are 10 % of sales and the discounts and bad debts amount to 2 % of the total sales. Prepare Sales Budget for the year 2003.

Sales Budget for the Year 2003

Paniculars
Qty. Units Product A Product B Total (I) 5,000 2,500 7,500

1st Quaner
Price Rs. 10 20 Value Rs. 50,000 50,000 1,00,000

211d Quaner
Qty. Units 6,000 2,250 8,250 Price Rs. 10 20 Value Rs. 60,000 45,000 1,05,00

3rd Quaner
Qty. Price Units Rs. 6,500 2,000 8,500 10 20 Value Rs. 65,000 40,000 1,05,000

4th Quaner
Qty. Units 7,500 1,900 9,400 Price Rs. 10 20 Value Rs. 75,000 38,000 1,13,000

Total
Qty. Units 25,000 8,650 33,650 Price Rs. 10 20 Value Rs. 2,50,000 1,73,000 4,23,000

Less: Sales Return at 10% on Sales Discount 'Bad Debts at 2% on Sales

Total (2) Net Sales
(I) - (2)

10,000

10,500

10,500

11,300

42,300

2,000 12,000 88,000

2,100 12,600 92,400

- - - -

2,100 12,600 92,400

2,260 13,560 92,400

8460 50,760 3,72,240

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Illustration: 7 Natarajan Ltd. has four sales territories A, B, C, D. Each salesman is expected to sell the following number of units during the First Quarter of 2003. Assume the Average Selling Price to be Rs. 10:
Territory Month A Units

B
Units

C
Units

D Units
1,750 2,000 2,250

April May June

500 1,000 1,250

750 900 1,000

1,250 1.400 '1,500

Solution: Sales Budget, First Quarter 2003

Territory Qty. unit April Price Rs. Value Rs. Qty. unit May Price Rs. Value Rs. June Qty. Price unit Rs. Value Rs. Quter Qty. unit Value Rs.

A B C D
Total

500 750 1,250 1,750 4,250

10 10 10 10

5,000 7,500 12,500 17,500 42,500

1,000 900 1.400 2,000 5,300

10 10 10 10

10,000 9,000 14,000 20,000 53,000

1,250 1,000 1,500 2,250 6,000

10 10 10 10

12,500 10,000 15,000 22,500 60,000

2,750 2.650 4,150 6,000 15,550

27.500 26,500 41,500 60,000 1,55,500

Production Budget Production budget is usually prepared on the basis of sales budget. But it also takes into account the stock levels desired to be maintained. The estimated output of business firm during a budget period will be forecast in production budget. The production budget determines the level of activity of the produce business and facilities planning of production so as to maximum efficiency. The production budget is prepared by the chief executives of the production department. While preparing the production budget, the factors like estimated sales, availability of raw materials, plant capacity, availability of labour, budgeted stock requirements etc. are carefully considered. Cost of Production Budget After Preparation of production budget, this budget is prepared. Production Cost Budgets show the cost of the production determined in the production budget. Cost of Production Budget is grouped in to Material Cost Budget, Labour Cost Budget and Overhead Cost Budget. Because it breaks up the cost of each product into three main elements material, labour and overheads. Overheads may be further subdivided in to fixed, variable and semi-fixed overheads. Therefore separate budgets required for each item. Illustration: 8 From the following particulars prepare a production budget of product P and Q of Nancy sales Corporation for the First Quarter of 2003:
Particulars Product P Product Q Product R

Sales (in units) : January February March Selling Price Per unit (Rs.)

20,000 15,000 25,000 5

15,000 20,000 25.000 10

5,000 5,000 5,000 20

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A Textbook of Financial Cost and Management Accounting

Particulars

Product P

Product Q

Product R

Targets for 1st Quarter 2003 : Sales Quantity increase Sales Price increase Stock Position I "Jan. 2003 : Stock position and Jan. 2003 Sales Stock Position 31" Mar. 2003 : Stock Position end Jan. & Feb. Percentage of subsequent month sales

10% Nil 50 % 10,000 50%

10% 10% 50 % 20,000 50 %

10% 20 % 50 % 5,000 50 %

Solution: Production Budget (Units) of Product P and Q for the First Quarter of 2003
Product Particulars

April

May

June

Total

Expected Sales Add : Closing stock

Less : Opening stock

22,000 8,250 30,250 11,000 19,250 16,500 11,000 27,500 13,750 13,750

16,500 13,750 30,250 8,250 22,000 22,000 13,750 35,750 17,875 17,875

27,500 10,000 37,500 13,750 23,750 27,500 20,000 47,500 23,750 23,750

66,000 10,000 76,000 10,000 66,000 66,000 20,000 86,000 13,750 72,250

Budgeted Production (in units) Q Expected sales Add : Closing stock

Less: Opening stock

Budgeted Production (to be Produced)

Illustration: 9 From the following particular, you are required to prepare production budget of Mrs. V. G. P. Ltd. a manufacturing organization that has three products X, Y and Z
Product Estimated Stock at the beginning of the budget period Estimated Stock at the end of the budget Period Estimated Sales as Per sales budget

X y

5,000 units 4,000 units 6,000 units

6,400 units 3,850 units 7,800 units

21,600 units 19,200 units 23,100 units

Solution:
Particulars

X (Units)
21,600 6,400 28,000

Y (Units)

Z (Units)
23,100 7,800 30,900 6,000 24,900

Expected Sales during the period Add : Closing stock at the end of budget period
Less : Opening stock at the beginning of the budget period

19,200 3,850 23,050 4,000 19,050

5,000 23,000

Budgeted Production

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Illustration: 10
Production cost of a factory for a year is as follows :
Direct wages Rs. 40,000 Direct materials Rs. 60,000 Production overhead fixed Rs. 20,000 Production overhead variable Rs. 30,000 During the forthcoming year, it is expected that (a) The average rate for direct labour remuneration will be far from Rs. 3 per hour to Rs. 2 per hour (b) Production efficiency will remain unchanged (c) Direct labour hours will increase by 33 1/ 3 % The purchase price per unit of direct materials and of the other materials and services which comprise overheads will remain unchanged. Draw up a budget and a factory overhead rate, the overhead being absorbed on a direct wage basis.

Solution: Cost of Production Budget

Paniculars Rs. Amount Rs.

Direct Materials Direct wages [RS. 40,000 x Prime Cost Add : Production Overhead : Fixed Variable Factory cost (or) Cost of production ; x :

60,000

j
Rs.20,OOO Rs.30,OOO

35,556 95,556

50,000 1,45,556

Illustration: 11
Prepare a Production Budget for each month and Production Cost budget for the six months period ending 31 51 Dec. 2003 from the following data of product "X":
(1)

The units to be sold for different months are as follows: July, 2003 August September October November December 2003 January 2004 1,100 1,100 1,700 1,900 2,500 2,300 2,000

(2) (3) (4)

There will be no work in progress at the end of any month. Finished units equal to half the sales for the next month will be in stock at the end of each month (including June 2003). Budgeted production and production cost for the year ending 31" December 2003 are as follows: 22,000 Rs.IO.00

Production (Units) Direct Material Per unit

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A Textbook of Financial Cost and Management Accounting

Direct wages Per unit Total factory overhead apportioned to product

Rs. 4.00 88,000

(ICWA; Inter)

Solution: (A) Production Budget (from July to December)

Particulars July August Sept. Oct. Nov. Dec. Total

Estimated Sales Add,' Closing Stock of finished goods (half of next months sales)
Less,' Opening Stock of finished goods

1,100

1,100

1,700

1,900

2,500

2,300

10,600

550 1,650 550 1,100

850 1,950 550 1,400

950 2,650 850 1,800

1,250 3,150 950 2,200

1,150 3,650 1,250 2,400

1,000 3,300 1,150 2,150

1,000 11,600 550 11,050

Budgeted Production

Working Notes :

= Expected Sales + Desired Closing Stock This is the closing stock June 2003 = 50 % of sale of July 2003.
Estimated Production
Particulars

Estimated Opening Stock.

(B) Production Cost Budget (from July to Dec.)

Amount ( 11.050 Units) Amount (Per Unit)

Direct Material cost (at Rs. 10 per unit) Direct Wages (at Rs. 4 per unit) Factory Overhead 88,000 22,000 x 11,050

} }

1,10,500 44,200

10
4

44,200 1,98,900

4 18

Total Cost of Production

Assumed to be variable. If it is fixed, 50 % of Rs. 88,000 (Rs. 44,000) is to be charged.

Material Purchase Budget The different level of material stock are based on planned out. Once the production budget is prepared, it is necessary to considered the requirement of materials to carryout the production activities. Material Purchase Budget is concerned with purchase and requirement of direct materials to be made during the budget period. While preparing the materials purchase budget, the following factors to be considered carefully: (1) (2) (3) (4) (5) (6) Estimated sales and production. Requirement of materials during budget period. Expected changes in the prices of raw materials. Different stock levels, EOQ etc. Availability of raw materials, i.e., seasonal or otherwise. Availability of financial resources.

Budgeting and Budgetary Control

579

(7) (8)

Price trend in the market. Company's stock policy etc.

Illustration: 12 Draw up a material purchase budget from the following information : Estimated sales of a product is 30,000 units. Two kinds of raw materials A and B are required for manufacturing the product. Each unit of the product requires 3 units of A and 4 units of B. The estimated opening balance in the beginning of the next year: finished goods 5,000 units; A, 6,000 units; B, 10,000 units. The desirable closing balance at the end of the next year: finished product, 8,000 units; A, 10,000 units; B 12,000 units. Solution:
Estimated Production

Expected Sales + Desired Closing Stock of Finished Goods - Estimated Opening Stock of Finished Goods 30,000 + 8,000 - 5,000 33,000 units

Material Purchase Budget for the year

Particulars Material Required to meet Production Target Material A - 33,000 x 3 Material B - 33,000 x 4 Add : Desired closing stock at the end of next year Less : Expected stock at the commencement of next year (opening balance) Quantity of Materials to be purchased Material A Units 99,000 10,000 1,09,000 6,000 1,03,000 Material B Units 1,32,000 12,000 1,44,000 10,000 1,34,000

Cash Budget This budget represent the anticipated receipts and payment of cash during the budget period. The cash budget also called as Functional Budget. Cash budget is the most important of all the functional budget because, cash is required for the purpose to meeting its current cash obligations. If at any time, a concern fails to meet its obligations, it will be technically insolvent. Therefore, this budget is prepared on the basis of detailed cash receipts and cash payments. The estimated Cash Receipts include:
(1)

Cash Sales Credit Sales Collection from Sundry Debtors Bills Receivable Interest Received Income from Sale of Investment Commission Received Dividend Received

(2)
(3)

(4)
(5) (6)

(7)

(8)

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A Textbook of Financial Cost and Management Accounting

(9)

Income from Non-Trading Operations etc.

The estimated Cash Payments include the following :

(1)

Cash Purchase Payment to Creditors Payment of Wages Payments relate to Production Expenses Payments relate to Office and Administrative Expenses Payments relate to Selling and Distribution Expenses Any other payments relate to Revenue and Capital Expenditure Income Tax Payable, Dividend Payable etc.

(2) (3) (4) (5) (6) (7) (8)

Illustration: 13 A company is expecting to have Rs. 25,000 cash in hand on 1st April 2003 and it requires you to prepare an estimate of cash position in respect of three months from April to June 2003, from the information given below :
Sales Rs. Purchase Rs. Wages Rs. Expenses Rs.

February March April May June

70,000 80,000 92,000 1,00,000 1,20,000

40,000 50,000 52,000 60,000 55,000

8,000 8,000 9,000 10,000 12,000

6,000 7,000 7,000 8,000 9,000

Additional Information :
(a) (b) (c) (d) Period of credit allowed by suppliers - two months. 25 % of sale is for cash and the period of credit allowed to customer for credit sale one month. Delay in payment of wages and expenses one month. Income Tax Rs. 25,000 is to be paid in June 2003.

Solution: Cash Budget

Particulars April Rs. May Rs. June Rs. Total Rs.

Opening balance of cash

25,000 23,000 60,000 1,08,000 40,000 8,000 7,000

53,000 25,000 69,000 1,47,000 50,000 9,000 7,000

81,000 30,000 75,000 1,86,000 52,000 10,000 8,000 25,000 95,000 91,000

1,59,000 78,000 2,04,000 4,41,000 1,42,000 27,000 22,GOO 25,000 2,16,000 2,25,000

Cash Respects :
Cash Sales Debtors Total Cash Receipts - (l)

Cash Payments :
Creditors Wages Expenses Income tax Total Payment - (2) Closing Balance of Cash (1-2)

55,000 53,000

66,000 81,000

Budgeting and Budgetary Control

58/

Illustration: 14
Prasad & Co. wishes to prepare cash budget from January. Prepare a cash budget for the first six months from the following estimated revenue and expenses:
Month Total Sales Rs. Materials Rs. Wages Rs. Production Overheads Rs. Selling and Distribution Overheads Rs.

January February March April May June

10,000 11,000 14,000 IS,OOO 15,000 20,000

10,000 7,000 7,000 11,000 10,000 12,500

2,000 2,200 2,300 2,300 2,000 2,500

1,600 1,650 1,700 1,750 1,600 I,Soo

400 450 450 500 450 600

Additional Information 1. 2. 3. 4. 5. 6. 7. S. Cash balance on 1st January was Rs. 5,000. A new machinery is to be installed at Rs. 10,000 on credit, to be repaid by two equal installments in March and April. Sales commission
@

5 % on total sales is to be paid within a month of following actual sales.

Rs. 5,000 being the amount of 2nd call may be received in March. Share Premium amounting to Rs. 1,000 is also obtainable with the 2nd call. Period of credit allowed by suppliers - 2 months. Period of credit allowed to customers - 1 month. Delay in payment of overheads - 1 month. Delay in payment of wages -Ih month. Assume cash sales to be 50 % of total sales.

Solution:
Cash Budget from January to June
Particulars January Rs. February Rs. March Rs. April Rs. May Rs. June Rs.

Opening Balance Estimated Cash Receipts: Cash Sales Credit Sales Second Call Share Premium Total Cash Receipts (A) Estimated Cash Payments: Materials Wages Production Overheads

5,000

9,000

14,900

13,500

12,350

16,550

5,000

10,000

5,500 5,000

19,500

7,000 5,500 5,000 1,000 33,400

9,000 7,000

7,500 9,000

10,000 7,500

29,500

2S,S50

34,050

,
1,000

2,100

10,000 2,250 1,650

7,000 2,300 1,700

7.000 2,150 1,750

11,000 2,250 1,600

1,600

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A Textbook of Financial Cost and Management Accounting

Selling & Distribution Overheads Sales Commission Purchase of Machinery Total Cash Payment (B) Closing Balance (A - B)

1,000 9,000

400 500

4,600 14,900

450 550 5,000 19,900 13,500

450 700 5,000 17,150 12,350

500 900

450 750

12,300 16,550

16,050 18,000

Illustration: 15
From the following data, forecast the cash position at the end of April, May and June 2003.

Month
February March April May June

Sales Rs.
60,000 65,000 40,000 58,000 44,000

Purchases Rs.
42,000 50,000 52,000 53,000 40,000

Wages Rs.
5,000 6,000 4,000 5,000 4,000

Miscellaneous Rs.
3,500 4,000 3,000 6,000 3,000

Additional Inrormation
1. 2.
3.

Sales: 10 % realized in the month of sales; balance realised equally in two subsequent months. Purchases: These are paid in the month following the month of supply. Wages: 10 % Paid in arrears following month. Miscellaneous expenses: Paid a month in arrears. Rent: Rs. 500 Per month paid Quarterly in advance due in April. Income Tax: First installment of advance tax Rs. 15,000 due on or before 15th June. Income from Investment: Rs. 3,000 received quarterly in April, July etc. Cash in hand: Rs. 3,000 on 1st April 2003.

4.
5.

6. 7. 8.

Solution: Cash Budget for the month of April, May and June
Paniculars
Opening Balance of Cash Add: Cash Receipts: Cash Sales Receipts from Debtors (Credit Sales) Collection in 1st month Collection in 2nd month Income from Investment Total Cash Receipts (1)

April Rs.
3,000 4,000

May Rs.
7,550 5,800

June Rs.
700 4,400

29,250 27,000 3,000 66,250 50,000

18,000 29,250

19,800 18,000

60,600 52,000

42,900 53,000

Less : Cash Payments : Creditors for Purchases

Budgeting and Budgetary Control

583

Wages; Current ( 90%) Arrears (10%) Rent Miscellaneous Expenses Income Tax Total Payments (2) Closing Balance of Cash ( 1- 2)

3,600 600 500 4,000

4,500 400 3,000

3,600 500 6,000 15,000 78,100 (-)35,200

58,700 7,550

59,900 700

Working Notes
(I)

Out of total sales, 10 % are cash sales. Balance 90 % are credit sales. In any given month 50 % of credit sale of the previous two months are collected (See W.N.) In any given month, 90 % of the wages of the same month and 10 % of previous month's wages are paid.

(2)

(3) Working Notes for collections of cash from Debtors and Sales
Particulars
Total Sales

February Rs.
60,000 6,000 54,000

March Rs.
65,000 6,500 58,500

April

Rs.
40,000 4,000 36,000

May Rs.
58,000 5,800 52,200

June Rs.
44,000 4,400 39,600

Less : Cash Sales}

(10%) Credit Sales Collection in 1st month after Credit Sales Collection in 2nd month after Credit Sales Total Credit

}
}

27,000

29,250

18,000

19,800

27,000 56,250

29,250 47,250

18,000 37,800

Master Budget When the functional budgets have been completed, the budget committee will prepare a Master Budget for the target of the concern. Accordingly a budget which is prepared incorporating the summaries of all functional budgets. It comprises of budgeted profit and loss account, budgeted balance sheet, budgeted production, sales and costs. The ICMA England defines a Master Budget as "the summary budget incorporating its functional budgets, which is finally approved, adopted and employed." The Master Budget represents the activities of a business during a profit plan. This budget is also helpful in coordinating activities of various functional departments. Illustration: 16 Pushpack & Co., a glass manufacturing company requires you to calculate and present the budget for the next year from the following information :
Toughened Glass Bent Toughened Glass Direct Material Cost Direct Wages Rs. 2,00,000 Rs. 3,00,000 60% of Sales 10 workers @ Rs. 100 per month

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A Textbook of Financial Cost and Manageme.1t Accounting

Factory Overheads
Indirect Labour: Work Manager Foreman Stores and Spares Depreciation on Machinery Light and Power Repairs and Maintenance Other Sundries Rs. 300 Per month Rs. 200 Per month 2% on Sales Rs.6,ooO Rs. 2,000 Rs.4,ooO 10% on direct Wages

Administration, Selling and Distribution expenses Rs. 7,000 per year.

Solution: Master Budget for the year ending ...... .

Particulars Amount Amount

Sales (as per Sales Budget): Toughened glass Bent Toughened glass
Less :Cost of Production: (as per cost of Production Budget) Direct Materials Direct Wages

2,00,000 3,00,000 5,00,000

Prime Cost Add: Factory Overhead: Variable: Stores and Spares Light and Power Repairs and Maintance Fixed: Work Manager's Salary Foremen Salary Depreciation Sundries Work's Cost Gross Profit Less: Administration, Selling & Distribution Overheads Net Profit

3,00,000 12,000 3,12,000

Rs. Rs. Rs. Rs. Rs. Rs. Rs.

10,000 2,000 4,000

16,000

3,600 2,400 6,000 1,200

13,200 3,41,200

3,41,200 1,58,800

7,000 1,51,800

Fixed Budget A budget is drawn for a particular level of activity is called fixed budget. According to ICWA London "Fixed budget is a budget which is designed to remain unchanged irrespective of the level of activity actually attained." Fixed budget is usually prepared before the beginning of the financial year. This type of budget is not going to highlight the cost variances due to the difference in the levels of activity. Fixed Budgets are suitable under static conditions.

Budgeting and Budgetary Control

585

Flexible Budget Flexible Budget is also called Variable or Sliding Scale budget, "takes both the fixed and manufacturing costs into account. Flexible budget is the opposite of static budget showing the expected cost at a single level of activity. According to leMA, England defined Flexible Budget is a budget which is designed to change in accordance with the level of activity actually attained." According to the principles that guide the preparation of the flexible budget a series of fixed budgets are drawn for different levels of activity. A flexible budget often shows the budgeted expenses against each item of cost corresponding to the different levels of activity. This budget has come into use for solving the problems caused by the application of the fixed budget. Advantages of Flexible Budget
(1)

In flexible budget, all possible volume of output or level of activity can be covered. Overhead costs are analysed into fixed variable and semi-variable costs. Expenditure can be forecasted at different levels of activity. It facilitates at all times related factor can be compared. which are essential for intelligent decision making. A flexible budget can be prepared with standard costing or without standard costing depending upon What the Company opts for. Flexible budget facilitates ascertainment of costs at different levels of activity, price fixation, placing tenders and Quotations. It helps in assessing the performance of all departmental heads as the same can be judged by terms of the level of activity attained by the business. Distinction between Fixed Budget and Flexible Budget
Fixed Budget Flexible Budget

(2) (3) (4) (5) (6) (7)

1. It does not change with the volume of activity. 2. All costs are related to one level of activity only. 3. If budget and actual activity levels vary. cost
ascertainment does not provide a correct picture. 4. Ascertainment of costs is not possible in fixed cost.

1. It can be recast on the basis of volume of cost. 2. Costs are analysed by behaviour and variable costs
are allowed as per activity attained.

3. Flexible budgeting helps in fixation of selling price

at different levels of activity. 4. Costs can be easily ascertained at different levels of activity. 5. It has more application and can be used as a tool for effective cost control. 6. It is designed to change according to changed conditions. 7. Comparisons are realistic according to the change in the level of activity. 8. Costs are classified according to the nature of their variability.

5. It has a limited application for cost control. 6. It is rigid budget and drawn on the assumption that
conditions would remain constant.

7. Comparison of actual and budgeted performance

cannot be done correctly because the volume of production differs. 8. Costs are not classified according to their variability. i.e . fixed. variable and semi-variable.

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A Textbook of Financial Cost and Management Accounting

Method of Preparing Flexible Budget The following methods are used in preparing a flexible budget:
(1)

Multi-Activity Method. Ratio Method. Charting Method.

(2) (3)

(1) Multi-Activity Method: This method involves preparing a budget in response to different level of activity. The different level of activity or capacity levels are shown in Horizontal Columns, and the budgeted figures against such levels are placed in the Vertical Columns. The expenses involved in production as per budget are grouped as fixed, variable and semi variable. (2) Ratio Method: According to this method, the budget is prepared first showing the expected normal level of activity and the estimated variable cost per unit at the side expected level of activity in addition to the fixed cost as estimated. Therefore, the expenses as per budget, allowed for a particular level of activity attained, will be calculated on the basis of the following formula : Budgeted fixed cost + (Variable cost per unit of activity x Actual unit of activity) (3) Charting Method: Under this method total expenses required for any level of activity, are estimated having classified into three categories, viz., Variable. Semi Variable and Fixed. These figures are plotted on a graph. The expenses are plotted on the Y-axis and the level of activity are plotted on X-axis. The graph will thus, help in ascertaining the quantum of budgeted expenses corresponding to the level of activity attained with the help of this chart. Zero Base Budgeting (ZBB) Zero Base Budgeting is a new technique of budgeting. It is designed to meet the needs of the management in order to ensure the operational efficiency and effective utilization of the allocated resources of a concern. This technique was originally developed by Peter A. Phyhrr, Manager of Taxas Instrument during 1969. This concept is widely used in USA for controlling their state expenditure when Mr. Jimmy Carter was the president of the USA. At present the technique has for its global recognition for many countries have implemented in real terms. According to Peter A. Phyhrr ZBB is defined as an "Operative Planning and Budgeting Process" which requires each Manager to justify his entire budget in detail from Scratch (hence zero base) and shifts the burden of proof to each Manager to justify why we should spend any money at all." In zero-base budgeting, a manager at all levels have to justify the importance of activity and to allocate the resources on priority basis. Important Aspects of ZBB Zero Base Budgeting involves the following important aspects:
(1)

It emphasises on all requisites of budgets. Evaluation on the basis of decision packages and systematic analysis, i.e., in view of cost benefit analysis. Planning the activities, promotes operationai efficiency and monitors the performance to achieve the objectives.

(2) (3)

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587

Steps Involved in ZBB The following are the steps involved in Zero Base Budgeting:
(1)

No Previous year performance of inefficiencies are to be taken as adjustments in subsequent year. Identification of activities in decision packages. Determination of budgeting objectives to be attained. Extent to which Zero Base Budgeting is to be applied. Evaluation of current and proposed expenditure and placing them in order of priority. Assignment of task and allotment of sources on the basis of cost benefit comparison. Review process of each activity examined afresh. Weightage should be given for alternative course of actions.

(2) (3) (4) (5) (6) (7) (8)

Advantages of ZBB
(1)

Utilization of resources at a maximum level.

It serves as a tool of management in formulating production planning.

(2) (3) (4) (5) (6) (7) (8) (9)

It facilitates effective cost control. It helps to identify the uneconomical activities. It ensures the proper allocation of scarce resources on priority basis. It helps to measure the operational inefficiencies and to take the corrective actions. It ensures the principles of Management by Objectives. It facilitates Co-operation and Co-ordination among all levels of management. It ensures each activity is thoroughly examined on the basis of cost benefit analysis.

Illustration: 17 The expenses budgeted for production of 10,000 units in a factory are furnished below :
Per unit Rs.
Materials Labour Variable factory overheads Fixed factory overhead (Rs. 1,00,000) Variable expenses (Direct) Selling expenses (10 % Fixed) Distribution expenses (20 % Fixed) Administrative expenses (Rs. 50,000) Total cost of sale per unit You are required to prepare a budget for the production of 8,000 units. 70 25 20

10 5
13

7 5
155

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A Textbook of Financial Cost and Management Accounting

Solution: Flexible Budget

Particulars Output 10,000 units Per unit
Variable Expenses: Material cost Labour cost Direct expenses (variable) Prime cost Add: Factory overheads : Variable overheads Fixed overheads Works cost Add: Administrative expenses Fixed (Assumed) Cost of production Add: Selling Expenses Fixed - 10 % of Rs. 13 Variable - 90 % of Rs. 13 Add: Distribution Expenses: Fixed - 20 % of Rs.7 Variable - 80 % of Rs.7 Total Cost of Sales 70 25 5 100 20 10 130 5 135 1.30 11.70 1.40 5.60 155

Output 8,000 units Per unit

70 25 5 100 20 12.50 132.50 6.25 138.75 1.63 11.70 1.75 5.60 159.43

Amount
7,00,000 2,50,000 50,000 10,00,000 2,00,000 1,00,000 13,00,000 50,000 13,50,000 13,000 1,17,000 14,000 56,000 15,50,000

Amount
5,60,000 2,00,000 40,000 8,00,000 1,60,000 1,00,000 10,60,000 50,000 11,10,000 13,000 93,600 14,000 44,800 12,75,400

IIIustration: 18
Prepare a flexible budget for overheads on the basis of the following data. Ascertain the overhead rates at 50 %. 60 % and 70 % capacity.
At 60 % capacity Rs.
Variable overheads : Indirect Material Indirect Labour Semi-variable overheads: Electricity (40 % fixed 60 % Variable) Repairs ( 80 % fixed 20 % Variable) Fixed Overheads : Depreciation Insurance Salaries Total overheads Estimated direct labour hours 3,000 9,000 15,000 1,500 8,250 2,250 7,500 46,500 93,000

Budgeting and Budgetary Control

589

Solution: Flexible Budget

Particulars 50 % Capacity 60 % Capacity 70 % Capacity

Variable overheads: Indirect material Indirect labour Semi-variable overheads: Electricity Repairs and Maintenance Fixed overheads : Depreciation Insurance Sales Total Overheads Estimated direct labour hours Overhead Rate

2,500 7,500 13,500 1,450 8.250 2,250 7,500 42.950 77,500 Re.0.55

3,000 9,000 15,000 1,500 8,250 2,250 7,500 46,500 93,000 Re.0.50

3,500 10,500 16.500 1.550 8,250 2,250 7,500 50,050 1,08,500 Re.0.46

Working Notes :
(1) Electricity: Rs. 15,000 is the cost of electricity at 60 % capacity, of which 40% are fixed overheads, i.e., Rs. 6,000 and variable is Rs. 9,000 :

For 60 % capacity variable overheads For 50 % capacity variable overheads Therefore electricity cost at 50 % capacity For 70 % capacity, variable overheads Therefore electricity cost at 70 %

Rs.9,000 9,000 - - x 50 = Rs.7,500 60 6,000 + 7,500 = Rs. 13,500 9,000

x 70 = Rs. 10,500

=
= = =

60 Rs. 10,500 + Rs. 6,000 = Rs. 16,500

(2) Repairs and Maintenance: Rs. 1,500 is the cost of repairs and maintenance at 60 % capacity, of which 80% is fixed overhead, i.e., Rs. 1,200 and variable is Rs. 300 :

For 60 % capacity variable overhead For 50 % capacity variable overhead

= Rs.300
300 - - x 50 60

=Rs. 250

Therefore the total cost of repairs and maintenance at 50 % = Rs. 1,200 + Rs. 250 = Rs.1,450 For 70 % capacity, the variable overhead

=-60

300

x 70

=Rs. 350

Therefore the total cost of repairs and maintenance = Rs. 1,200 + Rs. 350 = Rs. 1,550

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A Textbook of Financial Cost and Management Accounting

Illustration: 19 With the following data for a 60 % activity prepare a budget for production at 80 % and 100 % capacity
Production at 60 % capacity 300 units Materials Rs. lOOper unit Labour Rs. 40 per unit Expenses Rs. IO per unit Factory expenses Rs. 40,000 ( 40 % fixed) Administrative expenses Rs. 30,000 ( 60 % fixed)

Solution: Flexible Budget

Particulars 60 % Capacity 300 units 80 % Capacity 400 units 100 % Capacity 500 units

Direct cost : Material Rs. 100 per unit Labour Rs. 40 per unit Expenses Rs. 10 per unit Total Direct Costs Add: Variable Factory Expenses (Rs. 40 per unit) Variable Administrative Expenses (Rs. 20 per unit) Fixed Factory Expenses (40 % of Rs, 40,000) Fixed Administrative Expen. ( 60 % of Rs. 30,000)
Total

30,000 12,000 3,000 45,000 12,000 6,000 16,000 18,000 97,000

40,000 16,000 4,000 60,000 16,000 8,000 16,000 18,000 1,18,000

50,000 20,000 5,000 75,000 20,000 10,000 16,000 18,000 1,39,000

Illustration: 20

as under:

The Cost Sheet of a Company based on a budgeted volume of sales of 3,00,000 units per Quarter is
Rs. Per unit

Direct materials Direct wages Factory overheads ( 50 % fixed) Selling and Administrative overheads (variable) Selling Price

5.00 2.00 6.00 3.00 18.00

When the budget was discussed it was felt that the company would be able to achieve only a volume of 2,50,000 units of production and sales per Quarter. The Company therefore decided that an aggressive sales promotion campaign should be launched to achieve the following improved operations:

Proposal I:
(a) Sell 4,00,000 units per quarter by sending Rs. 2,00,000 on special advertising (b) The factory fixed costs will increase by RsA,oo,OOO per Quarter

Proposal II :
(a) (b) (c) (d) (b) Sell 5,00,000 units per Quarter subject to the following conditions An overall price reduction of Rs. 2 per unit is allowed on all sales Variable Selling and Administration costs will increase by 5 % Direct Material costs will be reduced by I % due to purchase price discounts The fixed factory costs will increase by Rs. 2,00,000 more

You are required to prepare a Flexible Budget at 2,50,000 units, 4,00,000 units and 5,00,000 units of output per quarter and calculate the profit at each of the above levels of output.

Budgeting and Budgetary Control

591

Solution: Flexible Budget

Paniculars 2.50.000 units Rs. 4.00.000 units Rs. 5.00.000 units Rs.

Sales Revenue Variable Costs : Direct Materials @ Rs.5 Factory Labour @ Rs. 2 Factory Overheads @ Rs. 3 Sales and Administrative Overheads (? variable) @ Rs. 3 Total Variable Cost Contribution (Sales - Total Variable cost) Fixed Costs : Factory Overhead Sales and Administrative } Overhead (Fixed) Increase in fixed cost Advertisement Total Fixed Cost Profit (Contribution - Fixed cost)

45,00,000 12,50.000 5,00,000 7,50,000 2,50,000 27,50,000 17,50,000

72,00,000 20,00,000 8,00,000 12,00,000 4,00,000 44,00,000 28,00,000

8,00,000 24,75,000 10,00,000 15,00,000 5,25,000 55,00,000 25,00,000

9,00,000 6,00,000

9,00,000 6,00,000 4,00,000 2,00,000 21,00,000 7,00,000

9,00,000 6,00,000 6,00,000

15,00,000 2,50,000

21,00,000 4,00,000

Illustration: 21
The Managing Director of your company has been given the following statement showing the result for August 2003.
Month ending 31" August 2003
Master Budget Actual Variance

Units produced and sold Sales Direct materials Direct wages Variable overhead Fixed overhead Total cost Net profit The standard cost of the product are as follows :

10,000 units Rs. 40,000 Rs. 10,000 15,000 5,000 5,000 35,000 5,000

9,000 units Rs. 35,000 Rs. 9,200 13,100 4,700 4,900 31,900 3,100

1000 units Rs. (5,000) Adverse Rs. 800 1,900 300 100 3,100 (1,900) Adverse

Per unit Rs.

Direct material (lkg @ Re. 1 per kg) Direct Wages (1 hour @ Rs. 1.50) Variable overhead ( 1hour @ Re. 0.50)

1.00 1.50 0.50

Actual results for the month showed that 9,800 kg of material were used and 8,800 labour hours were recorded.

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A Textbook of Financial Cost and Management Accounting

Required : (a) Prepare a flexible budget for the month and compare with actual results (b) Calculate the variances which have arisen.

Solution: Statement showing Flexible Budget and its Comparison with Actual
Particulars Master Budget For 10,000 Units Rs. Flexible Budget Per Unit Rs. For 9,000 Rs. Actual for 9,000 Units Rs. Variance Rs.

Sales Less : Variable cost: Direct materials Direct wages Variable overheads Total Variable Costs Contribution (Sales - Total variable cost) Less : Fixed overheads Net profit

40,000 10,000 15,000 5,000 30,000

4.00 1.00 1.50 0.50 3.00 1.00 0.50 0.50

36,000 9,000 13,500 4,500 27,000 9.000 5,000 4,000

35,000 9,200 13,100 4,700 27,000 8,000 4,900 3,100

1,000 (A) 200 (A) 400 (F) 200 (A)

1000 (A) 100 (F) 900 (A)

10,000 5,000 5,000

Illustration: 22 A company operates at 50 % of capacity utilization. At this level of operation, the sales value is Rs. 9,00,000. At 100 % capacity utilization the following costs and relationships will apply:
Factory Overheads Rs. 1,80,000 ( 50 % Variable) Factory Cost 60 % of sales Selling Costs (75 Variable), i.e., 20 % of sales The company anticipates that its sales will increase up to 75 % of capacity utilization. The company also receives a special order from a government department. This order will occupy 15 % of capacity utilization of the plant. The prime cost in this order is Rs. 1,35,000 and the variable selling cost will only be 2 % of the sales value offered. Besides, the cost of processing the order is Rs. 8,000. The sales price offered is Rs. 1,45,000. Required: (1) Present a statement of profitability at 50 % and 75 % level of activity. (2) Evaluate the government order and state whether it is acceptable or I>t.

Solution: Flexible Buoget

Particulars 50 % Capacity Rs. 75 % Capacity Rs.

Sales Prime cost 50 % of sales 75 % of sales Factory overheads : Variable Cost Fixed Cost Factory Cost (Prime cost + Factory overheads) Selling Cost : Variable Cost Fixed Cost Total Cost (Factory Cost + Selling Cost) Profit (Sales - Total Cost)

9,00,000 4,50,000 45,000 90,000 5,85,000 1,35,000 90,000 8,10,000 90.000

13,50,000 6,75,000 67,500 90,000 8,32,500 2,02,500 90,000 11,25,000 2,25,000

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Working Notes: Sales at 50% Sales at 100%

=Rs. 9,00,000 =Rs. 18,00,000

Rs.

Profitability at 100% Capacity

Sales Prime Cost (10,80,000 - 1,80,000) Factory Overhead Factory Cost Selling Cost Total Cost Profit (Sales - Total Cost) (18,00,000 - 1,44,0000) Evaluation of Government order ( 15 % Capacity)
Rs.

18,00,000 9,00,000 1,80,000 10,80,000 3.60,000 14,40,000 3,60,000

=50% of sales
Given

= 60% of sales = 20% of sales

Sales Prime Cost Factory overhead (Variable cost) Selling cost variable @ 2 % Processing cost Total Cost
Loss (Sales - Total cost) 1,45,000 - 1,59,400

1,45,000 1,35,000 13,500 2,900 8,000 1,59,400 1,440

Hence not acceptable.

QUESTIONS 1. 2. 3. 4. 5. 6. 7. 8. 9. What do you mean by a budget? What are the essentials of a budget? What are the differences between budgets and forecasts? What do you understand by budgetary control? Explain briefly the characteristics of a good budget. What are the objectives of Budgetary Control? What are the scope and techniques of Standard Costing and Budgetary control? Describe essential requisites for effective budgetary control. What do you understand by organization for budgetary control? Write short notes on : (a) Budget Centre. (b) Budget Officer. (c) Budget Committee. (d) Budget Manual. (e) Budget Period. (f) Key Factor. (g) Performance of Budgeting. What are the advantages of budgetary control? What are the limitations of budgetary control? Briefly explain the different types of budgets. What you understand by control ratios? What is sales budget? What are the factors considered in developing the sales budget? Write short notes on : (a) Production Budget. (b) Cost of Production Budget. (c) Materials Budget. What do you understand by Cash Budget? Discuss the procedure for preparing the cost budget. What do you understand by Master Budget? What do you understand by Fixed Budget and Flexible Budget? Whiit are the advantages of Flexible Budget? What are the differences between fixed budget and flexible budget? Describe the different methods of preparing Flexible Budget.

to.
11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

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EXERCISES

A Textbook of Financial Cost and Management Accounting

(1) XYZ Ltd. has prepared the budget for tbe production of a lakh units of the only commodity manufactured by them for a costing period as under:
I

Raw Material 2.52 Per unit Direct Labour 0.75 Per unit Direct Expenses 0.10 Per unit 2.50 Per unit Works overheads (60 % Fixed) 0.40 Per unit Administration overhead ( 80 % Fixed) Selling overheads ( 50 % Fixed) 0.20 Per unit The actual production during the period was only 60,000 units. Calculate the revised budget cost per unit. . (ICWA, Inter) [Ans : Cost of Sales Rs. 4,65,000; Per unit @ Rs. 7.75) (2) The expenses budgeted for production of 10.000 units in a factory are furnished below:

Rs. Per unit

Materials Labour Variable overheads Fixed overheads (Rs. 1,00,(00) Variable expenses (direct) Selling expenses (l0% fixed) Distribution expenses (20 % fixed) Administration expenses (Rs. 50,(00) 70 25 20 10 5 13 7

Total cost of sales per unit (to make and sell) 155 Prepare a budget for the product of (a) 8,000 units and (b) 6,000 units Assume that administration expenses are rigid for all levels of production. [Ans : Total Cost Rs. 12,75,400 for 8,000 units; Rs. 10,00,800 for 6,000 units] (3) The income and expenditure forecasts for months of March to August, 2003 are given as follows: Months March April May June July August Sales (credit) 60,000 62,000 64,000 58,000 56,000 60,000 Purchases (Credit) 36,000 38,000 33,000 35,000 39,000 34,000 Wages 9,000 8,000 10.000 8,500 9,500 8,000 Manufacturing Expenses 3,500 3,750 4.000 3,750 5,000 5,200 Office Expenses 2,000 1,500 2,500 2,000 1,000 1,500 Selling Expenses 4,000 5,000 4,500 3,500 3,500 4,500

Additional Information You are given the following further information: (a) Plant costing Rs. 16,000 is due for delivery in July payable 10 % on delivery and the balance after 3 months. (b) Advance tax of Rs, 8,000 is payable in March and June each. (c) Creditors allow 2 months credit and debtors are paying one month late. Opening balance of cash Rs. 8,000 lag or one month in expenses. [Ans : Balance: May Rs. 15,750; June Rs. 12,750; July Rs. 18,400] (4) From the following average figures of previous quarters, prepare a manufacturing overhead budgeted for the quarter ending on March 31, 2003. The budget output during this quarter is 6,000 units: Fixed overheads Rs. 60,000 Variable overheads Rs. 30,000 (Varying @ Rs. 5 per unit) Semi variable overheads 30,000 ( 40 % fixed and 60 % varying @ Rs. 3 per unit) [Ans : 1,68,000] (5) Calculate (a) Efficiency Ratio (b) Activity Ratio and (c) Capacity Ratio from the following figures: Budgeted Production Actual Production 176 units 150 units

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Standard hour per unit 20 Actual working hours 1,200 [Ans : (a) Efficiency Ratio = 125%; (b) Activity Ratio = 85. 23%; (b) Capacity Ratio = 68. 18%] (6) A department of Tan India Company attains sale of Rs. 6,00,000 at 80% on its nonnal capacity and its expenses are give below:
Particulars Rs.

Administration Costs : Office salaries General expenses Depreciation Rate and Taxes Distribution Costs: Wages Rent Other expenses Selling Cost: Salaries Traveling expenses Sales office General expenses

90,000 2% on sales Rs.7,5oo Rs.8,750 Rs. 15,000 1% of sales 4% of sales 8% 2% 1% 1% of sales of sales of sales of sales

Draw up flexible administration, selling and distribution costs budget, operating at 90 per cent, 100 per cent and 110 per cent of nonnal capacity. (7) The following expresses relate to a cost center operating at 80% of nonnal capacity (sales are in 12,00,000). Draw up flexible administration, selling and distribution costs budget operating at 90%, 100% and 1l0% of normal capacity.
Administration costs Rs.

Office Salaries General Expenses Depreciation Rates and taxes

Selling Costs Salaries Traveling Expenses Sales Office General Expenses

30,000 1.5% of sales 15,000 17,500

Rs. 4% of sales 1.5% of sales 1% of sales 1% of Sales

Distribution Costs Rs. 30,000 Wages 5% of sales Rent Other expenses 2% of sales [Ans: Total costs : 80% of capacity Rs. 6,000; 90% of Capacity Rs. 67,500; 100% of capacity Rs. 75,000; 110% of capacity Rs. 82,500.]

(8) PQR Company Ltd. has given the following particulars, you are required to prepare a cash Budget for the three months ending I" Dec. 2003.
Months Sales Materials Wages Overheads

August September October November December (i)

20,000 21,000 23,000 25,000 30,000

10,200 10,000 9,800 10,000 10,800

3,800 3,800 4,000 4,200 4,500

1,900 210 2,300 2,400 2,500

Credit Tenns are : Sales I Debtors - 10% sales are on cash basis: 50% of the credit sales are coIlected next month and the balance in the following month Materials 2 month Creditors Wages lI5 month Overheads \12 month

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(ii) (iii)

A .Textbook of Financial Cost and Management Accounting Cash balance on I" October 2003 in expected to be Rs. 8,000 A machinery will be miscalled in August, 2003 at a cost of Rs. 1,00,000. The monthly installment of Rs. 5,000 payable from October onwards. (iv) Dividend at 10% on preference there capital of Rs. 3,00,000 be paid on I" December 2003. {v) Advance to be received for sales of vehicle Rs. 20,000 in December. wi) Income tax (advance) to be paid I December Rs. 5,000 [Ans: October closing balance Rs. 7,390; November closing balance Rs. 8,180; December Bank overdraft Rs. 3.910]

will

(9)

With the following data for a 60% capacity, prepare a budget for production at 80% and 100% activity. Production at 60% activity 600 units materials Rs. 100 per unit (100% variable) Materials Rs. 40 per unit (100% variable) Labours Rs. 40 per unit (100% variable) Direct Expenses Rs. 10 per unit (Rs. 6 per unit fixed) Factory expenses Rs. 40,000 (40% fixed) Administrative expenses Rs. 30,000 (60% fixed) [Ans: Total Costs : 60% Capacity Rs. 1,60,000 80% capacity Rs. 2,00,800 100% capacity Rs. 2,41,600]

(10) A factory is currently to 50% capacity and produces 10,000 units estimate the profits of the company when it works at 60% and 80% capacity and offer your critical comments.

At 60% working raw materials cost increases by 2% and selling price falls by 2% at the 80% working, raw material cost increases by 5% and selling price falls by 5%. A 50% capacity working the product costs Rs. 180 per unit and is sold at Rs. 200 per unit. The unit cost of Rs. 180 is made up as follows : Rs. 100 Materials Rs.30 Labour Rs. 30 (40% fixed) Factory Overhead Rs. 20 (50% fixed) Administrative Overhead [Ans: Rs. 2,00,000; Rs. 2,12,000; Rs. 2,12,000]
(11) PQR Ltd. manufactures two products X and Y. Product X takes 6 hours to make while product Y takes 12 hours. In a month of 25 days of 8 hours each, 1,200 units of X and 750 units of Y were produced. The firm employs 75 men in the department responsible for producing these two products. The budget hours are 1,86.000 per annum. You are required to calculate a Activity Ratio, Capacity Ratio and Efficiency ratio. [Ans: Activity ratio 104.5%; Capacity Ratio 96.8% Efficiency Ratio 108%]
(12)

Glass manufacturing company requires you to calculate and present the budget for the next year from the following Sales: Toughened glass Rs. 3,00,000 Bent Toughened glass Rs. 5,00,000 Direct Material cost 60% of sales Direct wages 20 workers @ Rs. 150 P.M. Factory Overheads Indirect Labour - Works Manager Rs. 500 per month, Foreman Rs. 400 per month. Stores and spares 2 Ih% on sales Depreciation machinery Rs. 12,600 Light and power Rs. 5,000 Repairs etc. Rs. 8,000 Other sundries 10% on Daily wages Administration selling and distribution expenses Rs. 14,000 per annum [Ans: Sales budget - sales revenues Rs. 7,86,000; production cost budget Rs. 5,76,000; expected profit as budgeted Rs. 2,10,000]

information :

DOD