Table of Contents

1. Introduction to Management Accounting ........................................................................ 4

1.1 What Is Management Accounting? ................................................................................................... 4
1.2 Nature and Purpose of Management Accounting .......................................................................... 4
1.3 The Managerial Processes of Planning, Decision-Making, and Control ..................................... 5
1.4 Strategic vs Tactical vs Operational Planning .................................................................................. 6
1.5 Management Accounting vs Financial Accounting ........................................................................ 7
2. Cost Concepts and Classification ..................................................................................... 8
2.1 Cost Classification Basics .................................................................................................................... 8
2.2 Production vs Non-Production Costs ................................................................................................ 9
2.3 Costs by Function vs Costs by Nature ............................................................................................... 9
2.4 Direct vs Indirect Costs ........................................................................................................................ 9
2.5 Fixed vs Variable vs Stepped Costs ................................................................................................... 9
3. Cost-Volume-Profit (CVP) Analysis ................................................................................. 10
3.1 What is CVP Analysis? ........................................................................................................................ 10
3.2 Contribution Margin and Break-Even Point ................................................................................... 10
3.3 Margin of Safety .................................................................................................................................. 10
3.4 Target Profit .......................................................................................................................................... 10
4. Cost Accounting Techniques .......................................................................................... 11
4.1 Cost Accounting Techniques Overview .......................................................................................... 11
4.2 Materials Cost Accounting ................................................................................................................ 12
4.3 Labor Cost Accounting ...................................................................................................................... 12
4.4 Overheads Cost Accounting ............................................................................................................ 14
4.5 Marginal vs Absorption Costing ...................................................................................................... 14
4.6 Calculating Profits under Marginal and Absorption Costing ...................................................... 15
5. Budgeting Basics............................................................................................................ 16
5.1 Why Do Companies Need Budgets? .............................................................................................. 16
5.2 The Importance and Benefits of Budgeting................................................................................... 16
5.4. The Master Budget ............................................................................................................................ 18
5.5 Budgeting Techniques ....................................................................................................................... 19
5.6 Budgeting vs Forecasting .................................................................................................................. 22
5.7 Budgeting Control and Variance Analysis ...................................................................................... 22

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6. Standard Costing and Variance Analysis ........................................................................ 24
6.1 Understanding Standard Costs ........................................................................................................ 24
6.2 Standard Costing Benefits and Limitations .................................................................................... 24
6.3 Variance Analysis Overview .............................................................................................................. 25
6.4 Sales Variances .................................................................................................................................... 25
6.5 Material Variances ............................................................................................................................... 26
6.6 Labor Variances ................................................................................................................................... 26
6.7 Total Variable Overhead Variances .................................................................................................. 26
6.8 Reconciliation between Standard and Actual Profit ..................................................................... 26
7. Performance Measurement & Control ............................................................................ 27
7.1 Performance Measurement – Overview .......................................................................................... 27
7.2 Key Performance Indicators (KPIs) ................................................................................................... 27
7.3 Balanced Scorecard ........................................................................................................................... 29
7.4 Performance Control Systems .......................................................................................................... 29
7.5 Benchmarking ..................................................................................................................................... 30
GLOSSARY ......................................................................................................................... 31

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1. Introduction to Management Accounting

1.1 What Is Management Accounting?

Management Accounting involves collecting, analyzing, interpreting, and presenting
financial information for managers to use internally for planning, decision-making, and
overall control. It supports the management team by providing reports on strategic
direction, operational control, and performance monitoring.

1.2 Nature and Purpose of Management Accounting

The role of management accountants is essential because they provide critical financial
data and analysis for planning, controlling, and strategic decision-making.

The primary purpose of management accounting is to optimize the organization’s

economic efficiency—maximizing profits and shareholder value.

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1.3 The Managerial Processes of Planning, Decision-Making, and Control

Planning
The managerial planning process entails defining goals and mapping out strategies—
incorporating budgeting and forecasting.
Decision-Making
Utilizing relevant financial data enables informed decision-making between alternatives
through cost-benefit analysis and risk assessment.
Control
The control process ensures the organization's strategic objectives are on track by
monitoring performance against budgets and standards and implementing corrective
actions when necessary.

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1.4 Strategic vs Tactical vs Operational Planning

Strategic Planning
Focused on long-term core business goals, such planning sets the company's direction for
three to five years.
Tactical Planning
This type of planning imбуplements components of a strategic plan over one to three
years, focusing on shorter-term actions.
Operational Planning
This category involves detailed, short-term guidance for daily operations, typically
spanning a year or less.

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1.5 Management Accounting vs Financial Accounting

Management accounting differs from financial accounting in several aspects, including

purpose, audience, perspective, insights, reporting requirements, and regulations.

7
2. Cost Concepts and Classification

2.1 Cost Classification Basics

8
2.2 Production vs Non-Production Costs
Production costs are incurred during manufacturing, including direct materials, labor, and
overheads.
 Materials: These are the raw inputs transformed into finished goods—either direct
(raw materials) or indirect (not directly traceable to the final product).
 Labor: The human effort needed to create a product, like materials, can be direct
(hands-on manufacturing) or indirect (supporting production).
 Overheads: This includes production costs like factory rent, equipment
depreciation, and utilities, excluding direct materials and labor.
Non-production costs encompass selling and administrative expenses unrelated to
production.
 Selling Costs: These are expenses related to marketing, distribution, and product
sales, such as advertising and shipping.
 General Costs: Such Expenses include those related to the broad operations of the
business—such as executive salaries—and are not specific to any one function.
 Administrative Costs: These costs are associated with the general administration of
the business, like office supplies and clerical salaries.
 Finance Costs: This category includes expenses related to the company’s financing,
including interest payments.
2.3 Costs by Function vs Costs by Nature
 By Function: Costs are classified based on the department or segment of the
business, such as production, research, and marketing.
 By Nature: Costs are categorized according to their nature—e.g., salaries, rent, and
utilities—and can be further categorized into fixed, variable, or mixed costs.
2.4 Direct vs Indirect Costs
 Direct costs can be directly traced to a cost object (e.g., a product, project, or
department).
 Indirect costs—such as factory rent, insurance, and utilities—cannot be traced
directly to a cost object and are, therefore, allocated.
2.5 Fixed vs Variable vs Stepped Costs
 Fixed costs like rent, salaries, and insurance do not change with the production or
sales volume level.
 Variable costs—such as raw materials and sales commissions—change
proportionally to the production or sales volume level.
 Stepped costs are fixed within certain activity levels but adjust (increase or
decrease) when these levels are exceeded—e.g. when extra machinery or staff are
needed as production capacity grows.

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3. Cost-Volume-Profit (CVP) Analysis

3.1 What is CVP Analysis?

The primary purpose of CVP analysis is to understand how changes in cost and volume
affect a company's profit.

3.2 Contribution Margin and Break-Even Point

Contribution Margin:

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 (𝐶𝑀) = 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡𝑠(𝑉𝐶)

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 𝑅𝑎𝑡𝑖𝑜 =
𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒

Break-even Point: The point where total revenue equals total costs, resulting in neither
profit nor loss.

𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠

𝐵𝑟𝑒𝑎𝑘 − 𝑒𝑣𝑒𝑛 𝑃𝑜𝑖𝑛𝑡 (𝑢𝑛𝑖𝑡𝑠) =
𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡 − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡

𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠

𝐵𝑟𝑒𝑎𝑘 − 𝑒𝑣𝑒𝑛 𝑃𝑜𝑖𝑛𝑡 (𝑑𝑜𝑙𝑙𝑎𝑟𝑠) =
𝐶𝑜𝑛𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 𝑅𝑎𝑡𝑖𝑜

3.3 Margin of Safety

Margin of Safety: This is the amount by which sales can drop before reaching the break-
even point.

𝑀𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑆𝑎𝑓𝑒𝑡𝑦 (𝑢𝑛𝑖𝑡𝑠) = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑆𝑎𝑙𝑒𝑠 (𝑢𝑛𝑖𝑡𝑠) − 𝐵𝑟𝑒𝑎𝑘 − 𝑒𝑣𝑒𝑛 𝑆𝑎𝑙𝑒𝑠(𝑢𝑛𝑖𝑡𝑠)

𝑀𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑆𝑎𝑓𝑒𝑡𝑦 ($) = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑆𝑎𝑙𝑒𝑠 − 𝐵𝑟𝑒𝑎𝑘 − 𝑒𝑣𝑒𝑛 𝑆𝑎𝑙𝑒𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑆𝑎𝑙𝑒𝑠 − 𝐵𝑟𝑒𝑎𝑘 − 𝑒𝑣𝑒𝑛 𝑆𝑎𝑙𝑒𝑠

𝑀𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑆𝑎𝑓𝑒𝑡𝑦 (%) = 𝑥 100
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑆𝑎𝑙𝑒𝑠

3.4 Target Profit

𝑃𝑟𝑜𝑓𝑖𝑡 = 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 − 𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠

𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠 + 𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡

𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑈𝑛𝑖𝑡𝑠 𝑡𝑜 𝑏𝑒 𝑆𝑜𝑙𝑑 =
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡

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4. Cost Accounting Techniques

4.1 Cost Accounting Techniques Overview

Costing Systems are the methods used to allocate production costs to products or
services. The choice of system affects how costs are tracked and managed.

Traditional Costing allocates overhead based on a single cost driver, such as machine
hours. This method is simple but may not accurately reflect the actual resource
consumption of different products.

Job Costing assigns costs to custom products or services. Used when products are
distinct and easily identifiable throughout the production process. Costs are traced to each
individual job.

Batch Costing - a variant of job costing, where a batch of identical products is treated as a
single job.

Process Costing averages costs over all units produced, typically in continuous processes.

ABC Costing - assigns costs to products and services based on the resources they
consume. This approach first assigns costs to the activities that are the real cause of the
overhead and then assigns the cost of those activities only to the products that are actually
demanding the activities.

Target Costing is the process of determining the maximum cost that can be incurred on a
product, with the firm still earning the required profit margin from that product when it is
sold at the target selling price.

Absorption (Full) Costing Includes all overheads, both variable and fixed, in the cost of
products. This ensures comprehensive product costing but can result in higher per-unit
costs when production volume is low.

Marginal (Variable) Costing: Only includes variable overheads in product costs, treating
fixed overheads as period expenses. This method can provide clearer insights into the
impact of production volume on costs, but it may understate the total cost of producing
each unit.

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4.2 Materials Cost Accounting
Management accountants use several calculations to ensure optimal inventory levels,
including reorder levels, maximum and minimum inventory levels, and the cost of holding
buffer stock.

Reorder Level
This level is where new stock should be ordered to avoid stockouts. It accounts for the
worst-case scenario of maximum usage and longest lead time.
𝑅𝑒𝑜𝑟𝑑𝑒𝑟 𝑙𝑒𝑣𝑒𝑙 = 𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑢𝑠𝑎𝑔𝑒 𝑥 𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒
Maximum Inventory Level
This is the highest stock quantity that can be stored—accounting for the re-order level, re-
order quantity, and minimum usage over the shortest lead time.
𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑙𝑒𝑣𝑒𝑙
= 𝑅𝑒𝑜𝑟𝑑𝑒𝑟 𝑙𝑒𝑣𝑒𝑙 + 𝑅𝑒 − 𝑜𝑟𝑑𝑒𝑟 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
− 𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒 𝑥 𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝑑𝑒𝑚𝑎𝑛𝑑
Minimum Inventory Level (Buffer Stock)
Here, the lowest stock quantity is kept on hand to avoid stockouts, considering the average
usage and lead time.
𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑙𝑒𝑣𝑒𝑙 = 𝑅𝑒𝑜𝑟𝑑𝑒𝑟 𝑙𝑒𝑣𝑒𝑙 − 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑢𝑠𝑎𝑔𝑒 𝑥 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒
Buffer Stock Holding Costs
This includes the cost incurred for keeping the buffer stock on hand, calculated based on
the buffer stock quantity and the cost per unit per annum.
𝐶𝑜𝑠𝑡 𝑜𝑓 ℎ𝑜𝑙𝑑𝑖𝑛𝑔 𝑏𝑢𝑓𝑓𝑒𝑟 𝑠𝑡𝑜𝑐𝑘
= 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑏𝑢𝑓𝑓𝑒𝑟 𝑠𝑡𝑜𝑐𝑘 𝑥 𝐶𝑜𝑠𝑡 𝑜𝑓 ℎ𝑜𝑙𝑑𝑖𝑛𝑔 𝑜𝑛𝑒 𝑢𝑛𝑖𝑡 𝑜𝑓 𝑠𝑡𝑜𝑐𝑘

These metrics and calculations are essential for effective material cost accounting,
ensuring that stock levels are managed efficiently to balance cost and availability.

4.3 Labor Cost Accounting

Cost accounting for labor is critical to management and operational efficiency. Key issues
include identifying direct vs indirect costs, managing overtime premiums, and addressing
inventory costing and valuation complexities.

Labor cost encompasses all financial compensation, benefits, and taxes a business pays
for employee work and is categorized as follows.
 Direct Labor Costs: Costs directly associated with the production of goods/services
(e.g., wages for assembly line workers)
 Indirect Labor Costs: Costs not directly traceable to specific products/services
(e.g., salaries for supervisors and maintenance staff)

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Employee Payment Systems
Different systems are used to compensate employees based on the nature of work,
responsibilities, and business goals.
 Hourly Wage: Fixed rate for each hour worked, typical for varying work hours
 Salary: Steady payment irrespective of hours, favored in managerial or professional
roles
 Commission: Compensation tied to sales or deals, motivating sales achievements
 Piece-Rate: Pay per produced item, prevalent in manufacturing
 Bonus Systems: Extra earnings linked to performance metrics, goals, or firm
profitability
 Profit Sharing: Yearly share of company profits to employees, fostering alignment
with corporate success

Idle Time
Idle time occurs when employees cannot perform productive work due to such factors as
equipment failures or material shortages. The following aspects characterize this situation.
 Not linked to specific tasks or products
 Treated as an indirect cost and included in the overhead
 Detrimental to labor efficiency and inflates the cost of goods sold without adding
value
 Critical to manage for profitability and operational effectiveness

Measuring Employee Attrition

The Employee Turnover Rate measures how frequently employees depart from the
company within a given period, typically annually.

𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑒 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑟𝑎𝑡𝑒 = x 100

This ratio aids businesses in the following:

 Assessing employee retention effectiveness
 Pinpointing issues in workplace culture, compensation, or job satisfaction
 Crafting strategies to enhance retention
High turnover rates indicate potential organizational problems, while lower rates suggest
good retention.

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4.4 Overheads Cost Accounting
Traditional Costing
Traditional costing allocates overhead based on a single cost driver, such as machine
hours. This method is simple but may not accurately reflect the actual resource
consumption of different products.
Activity-based Costing (ABC)
ABC allocates overhead based on multiple activities that drive costs. This method is more
accurate as it considers various activities contributing to overhead costs.
Absorption (Full) Costing
Absorption costing incorporates all overheads (variable and fixed) into product costs,
ensuring thorough costing but potentially raising per-unit costs with low production
volumes.
Marginal (Variable) Costing
Variable costing includes variable overheads in product costs, treating fixed overheads as
period expenses. This method can provide more precise insights into the impact of
production volume on costs, but it may understate the total cost of producing each unit.

4.5 Marginal vs Absorption Costing

Marginal Costing
Only variable production costs are included in product costs.
 Direct materials are considered variable costs and are included in the cost of goods
sold when incurred.
 Direct labor, like materials, is a variable cost charged to the cost of goods sold when
the labor is used in production.
 Only variable overheads are charged to the cost of goods sold. Fixed overheads are
treated as period costs and expenses in the incurred period.
 Fixed overheads are treated as period costs and charged to the income statement
in the period incurred.
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡𝑖𝑛𝑔 𝑈𝑛𝑖𝑡 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝐶𝑜𝑠𝑡
= 𝐷𝑖𝑟𝑒𝑐𝑡 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 + 𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 + 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠

Absorption Costing
All production costs (variable and fixed) are included in product costs.
 Direct materials costs are part of the product cost and are absorbed into the cost of
goods sold as inventory is sold.
 Direct labor costs are part of the product cost and are included in the cost of goods
sold based on the number of units sold.
 Fixed and variable manufacturing overheads are absorbed into the cost of
producing each unit based on a predetermined overhead rate.

14
  Fixed overheads are allocated to units produced and, therefore, can remain in
inventory.
𝐴𝑏𝑠𝑜𝑟𝑝𝑡𝑖𝑜𝑛 𝐶𝑜𝑠𝑡𝑖𝑛𝑔 𝑈𝑛𝑖𝑡 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝐶𝑜𝑠𝑡
= 𝐷𝑖𝑟𝑒𝑐𝑡 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 + 𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 + 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
+ 𝐹𝑖𝑥𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝐴𝑙𝑙𝑜𝑐𝑎𝑡𝑒𝑑 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡

4.6 Calculating Profits under Marginal and Absorption Costing

Marginal Costing Profit Calculation:
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 = 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡𝑠*
*including variable production and variable non-production costs
𝑃𝑟𝑜𝑓𝑖𝑡 = 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 − 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠

Absorption Costing Profit Calculation:

𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 = 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 − 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑*
*including all production costs
𝑃𝑟𝑜𝑓𝑖𝑡 = 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 − 𝑁𝑜𝑛 − 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝐶𝑜𝑠𝑡𝑠

15
5. Budgeting Basics

5.1 Why Do Companies Need Budgets?

Financial plans (or budgets) are crucial for future forecasting and vital to management
control systems. They fulfill the following roles:
 Planning: Financial frameworks compel management to strategize for future
operations and objectives.
 Coordination and Communication: Fiscal tools relay management’s expectations
throughout the organization.
 Benchmarking: Financial guidelines establish a standard against which
performance can be compared and assessed.
 Performance Evaluation: Fiscal metrics are employed to evaluate the performance
of departments and individuals.
 Resource Allocation: Allocation plans aid in distributing resources efficiently where
they are most needed.
 Motivation: Financial outlines can inspire employees to achieve their goals.

5.2 The Importance and Benefits of Budgeting

Budgeting is crucial for any organization as it serves as a comprehensive roadmap for
future planning, enabling companies to outline expected revenue, expenses, and resource
allocations.

It transforms strategic goals into specific, actionable objectives, ensuring alignment across
all departments. By setting ambitious yet realistic targets, budgeting motivates employees
and management to achieve their best performance while providing a reality check
against actual results.

16
Benefits of Budgeting
 Fosters planning and proactivity - counteracts short-termism and biased
perspectives.
 Target setting tool - Success is measured by the ability to meet budget targets.
 Performance management - Acts as a reality check for assessing performance.
 Cost control
 Revenue maximization - encourages efforts to surpass revenue expectations.
 Communication tool - ensure everyone understands their role in achieving the
organization's goals.

Ultimately, budgeting enhances communication, transparency, and accountability, driving

overall organizational success.

5.3 Budget Preparation Steps

1. Set Goals and Objectives: Define the financial and operational goals of the
company for the upcoming period;
2. Gather Information: Compile historical data and potential future changes in market
conditions;
3. Initial Preparation: Draft the initial budget using input from various departments;
4. Review and Revise: Discuss the draft with department heads and revise it for a
realistic and achievable budget;
5. Approve: The final budget is reviewed by senior management and approved;
6. Communicate: Once approved, the budget is distributed and used as a guide for
operations;
7. Monitor and Control: Regularly compare actual results with the budget and
investigate variances.

17
5.4. The Master Budget
The Master Budget is a comprehensive financial planning document that consolidates all
individual budgets related to sales, production, operations, and financial activities for a
specific fiscal year.

Operating Budgets
Sales Budget
This budget projects future sales revenue based on estimated sales volume and pricing.
This is the foundational budget as it drives other operating budgets.
Production Budget
This budget estimates the number of units needed to meet sales goals and desired
inventory levels.
 Direct Materials Budget estimates the cost of raw materials required for
production.
 Direct Labor Budget estimates the labor hours and associated costs needed for
production.
 The Manufacturing Overheads Budget includes all indirect production costs, such
as utilities, maintenance, and factory supplies.
Selling, General and Administrative Expenses (SG&A) Budget
It projects all non-production-related expenses, including salaries, rent, office supplies, and
marketing costs.
Cash Flow Budget
This budget is a detailed plan of the organization's cash inflows and outflows over a
specific period.
Capital Budget
The capital budget plans for significant investments in long-term assets to support the
organization's future operations and growth.

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5.5 Budgeting Techniques

Incremental Budgeting
Incremental budgeting is a method where the previous year's budget is used as a base,
and adjustments are made for the new budget period. These adjustments can be either
increases or decreases in amounts.

Advantages
 Simplicity: Easy to implement and understand
 Stability: Provides continuity and stability from one period to the next
 Time-Efficient: Requires less time and effort compared to other budgeting
methods
Limitations
 Inefficiency: May perpetuate inefficiencies as it assumes existing expenditures are
necessary
 Lack of Innovation: Does not encourage re-evaluation of existing expenses or
consideration of alternative approaches
 Budgetary Slack: Managers may pad budgets to ensure increases in future
periods.
Example: Imagine a department with a budget of $100,000 last year. If the management
decides to increase the budget by 5% to account for inflation and other factors, the new
budget would be $105,000.
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Zero-Based Budgeting (ZBB)
Zero-based budgeting starts from a ‘zero base,’ and every expense must be justified for
each new period. Budgets are built around what is needed for the upcoming period,
regardless of whether the budget is higher or lower than the previous one.
Principles
 Justification of Expenses: Every expense must be justified and approved.
 Decision Packages: Activities are identified in decision packages, which are
evaluated and ranked based on importance.
Advantages
 Efficiency: Encourages cost management and efficiency
 Focus on Value: Allocates resources efficiently based on actual needs and benefits
rather than past spending
 Eliminates Redundancy: Helps eliminate unnecessary expenditures
Challenges
 Resource-Intensive: Requires significant time and effort to implement
 Complexity: Can be complex to manage and execute, especially in large
organizations

Example: A marketing department needs to justify every expense—such as $50,000 for a

new campaign, $20,000 for market research, and $10,000—for promotional events, based
on expected outcomes and strategic importance.

Activity-Based Budgeting (ABB)

Activity-based budgeting focuses on the costs of activities necessary to produce and sell
products and services. It aligns budgeting with activities that drive costs rather than
focusing solely on departmental budgets.
Principles
 Cost Drivers: Identifies activities and their cost drivers
 Resource Allocation: Allocates resources based on the cost of activities and their
contribution to organizational goals
Advantages
 Accuracy: Provides a more accurate picture of where resources are needed
 Cost Management: Helps in identifying and managing the costs associated with
specific activities
 Strategic Alignment: Ensures budgets are aligned with strategic objectives
Challenges
 Complexity: Can be complex to identify and track all activities and their costs.
 Data-Intensive: Requires detailed data collection and analysis.
20
Example: A company allocates its budget based on activities—such as production
($500,000), quality control ($100,000), and distribution ($150,000)—rather than simply
allocating a lump sum to departments.

Flexible Budgeting
A flexible budget adjusts or flexes for changes in the volume of activity. It’s more
sophisticated than a static budget and provides a more accurate reflection of costs. Unlike
a static budget—which remains at one amount regardless of the activity level—a flexible
budget scales according to revenue or activity levels.

It’s most useful for businesses where costs are heavily influenced by changes in sales
volume or other activity measures.

Principles
 Variable and Fixed Costs: Separate costs into variable and fixed categories
 Adjustments: Adjust budgeted costs based on actual activity levels
Advantages
 Real-Time Adjustments: Allows for adjustments based on actual performance
 Performance Evaluation: Provides a more accurate basis for performance
evaluation
 Responsiveness: Enhances responsiveness to changes in business conditions
Challenges
 Complexity: More complex to prepare and manage than static budgets
 Data Requirements: Requires timely and accurate data on activity levels

Example: A manufacturing company prepares a flexible budget based on different levels

of production volume. If the production is 10,000 units, the budget adjusts variable costs
like raw materials and labor to reflect this level rather than sticking to the budget prepared
for an estimated 8,000 units.

21
5.6 Budgeting vs Forecasting

5.7 Budgeting Control and Variance Analysis

Budgetary control is the process of monitoring and controlling the budgets to ensure that
the organization's financial goals are met. It involves comparing actual performance with
budgeted figures and taking corrective actions when necessary.

Establishing budget centers, assigning responsibility, and setting up a system for

monitoring and reporting are key components of budgetary control.

Variance Analysis
Variance analysis is the process of comparing actual financial performance with budgeted
figures to identify differences, known as variances. This analysis helps understand why
variances occur and what actions can be taken to correct them.

Variances can be favorable or adverse. A favorable variance means actual income

exceeds budgeted projections or expenses fall below them. Conversely, an adverse
variance arises when income falls short of the budget or costs exceed it.

22
To perform variance analysis, take the following steps:
1. Calculate Variances: Determine the difference between actual and budgeted
figures for each income and expense category;
2. Analyze Causes: Explore the causes of the discrepancies, considering external
influences like market conditions and internal issues like inefficiencies or errors;
3. Take Corrective Action: Based on the analysis, take appropriate actions to address
unfavorable variances and reinforce favorable ones. This may include revising
budgets, improving processes, or reallocating resources;
4. Report Findings: Communicate the variance analysis results to relevant
stakeholders. This will ensure that everyone is aware of the financial performance
and any necessary actions.

Variance analysis is essential for several reasons.

 Performance Evaluation: It helps evaluate the financial performance of different
departments and the organization.
 Cost Control: Organizations can control costs and improve efficiency by identifying
and addressing unfavorable variances.
 Decision Making: Variance analysis provides valuable insights that aid in making
informed financial decisions.
 Accountability: It promotes accountability by assigning responsibility for
budgetary performance to managers and departments.
 Strategic Planning: Variance analysis helps assess whether the organization is on
track to meet its strategic goals and objectives.

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6. Standard Costing and Variance Analysis

6.1 Understanding Standard Costs

Standard costs are the expected labor, material, and overhead costs associated with a
product or service. They’re predetermined unit costs that companies use to compare the
actual costs incurred. They provide a basis for budgeting, cost control, and performance
evaluation.

Development
Standard costs are developed using historical data, industry benchmarks, and analysis of
current market conditions.

6.2 Standard Costing Benefits and Limitations

Benefits
 Provides a clear target for cost control and efficiency improvements
 Simplifies the budgeting process
 Enhances decision-making
 Facilitates performance evaluation
Limitations
 May lack the flexibility needed to adjust to evolving market conditions or business
processes
 Could promote undesirable actions like bulk buying to gain favorable price
variances, risking surplus inventory
 Might become obsolete without frequent reviews and updates
 Potentially unsuitable for businesses with unique operations or those implementing
lean manufacturing
 Focusing only on variances may neglect broader strategic objectives.

24
 6.3 Variance Analysis Overview
Variance analysis calculates and assesses the discrepancies between planned and actual
financial performance.
 Total Sales Variance measures the gap between expected and actual sales
revenue, broken down into price and volume variances.
 Total Cost Variance captures the divergence between projected and actual costs,
including variances in materials, labor, and overhead.
 Material Variance assesses the difference in expected versus actual material costs—
further split into price and usage variances.
 Labor Variance evaluates the gap between anticipated and actual labor costs,
divided into rate and efficiency variances.
 Variable Overheads Variance gauges the discrepancy between budgeted and
actual overhead costs, split into expenditure and efficiency variances.

6.4 Sales Variances

𝑇𝑜𝑡𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒
= 𝐴𝑐𝑡𝑢𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑥 𝐴𝑐𝑡𝑢𝑎𝑙 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒
− 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑆𝑎𝑙𝑒𝑠 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑥 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒
Sales Volume Variance is the difference between the actual quantity sold and the
standard quantity multiplied by the standard selling price.
𝑆𝑎𝑙𝑒𝑠 𝑉𝑜𝑙𝑢𝑚𝑒 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒
= (𝐴𝑐𝑡𝑢𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
− 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑆𝑎𝑙𝑒𝑠 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦) 𝑥 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒
Sales Price Variance is the difference between the actual and standard selling prices
multiplied by the actual sales quantity.
𝑆𝑎𝑙𝑒𝑠 𝑃𝑟𝑖𝑐𝑒 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒
= (𝐴𝑐𝑡𝑢𝑎𝑙 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒 − 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒)𝑥 𝐴𝑐𝑡𝑢𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦

25
6.5 Material Variances
𝑇𝑜𝑡𝑎𝑙 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒
= 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑥 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑃𝑟𝑖𝑐𝑒 − 𝐴𝑐𝑡𝑢𝑎𝑙 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑥 𝐴𝑐𝑡𝑢𝑎𝑙 𝑃𝑟𝑖𝑐𝑒

Material Price Variance is the difference between the standard and actual price paid for
materials multiplied by the quantity purchased.
𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑃𝑟𝑖𝑐𝑒 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = (𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑃𝑟𝑖𝑐𝑒 − 𝐴𝑐𝑡𝑢𝑎𝑙 𝑃𝑟𝑖𝑐𝑒) 𝑥 𝐴𝑐𝑡𝑢𝑎𝑙 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦

Material Usage Variance is the difference between the standard quantity expected for
production and the actual quantity used multiplied by the standard price.
𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑈𝑠𝑎𝑔𝑒 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = (𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 − 𝐴𝑐𝑡𝑢𝑎𝑙 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦) 𝑥 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑃𝑟𝑖𝑐𝑒

6.6 Labor Variances

𝑇𝑜𝑡𝑎𝑙 𝐿𝑎𝑏𝑜𝑟 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝐻𝑜𝑢𝑟𝑠 𝑥 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑅𝑎𝑡𝑒 − 𝐴𝑐𝑡𝑢𝑎𝑙 𝐻𝑜𝑢𝑟𝑠 𝑥 𝐴𝑐𝑡𝑢𝑎𝑙 𝑅𝑎𝑡𝑒

Labor Rate Variance is the difference between the standard hourly labor rate and the
actual rate multiplied by the hours worked.
𝐿𝑎𝑏𝑜𝑟 𝑅𝑎𝑡𝑒 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = (Standard Rate − Actual Rate) x Actual Hours

Labor Efficiency Variance is the difference between the standard hours expected for
production and the actual hours worked multiplied by the standard labor rate.
𝐿𝑎𝑏𝑜𝑟 𝐸𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = (Standard Hours − Actual Hours) 𝑥 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑅𝑎𝑡𝑒

6.7 Total Variable Overhead Variances

𝑇𝑜𝑡𝑎𝑙 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒
= 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝐻𝑜𝑢𝑟𝑠 𝑥 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑅𝑎𝑡𝑒 − 𝐴𝑐𝑡𝑢𝑎𝑙 𝐻𝑜𝑢𝑟𝑠 𝑥 𝐴𝑐𝑡𝑢𝑎𝑙 𝑅𝑎𝑡𝑒

Variable Overhead Variances include variable overhead efficiency variance and variable
overhead expenditure variance.
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒
= (𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑅𝑎𝑡𝑒
− 𝐴𝑐𝑡𝑢𝑎𝑙 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑅𝑎𝑡𝑒)𝑥 𝐴𝑐𝑡𝑢𝑎𝑙 𝐻𝑜𝑢𝑟𝑠

𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝐸𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒

= (𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝐻𝑜𝑢𝑟𝑠 − 𝐴𝑐𝑡𝑢𝑎𝑙 𝐻𝑜𝑢𝑟𝑠)𝑥 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑅𝑎𝑡𝑒

6.8 Reconciliation between Standard and Actual Profit

This process adjusts the budgeted profit to reflect actual conditions encountered during
the period by analyzing variances that explain differences between expected and actual
results.

26
7. Performance Measurement & Control

7.1 Performance Measurement – Overview

Performance measurement involves statistical evidence to determine progress toward
specific defined organizational objectives.

Purpose
It includes a wide range of activities to assess the efficiency and effectiveness of actions.
Components
The components include key performance indicators (KPIs), financial metrics, operational
metrics, and benchmarks.
Application
Performance measurement tools and techniques are used to:
 Evaluate employee performance
 Assess organizational efficiency
 Align strategies with business objectives
 Drives strategies for continuous improvement

7.2 Key Performance Indicators (KPIs)

KPIs are quantifiable measures that gauge a company's performance against its strategic
and operational goals.

Characteristics
 Relevant: Directly linked to organizational goals
 Actionable: Indicate areas needing action
 Measurable: Provide a quantitative basis for decision-making

Examples: Revenue growth, profit margin, customer satisfaction, and employee turnover
rates

27
28
7.3 Balanced Scorecard

The Balanced Scorecard is a strategic planning and management system used for
business and industry, government, and nonprofit organizations worldwide to align
business activities to the vision and strategy of the organization.
It converts vision and strategy into operational objectives that drive behavior and
performance in four major perspectives:

 Financial: Profitability, growth, shareholder values

 Customer: Customer satisfaction and retention
 Internal Business Processes: Efficiency, output, quality
 Learning and Growth: Employee development and innovation

7.4 Performance Control Systems

Internal Controls include systems and procedures implemented to ensure the integrity of
financial and accounting information, promote accountability, and prevent fraud.
Risk Management involves forecasting and evaluating financial risks and identifying
procedures to avoid or minimize their impact.
Monitoring includes regularly tracking performance against KPIs and objectives to ensure
that strategic goals are met.
Reporting concerns communicating performance measurement to stakeholders through
reports that may include financial statements, management's discussion and analysis, and
explanatory notes.

29
7.5 Benchmarking

Benchmarking is the process of comparing an organization's performance metrics to

industry bests or best practices from other industries.
Purpose: To identify areas of improvement, set performance goals, and enhance overall
efficiency and effectiveness.

Types of Benchmarking

1. Internal Benchmarking
 Comparing performance metrics within the same organization across different
departments or units.
 Useful for large organizations with diverse operations.

2. Competitive Benchmarking
 Comparing an organization’s performance with direct competitors.
 Focuses on industry-specific standards and practices.

3. Functional Benchmarking
 Comparing similar functions or processes across different industries.
 Identifies best practices that can be adapted to the organization.

4. Generic Benchmarking
 Comparing broad-based processes or functions regardless of industry.
 Focuses on innovative practices that can improve performance.

30
GLOSSARY

Activity-Based Budgeting (ABB): A budgeting method that focuses on the costs of

activities necessary to produce and sell products and services. It allocates resources based
on the cost of activities and their contribution to organizational goals.

Activity-Based Costing (ABC): A costing methodology that identifies activities in an

organization and assigns the cost of each activity to all products and services according to
the actual consumption.

Balanced Scorecard: A strategic planning and management system used to align

business activities to the vision and strategy of the organization.

Benchmarking: A process by which a company evaluates various aspects of their

operations in terms of best practices within their sector or industry.

Break-Even Point: The volume of production or sales at which total revenues equal total
costs.

Budget: А financial plan for a defined period; an estimate of income and expenditure for a
set time.

Buffer Stock: Inventory held in reserve to protect against unforeseen shortages or

demands. Calculated as the reorder level minus average usage multiplied by average lead
time.

Capital Budget: A detailed plan for the acquisition of long-term assets and investments to
support future operations and growth.

Contribution Margin: Sales revenue minus variable costs.

Contribution Margin Ratio: The ratio of the contribution margin to total sales revenue. It
indicates the percentage of each sales dollar that contributes to covering fixed costs and
generating profit.

Cost: The monetary value spent to produce goods or services.

Cost Drivers: The structural determinants of the cost of an activity, reflecting any linkages
or interrelationships that affect it.

Cost of Holding Buffer Stock: The expense incurred for maintaining buffer stock,
calculated as the amount of buffer stock multiplied by the cost per unit per annum.

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Cost-Benefit Analysis: A systematic approach to estimating the strengths and weaknesses
of alternatives used to determine options that provide the best approach to achieving
benefits while preserving savings.

Cost-Volume-Profit (CVP) Analysis: A method of cost accounting used in managerial

economics to determine the breakeven point of cost and volume of goods.

Direct Costs: Costs that can be directly attributed to the production of specific goods or
services.

Employee Turnover Rate: The rate at which employees leave a company within a given
period, typically calculated as the number of employees who left divided by the average
number of employees, multiplied by 100.

Financial Accounting: The field of accounting concerned with the summary, analysis, and
reporting of financial transactions related to a business.

Fixed Costs: Business costs, such as rent, that are constant whatever the quantity of goods
or services produced; they do not vary with the volume of production.

Flexible Budget: A budget that adjusts or flexes for changes in the volume of activity. It is
more accurate than a static budget and scales according to revenue or activity levels.

Idle Time: The time during which employees are paid but are not productive, often due to
equipment failure or material shortages. Treated as an indirect cost and included in
overhead.

Incremental Budgeting: A budgeting method where the previous year's budget is used
as a base and adjustments are made for the new budget period.

Indirect Costs: Costs that are not directly traceable to a cost object such as a particular
project, but are related to the business's overall operating expenses.

Internal Control: A process for assuring the achievement of an organization’s objectives in

operational effectiveness and efficiency, reliable financial reporting, and compliance with
laws, regulations, and policies.

Job Costing: The accounting method used to track the expenses of a specific job such as
materials, labor, and overheads.

Key Performance Indicators (KPIs): Quantifiable measures that gauge a company's

performance against its strategic and operational goals.

Management Accounting: The process of identifying, measuring, analyzing, interpreting,

and communicating information for the pursuit of an organization's goals.

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Margin of Safety: The amount by which sales can drop before reaching the break-even
point. Calculated as current sales minus break-even sales.

Master Budget: A comprehensive financial planning document that consolidates all

individual budgets related to sales, production, operations, and financial activities for a
specific fiscal year.

Opportunity Cost: The benefit that is missed or given up when choosing one alternative
over another.

Process Costing: A cost allocation method that traces and accumulates direct costs, and
allocates indirect costs of a manufacturing process.

Reorder Level: The stock level at which new orders should be placed to avoid stockouts.
Calculated as maximum usage multiplied by maximum lead time.

Return on Investment (ROI): A performance measure used to evaluate the efficiency or

profitability of an investment.

Standard Cost: The expected cost of labor, materials, and overhead for a product or
service, used for budgeting, cost control, and performance evaluation.

Standard Costing: A cost allocation method that estimates the expected costs of
production.

Stepped Costs: Remain fixed over a range of activity but change (step up or down) once
that range is exceeded, such as the cost of additional machinery or personnel when
production capacity is increased.

Variable Costs: Costs that vary directly with the production volume or level of activity.

Variance: The difference between a budgeted, planned, or standard cost and the actual
amount incurred/sold.

Variance Analysis: A quantitative investigation of the difference between actual and

planned behavior.

Zero-Based Budgeting (ZBB): A budgeting method that starts from a zero base, and
every expense must be justified for each new period.

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