final projact of cost butget.docx

VIVEK COLLEGE OF COMMERCE

CHAPTER: 1

INTODUCTION

The future should be planned. The Business budget is a plan for future, which is

expressed, in monetary or physical terms. Budgets are nothing but the expressions,

largely in financial terms of management’s plan for operating and financing the

enterprise, during a specific period of time. The act of planning as to how the amount

should be spent is known as Budgeting. The act of continuously monitoring and

taking timely corrective actions is Budgetary Control. Therefore, Budgetary Control

has become an essential tool of management for controlling costs and maximizing

profits.

Cost Accountancy is the application of costing and costs Accounting Principles,

Methods and Techniques to the science, art and practice of cost control. The chief

tools for cost control are Budgetary control, Standard Costing and Cost Audit.

According to CIMA, London, Budget is defined as ‘a financial and/or quantitative

statement prepare and approved prior to a defined of time, of the policy to be pursued

during that period for the purpose of attaining a given objective. It may include

income, expenditure and the employme3nt of capital.’ In other words, Budget refers

to a plan covering all the sectors of operations expressed in monetary and/or

quantitative terms for a definite future period of time. Budget exhibits managerial

plans and policies, for the organization as a whole, or a part thereof, to achieve

business goals and objectives in quantitative terms for a definite future period.

ESSENTIALS OF A GOOD BUDGET :

1. It is prepared prior to a defined period of time.

2. It is prepared for the definite future period.

3. The policy to be followed to attain the given objectives must be laid before

the budget is prepared.

4. It is monetary and/or quantitative statements of the policy


CONCEPT OF BUDGETING

One of the primary objectives of cost accounting is to provide information to business

managements for planning and control. Budgeting acts as tool of both planning and

control. Budgeting is a formal process of financial planning using estimated financial

and accounting data.

MEANING OF BUDGETING

According to J.Batty, ’the entire process of preparing the Budgets is known as

Budgeting.’ Therefore, the term Budgeting refers to the act of preparing Budgets. It is

the managerial action of formulating Budgets.

The Institute of Cost and Management Accountants (UK) defines a budget as “a

financial and/or quantitative statement, prepared and approved prior to a defined

period of time, of the policy to be pursued during that period for the purpose of

attaining a given objective, it may include income, expenditure and the employment

of capital.”

FEATURES OF BUDGET

A budget must have the following features:

i. It should reflect the managerial plans and achieve business goals and

objectives.

ii. It is expressed either in monetary terms or quantitative terms or both.

iii. It is a comprehensive plan for a definite future period.

iv. Though it is basically an instrument of planning, it still provides the basis for

performance evaluation and control.

BUDGETING AND FORECASTING

Sometimes the terms” budgeting” and “forecasting” are used interchangeably. Both

terms have some similarities, for example, both relate to future events and involve


prediction of something. The basic difference between budgeting and forecasting lies

in degree of sophistication involved in the predictions used by them. According to the

National Association of Accountants (USA), “forecasting” is a process of predicting

or estimating a future happening.” Forecasting is an essential part of the budgeting

process. Forecasting come to an end after mere estimating. Budgeting is a process of

preparing budgets and further control aspects are involved in its procedure. Besides,

forecasting can be made by a firm for purposes other than budgeting, such as a

forecast of general business conditions. Such forecasts are sometimes not used in

budgeting.

Thus, budgeting is not merely forecasting of a particular event. It is not simply an

estimation or prediction; it is a plan. In simple terms, budgeting is an attempt, at the

beginning of the year (or at any to other or period), to plan the profit and loss account

for the year and to aim for a definite balance sheet at its end, instead of relying upon

chance.


CHAPTER: 2

BUDGETARY CONTROLMEANING OF BUDGETORY CONTROL:

It is the process of establishing of departmental budgets relating the responsibilities of

executives to the requirements of a policy, and the continuous comparison of actual

with budgeted results, either to secure by individual action the objectives of that

policy, or to provide a firm basis for its revision. First of all budgets are prepared and

then actual results are the comparison of budgeted and actual figures will enable the

management to find out discrepancies and take remedial measures at a proper time.

The budgetary control is a continuous process, which helps in planning and co-

ordination. It provides a method of control too. A budget is a means and budgetary

control is the end result.

In the words of J.A.Scolt "Budgetary control is the system of management control

and accounting in which all operations are forecast and so as possible planned ahead

and active results compared with the forecast and the planned ones.

BUDGETARY CONTROL is actually a means of control in which the actual results

are compared with the budgeted results so that appropriate action may be taken with

regard to any deviations between the two. Budgetary control has the following stages.

A. Developing Budgets:

The first stage in budgetary control is developing various budgets. It will be necessary

to identify the budget centers in the organization and budgets will have to develop for

each one of them. Thus budgets are developed for functions like purchase, sale,

production, manpower planning as well as for cash, capital expenditure, machine

hours, labor hours and so on. Utmost care should be taken while developing the


budgets. The factors affecting the planning should be studied carefully and budgets

should be developed after a thorough study of the same.

B. Recording Actual Performance:

There should be a proper system of recording the actual performance achieved. This

will facilitate the comparison between the budget and the actual. An efficient

accounting and cost accounting system will help to record the actual performance

effectively.

C. Comparison of Budgeted and Actual Performance:

One of the most important aspects of budgetary control is the comparison between the

budgeted and the actual performance. The objective of such comparison is to find out

the deviation between the two and provide the base for taking corrective action.

D. Corrective Action:

Taking appropriate corrective action on the basis of the comparison between the

budgeted and actual results is the essence of budgeting. A budget is always prepared

for future and hence there may be a variation between the budgeted results and actual

results. There is a need for investigation of the same and take appropriate action so

that the deviations will not repeat in the future. Responsibilities can be fixed on

proper persons so that they can be held responsible for any such deviations.

CONCEPT OF BUDGETARY CONTROL

Cary control is a means of control in which the actual state of affairs is compared with

the budget so that appropriate action may be taken with regard to any deviations

before it is too late. Briefly, the use of a budget to control a firm’s activities is known

as budgeting control. Budgetary control has the following main objectives:

1. To provide an organized procedure for planning. It provides a detailed plan of

action for a business over a definite period of time.


2. To coordinate all the activities of various departments of a business firm in such a

manner that the maximum profit will be achieved for the minimum use of resources

3. To provide a means of determining the responsibility for all deviations from the

plan (budget), and to supply information on the basis of which necessary corrective

may be taken. Thus, budgetary control has the objective of controlling cost.

ESSENTIAL OF BUDGETARY CONTROL:

1. Budgeting, or the process of preparing the budget, is the starting point for

budgetary control.

2. Distribution of budgets pertaining to each function to all the relevant sections

within the organization.

3. Collection of actual data pertaining to all budgeted activities.

4. Continuous comparison of actual performance with budgeted performance.

5. Analysis of variances in actual performance and budgeted performance.

6. Initiation of corrective action to ensure that actual performance is in line with

budgeted performance.

7. Revision of budgeted if it is felt that the budgets prepared are no longer

relevant on account of unforeseen developments.

OBJECTIVES OF BUDGETARY CONTROL

The primary objective of budgetary control's to help the management in systematic

planning and in controlling the operations of the enterprise. The primary objective can

be met only if there is proper communication and coordination amongst different

within the organization. Thus the objectives can be stated as:

Following are the main objectives of a budgetary control system:

i. Performance Evaluation: It is the most effective tool to the management for

the performance evaluation of all the business activities of the organization.


ii. Planning: It is a very effective tool of planning for all business activities

require some planning to ensure efficient and maximum use of scarce

resources. The budget is a formal planning framework that provides specific

deadlines to achieve departmental objectives and contributes towards the

overall objectives of an organisation.

iii. Coordinating: Coordinating is a managerial function under which all factors of

production and all department activities are balanced and integrated to achieve

the objectives of the organisation.

iv. Responsibilities: One of the important objectives of Budgetary Control is to

define the responsibility of the concerned executive who is engaged in

different business activities.

v. Communicating: It also acts as an effective communicative device of the

business on objectives among the different levels of employees of an

organization.

vi. Motivating: It also acts as useful motivating device to perform clearly the

defined responsibilities of different executives of the organization.

vii. Cost Control: It is used as a very powerful tool for controlling the costs of an

organization.

ADVANTAGES OF BUDGETARY CONTROL

Several advantages that accrue to Budgetary Control are as follows:

a) It acts as a very useful and effective tool for controlling cost.

b) It provides yardsticks for evaluation of actual performance.

c) It clearly defines the areas of responsibility of all concerned executives who

are engaged in various business activities, resulting in effective delegation of

authority.

d) It points out the efficiency of various business activities.

e) It increases the operational efficiency of all business activities.


f) It helps the management in the process of its planning in respect of various

business activities.

g) It coordinates various activities of different sections, divisions or departments

of the organization.

h) It facilitates the effective utilizations of all resources of the organization.

i) It motivates to attain goals.

j) It helps in obtaining loans from banks and financial institutions.

k) It creates an environment for standard costing.

LIMITATIONS OF BUDGETARY CONTROL

In spite of having many advantages of Budgetary Control, it suffers from the

following limitations:

i. Budget plans are based on estimates which may not be accurate in all cases.

ii. It plays a limited role in the process of controlling various business activities.

iii. Budgetary Control System introduced in an organization may be resisted by

some employees who are not as much efficient as others.

iv. Intodu8ction of budgetary Control System in an organization is an expensive

programmer.

v. Though it acts as an effective tool of the management, it is not a substitute of

the management.

vi. It loses its usefulness if it is not revised with the changing circumstances.

ORGANIZATION FOR BUDGETING (THE BUDGET

COMMITEE)

PREPARATION OF BUDGET:

A budgetary control is extremely useful for planning and controlling as described

above. However, for getting these benefits, sufficient preparation should be made. For

complete success, a solid foundation should be laid down and in view of this the

following aspects are of crucial importance.


I. BUDGET COMMITTEE:

For successful implementation of budgetary control system, there is a need of a

budget committee. In small or medium size organizations, there may not be carried

out by the Chief Account himself. Due to the size of organization, there may not be

too many problems in implementation of the budgetary control system. However, in

large size organization, there is a need of a budget committee consisting of the chief

executive, budget officer and heads of main departments in the organization. The

functions of the budget committee are to get the budgets prepared and then scrutinize

the same, to lay down broad policies regarding the preparation of budgets, to approve

the budgets, suggest for revision, to monitor the implementation and to recommend

the action to be taken in a given situation.

II. BUDGET CENTERS:

Establishment of budget centers is another important pre-requisite of a sound

budgetary control system. A budget canter is a group of activities or a section of the

Organization for which budget can be developed. For example, manpower planning

budget, research and development cost budget, production and production cost

budget, labor hour and so on. Budget centers should be defined clearly so that

Preparation becomes easy.

III. BUDGET PERIOD:

A budget is always prepared prior to a defined period of time. This means that the

period for which a budget is prepared is decided in advance. Thus a budget may be

prepared for three years, one year, six months, one month or even for a week. The

point is that the period for the functional budgets like sales, purchase, production etc.

are prepared for one year and then broken down on monthly basis. Budgets like

capital expenditure are generally prepared for a period from 1 year to 3 years. Thus

depending upon the type of budget, the period of the same is decided and it is

important that it is decided well in advance.


IV. PREPARATION OF AN ORGANIZATION CHART:

There should be an organization chart that shows clearly defined authorities and

responsibilities of various executives. The organization chart will define clearly the

functions to be performed by each executive relating to the budget preparation and his

Relationship with other executives. The organization chart may have to be ensuring

that each budget center is controlled by an appropriate member of the staff.

V. PRINCIPAL BUDGET FACTOR:

A principal budget factor is that factor the extent of whose influence must first be

assessed in order to prepare the functional budgets. Normally sales are the key factor

or principal budget factor but other factors like production, purchase, and skilled labor

may also be the key factors. The key factor puts restrictions on the other functions and

hence it must be considered carefully in advance. So continuous assessment of the

business situation becomes necessary. In all conditions the key factor is the starting

point in the process of preparation of budgets.

A typical list of some of the key factor is given below:

Sales: Consumer demand, shortage of sales staff, inadequate advertising

Material: Availability of supply, restrictions on import

Labor: Shortage of labor

Plant: Availability of capacity, bottlenecks in key processes

Management: Lack of capital, pricing policy, shortage of efficient executive, lack of

faulty design of the product etc.

VI. ACCOUNTING RECORDS:

It is essential that the accounting system should be able to record and analyze the

transaction involved. A chart of accounts or accounts code should be maintained

which may correspond with the budget centers for establishment of budgets and

finally, control through budgets. Responsibility for Budget direction and execution is


usually placed in the hands of a Budget Committee which reports directly to top

management. In large companies the budget committee is composed of executives in

charge of major functions of the business and includes the sales manager, HRD

manager, finance manager the production manager, the chief engineer, the treasurer

and the chief accounts officer.

VII. BUDGET MANUAL

ICMA English defines a Budget Manual as “a document, schedule or booklet which

sets out, inter alia, the responsibilities of the persons engaged in the routine of and the

forms and records required for budgetary control. Thus, it is a written document

which guides the executives in preparing various .it should be clear and there should

be no ambiguity in it. The Manual is subdivided into different sections for the purpose

of easy handling. They are;

Income Statement Budget

Statement of Retained Earning Budget

Budgeted Balance sheet or position Statement Budget

VIII. THE BUDGET PERIOD

The budget period is an important factor in developing a comprehensive budgeting

programme. The length of the budget period depends on the type of business, the

length of the manufacturing cycle from raw material to finished product, the ease of

difficulty of forecasting future market conditions and other factors. However, a

business enterprise generally prepares a SHORT-RANGE BUDGET, and LONG-

RANG BUDGET.

SHORT-RANGE BUDGET


They are for a short period. They are useful in case of consumer goods industries.

These Budgets are used by the lower level management. E.g., Material Budget Cash

Budget

LONG-RANG BUDGET

They are prepared for a long period. These are generally prepared by a financial

controller exclusively for the top-level management. These are useful for organization

having a long gestation period, generally expressed as a percentage or in physical

terms, e.g. Capital Expenditure Budget, R&D Budget, etc

CHAPTER: 3

TYPES OF BUDGETS

There are various types of budgets which are explained below:

FIXED AND FLEXIBLE BUDGETS:

The fixed and flexible budgets are discussed in detail in the following paragraphs.

i. Fixed Budget: When a budget is prepared by assuming a fixed percentage of

capacity utilization, it is called as a fixed budget. For example, a firm may

decide to operate at 90% of its total capacity and prepare a budget showing the

projected profit or loss at that capacity. This budget is defined by The Institute

of Cost and Management Accountants of [U.K.] as ‘the budget which is

designed to remain unchanged irrespective of the level of activity actually

attained. It is based on a single level of activity’. For preparation of this

budget, sales forecast will have to be prepared along with the cost estimate.

Cost estimate can be prepared by segregating the costs according to their


behavior i.e. fixed and variable. Cost predictions should be made element wise

and the projected profit or loss can be worked out by reducing the cost from

the sales revenue. Actually in practice, fixed budgets are prepared very rarely.

The main reason is that the actual output differs from the budgeted output

significantly. Thus if the budget is prepared on the assumption of producing

50, 000 units and actually the number of units produced are 40, 000, the

comparison of actual results with the budgeted ones will be unfair and

misleading. The budget may reveal the difference between the budgeted costs

and actual costs but the reason for the deviations may not be pointed out. A

fixed budget maybe prepared when the budgeted output and actual output are

quite close and not much deviation exist between the two. In such cases,

maximum control can be exercised between the budgeted performance and

actual performance.

ii. Flexible Budgets: a Flexible budget is a budget that is prepared for different

levels of capacity utilization. It can be called as a series of fixed budgets

prepared for different levels of activity. For example, a budget can be prepared

for capacity utilization levels of 50%, 60%, 70%, 80%, 90% and 100%. The

basic principle of flexible budget is that if budget is prepared for showing the

results at say, 15, 000 units and actual production is only 12, 000 units, the

comparison between the expenditures, budgeted and actual will not be fair as

the budget was prepared for 15, 000 units. Therefore it is developed for a

relevant range of production from 12, 000units to 15, 000 units. Thus even if

the actual production is 12,000 units, the results will be comparable with the

budgeted performance of 12, 000 units. Even if the production slips to8,000

units, the manager has a tool that can be used to determine budgeted cost at

8,000 units of output. The flexible budget thus, provides a reliable basis for

comparison because it is automatically geared to change in production

activity. Thus a flexible budget covers a range of activity, it is flexible i.e. easy

with variation in production levels and it facilitates performance measurement

and evaluation.


iii. While preparing flexible budget, it is necessary to study the behavior of cost

and divide them in fixed, variable and semi variable. After doing this, the costs

can be estimated for a given level of activity.

iv. It is also necessary to plan the range of activity. A firm may decide to develop

flexible budget for activity level starting to plan the range of activity level

from 50% to 100% with an interval of 10% in between. It is necessary to

estimate the costs and associate them with chosen level of activity.

v. Finally the profit or loss at different levels of activity will be computed by

comparing the costs with the revenues.

Illustration 1

A manufacturing company is currently working at 50% capacity and produces

10,000 units at a cost of Rs. 180 per unit as per the following details.

Materials: Rs.100

Labor: Rs.30

Factory Overheads: Rs.30 [40% fixed]

Administrative Overheads: Rs.20 [50% fixed]

The selling price per unit at present is Rs.200. At 60% working, material cost

per unit increases by 2% and selling price per unit falls by 2%. At 80%

working, material cost per unit increases by 5% and selling price per unit falls

by 5%.


Prepare a Flexible Budget to show the profits/ losses at 50%, 60% and 80%

capacity utilization.al Cost per Unit: Rs.180

Solution:

Flexible Budget

Particulars Capacity

Utilization

50%

Capacity

Utilization

60%

Capacity

Utilization

80%

A] Number of Units 10,000 12,000 16,000

B]Selling Price Per Unit 200 196 190

C] Variable Cost Per

Unit

• Direct Material

• Direct Labor

•Factory

Overheads[60%]

• Administrative

Overheads[50%]

Rs.100

Rs.30

Rs.18

Rs.10

Rs.102

Rs.30

Rs.18

Rs.10

Rs.105

Rs.30

Rs.18

Rs.10

D]Total Variable Cost

Per Unit

Rs.158 Rs.160 Rs.163

E] Total Variable Cost

[A X D]

Rs.15,80,000 Rs.19,20,000 Rs.26,08,000

F] Fixed Costs

[Rs.12 + Rs.10 = Rs.22

per unit at existing level

10,000 units.]

Rs.2,20,000 Rs.2,20,000 Rs.2,20,000

G] Total Cost[E + F] Rs.18,00,000 Rs.21,40,000 Rs.28,28,000

H] Sales Revenue

[A X V]

Rs.20,00,000 Rs.23,52,000 Rs.30,40,000


I] Profits/ Losses

[H – G ]

Rs.2,00,000 Rs.2,12,000 Rs.2,12,000

MASTER BUDGETS

All the budgets described above are called as ‘Functional Budgets’ that are prepared

for the planning of individual function of the organization. For example, Budgets are

prepared for Purchase, Sales, Production, Manpower Planning, and so on. A master

budget which is also called as ‘Compressive Budget’ is a consolidation of all the

functional budgets. It shows the projected Profit and Loss account and Balance sheet

of business organization. For preparation of this budget, all functional budgets are

combined together and the relevant figures are incorporated in preparation of the

projected Profit and Loss Account and Balance Sheet. Thus Master Budget is

prepared for the organization and not for individual functions.

SALES BUDGET

Sales Budget is an estimate of expected sales during a budget period. It lays down a

comprehensive plan and program for department. Sales Manager is responsible for

preparing Sales Budget. It expresses the figures in Quantity as well as in value. It is

generally prepared Territory Wise (Area wise). The degree of accuracy with which

sales are estimated determines the success of budgeting exercises. The following

points should be taken into account while preparing Sales Budgets.

i. Sales figures

ii. Assessment of sales

iii. Availability of key factor

iv. Seasonal fluctuation


v. Availability of financers

vi. General trade prospects

vii. Order book position

viii. Market intelligence

ix. External environment

x. Policy implication

The sales budget contains an itemization of a company's sales expectations for the

budget period, in both units and dollars. If a company has a large number of products,

it usually aggregates its expected sales into a smaller number of product categories;

otherwise, the sales budget becomes too unwieldy. The sales budget is usually

presented in either a monthly or quarterly format.

The information in the sales budget comes from a variety of sources. Most of the

detail for existing products comes from those personnel who deal with them on a day-

to-day basis. The marketing manager contributes sales promotion information, which

can alter the timing and amount of sales. The engineering and marketing managers

may also contribute information about the introduction date of new products, as well

as the retirement date of old products. The chief executive officer may revise these

figures for the sales of any subsidiaries or product lines that the company plans to

terminate or sell during the budget period.

The basic calculation in the sales budget is to itemize the number of unit sales

expected in one row, and then list the average expected unit price in the next row,

with the total revenues appearing in a third row. If any sales discounts or returns are

anticipated, these items are also listed in the sales budget.

It is extremely important to do the best possible job of forecasting, since the

information in the sales budget is used by most of the other budgets (such as the

production budget and the direct materials budget). Thus, if the sales budget is

inaccurate, then so too will be the other budgets that use it as source material.


The projected unit sales information in the sales budget feeds directly into the

production budget, from which the direct materials and direct labor budgets are

created. The sales budget is also used to give managers a general sense of the scale of

operations, for when they create the overhead budget and the sales and administrative

expenses budget. The total net sales dollars listed in the sales budget are carried

forward into the revenue line item in the master budget.

Example of the sales budget

ABC Company plans to produce an array of plastic pails during the upcoming budget

year, all of which fall into a single product category. Its sales forecast is outlined as

follows:

ABC Company Sales Budget for the Year Ended December 31, 2012

Quarter 1 Quarter 2 Quarter 3 Quarter 4

Forecasted unit sales 5,500 6,000 7,000 8,000

x Price per unit $10 $10 $11 $11

Total gross sales $55,000 $60,000 $77,000 $88,000

- Sales discounts &

allowances

$1,100 $1,200 $1,540 $1,760

= Total net sales $53,900 $58,800 $75,460 $86,240

ABC's sales manager expects that increased demand in the second half of the year

will allow it to increase its unit price from $10 to $11. Also, the sales manager expects

that the company's historical sales discounts and allowances percentage of two

percent of gross sales will continue through the budget period.

This example of the sales budget is simplistic, since it assumes that the company only

sells in one product category. In reality, this example might have been a detail page

that rolls up into the main sales budget, where it would occupy a single line item.

Illustration 2


XYZ & Co., manufactures two products X and Y and sells them through two

divisions east and west. For the purpose of submission of sales budget

committee, the following information has been made available

Budgeted Sales for the current year were:

Product East West

X 400 units @ Rs.9 600 units @ Rs. 9

Y 300 units @ Rs.21 500 units @ Rs.21

Actual sales for the current year were:

Product East West

X 500 units @ Rs.9 700 units @ Rs. 9

Y 200 units @ Rs.21 400 units @ Rs.21

Adequate market studies reveal that product X is popular bud under – priced. It

is observed that if price of X is increased by re. 1, it will find a ready market.

On the other hand, Y is overpriced to customers and market could absorb more

if sales price of Y be reduced by Re. 1. The management has agreed to give

effect to the above price changes.

From the information based on these price changes and reports from salesmen.

The following estimates have been prepared by divisional managers.

Percentage increase in sales over current budget is:

Product East West


X +10% +5%

Y +20% +10%

With the help of an intensive advertisement campaign, the following additional

sales above the estimated sales of divisional manager are possible;

Product East West

X (units) 60 70

Y (units) 40 50

Your are required to prepare a budget for sales incorporating the above

estimates and show the budgeted and actual sales of the current year.

Divisional

Product

Budget for future

period

Budget for current

period

Actual sales for

current period

Qty Price

Rs.

Value

Rs.

Qty Price

Rs.

Value

Rs.

Qty Price

Rs.

Value

Rs.

East X

Y

500

400

10

20

5000

8000

400

300

9

21

3600

6300

500

200

9

21

4500

4200

Total 900 13000 700 9900 700 8700

West X

Y

700

600

10

20

7000

12000

600

500

9

21

5400

10500

700

400

9

21

6300

8400

Total 130

0

19000 1100 15900 1100 14700

Total X 120 10 12000 1000 9 9000 1200 9 10800


Y0

100

0

20 20000 800 21 16800 600 21 12600

Total 220

0

32000 1800 25800 1800 23400

Illustration 3

1. Z Ltd., has prepared the following sales Budget for first five

months of 2011.

Month Sales Budget (units)

January 10,800

February 15,600

March 12,200

April 10,400

May 9,800

Inventory finished goods at the end of every month is to be equal to 25 % of sales

estimate for the next month. On 1st January2011, there were 2,700 units of product on

hand. There is no work-in progress at the end of any month.

Every unit product requires two types of materials in the following quantities;

Material A: 4 Kg.

Material B: 5 Kg.

Materials equal to one half of the requirements of the next month’s production are to

be in hand at the end of every month. This requirement was met on 1st January 2011.

Prepare the following budgets for the quarter ending on 31st march2011

a. Production Budget- Quantity Wise.


b. Materials Purchase Budget- Quantity wise

Solution:

Z Ltd.

Production Budget [In units] January – March 2011

Particulars January February March

I] Sales 10,800 15,600 12,200

II] Estimated Closing Stock 3,900 3,050 2,600

III] Gross Requirements[I+II] 14,700 18,650 14,800

IV] Opening Stock 2,700 3,900 3,050

V] Net Requirements[III-IV] 12,000 14,750 11,750

Materials Requirement Budget [Quantitative]

Material a- January –March 2011


Production [As per Production Budget-units] 12,000 14,750 11,750

Requirement for Production: 4 kg per unit 48,000 59,000 47,000

Add: Desired Closing Stock 29,500 23,500 20,500

Gross requirements 77,500 82,500 67,500

Less: Opening Stock 24,000 29,500 23,500

Net Requirements 53,500 53,000 44,000


Materials Requirement Budget [Quantitative]

Material B- January –March 2011


Production [As per Production Budget-

units]

12,000 14,750 11,750

Requirement for Production: 5 kg per unit 60,000 73,750 58,750

Add: Desired Closing Stock 36,875 29,375 25,625

Gross requirements 96,875 1,03,125 84,375

Less: Opening Stock 30,000 36,875 29,375

Net Requirements 66,875 66,250 55,000

Working Notes:

1) Production for April. Sales 10,400 [units] + Closing Stock 2,450

[units]

= 12,850 [units] – Opening Sock 2,600 [units] = 10,250 [units].

2) Material required for production in April:

A: 10,250 X 4 = 41,000 kg

B: 10,250 X 5 = 51,250 kg.

PRODUCTION BUDGET

This budget shows the production target to be achieved in the year or the future

period. The production budget is prepared in quantity as well as in monetary terms.

Before preparation of this budget it is necessary to study the principal budget or the

key factor. The principal budget factor can be sales demand or the production capacity

or availability of raw material. The policy of the management regarding the inventory


is also taken into consideration. The production budget is normally prepared for a

period of one year and broken down on monthly basis. Production targets are decided

by adding the budgeted closing inventory in the sales forecast and subtracting the

opening inventory from the total of the same. Production Cost Budget is prepared by

multiplying the production targets by the budgeted production cost per unit.

PRODUCTION BUDGET is used to propose how much you will manufacture (or

buy in from suppliers) so that you can compensate for the demand (identified on your

sales budget). If your maximum capacity for producing stock was 100 units for the

month (due to available resources), it may not be necessary to produce this maximum

(due to a lower demand) each month because it adds to expense and ties up finance. If

you expect a high demand during a certain month(s), it may be that your

manufacturing capacity cannot compensate. In which case, you may budget to

manufacture excess in the months where you do not manufacture the maximum so

that you can build up your supplies for the expected months with high demand.

Alternatively, it may be a call to buy/hire more machinery/staff in that particular

month to allow an increased capacity for production. See OPERATING BUDGET.

DEFINITION AND EXPLANATION OF PRODUCTION BUDGET:

The production budget is prepared after the sales budget. The production budget lists

the number of units that must be produced during each budget period to meet sales

needs and to provide for the desired ending inventory. Production needs can be

determined as follows.

Budgeted sales in units-------------------

Add desired ending inventory------------

Total need---------------------------------------

less beginning inventory--------------------

Required production--------------------------

XXXX

XXXX

--------

XXXX

XXXX

--------

XXXX


=====

Production requirements for a period are influenced by the desired level of ending

inventory. Inventories should be carefully planned. Excessive inventories tie up funds

and create storage problems. Insufficient inventories can lead to lost sales or crash

production efforts in the following period.

Example of a Production Budget:

Following is the production budget of Hampton Freeze Inc. (See explanation of

this production budget)

Hampton Freeze, Inc.

Production Budget For the Year Ended December 31, 2009

Quarter

1 2 3 4 Year

Budgeted sales (see

sales budget)

10,000 30,000 40,000 20,000 100,000

Add desired ending

inventory of finished

goods*

6,000 8,000 4,000 3,000 3,000

-----------

-

-----------

-

-----------

-

----------- -----------

Total needs 16,000 38,000 44,000 23,000 103,000

Less Beginning

inventory of finished

goods**

2,000 6,000 8,000 4,000 2,000

-----------

-

-----------

-

-----------

-

-----------

-

-----------

-

Required production 14,000 32,000 36,000 19,000 101,000

====== ====== ====== ====== ======


*Twenty percent of the next quarter’s sales. The ending inventory of 3,000 cases is

assumed

**The beginning inventory in each quarter is the same as the prior quarter's ending

inventory

Illustration 4

A Ltd. manufactures a single product P with a single grade of labor. The sales budget

and finished goods stock budget for the 1st Quarter ending on 30th June 2011 are as

follows:

Sales: 1400 units

Opening finished units: 100 units

Closing finished units: 140 units

The goods are imported only when the production work is complete and it is budgeted

that 10% of finished work will be scrapped.

The standard direct labor content of the product P is 3 hours. The budgeted

productivity ratio for direct is 80% only.

The company employs 36 direct operatives who are expected to average 144 working

hour each in the 1st quarter.

You are required to prepare,

I] Production Budget

II] Direct Labor Budget

III] Comment on the problem that your direct labor budget reveals and suggest

how this problem might be overcome.


Solution:

A Ltd.

Production Budget

April – June 2011

Particulars No. of units

I] Sales Forecast 1,400

II] Estimated Closing Stock 140

III] Gross Requirement [I + II] 1,540

IV] Opening Stock 100

V] Net Production Requirement [III – IV] Good Production 1,440

VI] Wastage [ 10% of total production –assumed] 160

VII] Total Production Requirement[ V + VI] 1,600

Direct Labor Budget

Particulars No. of hours

Total Standard Hours Required: 1,600 units X 3 4,800

Productivity Ratio: 80%

Actual Hours Required: 4,800/ .80 6,000

Budgeted Hours Available 36 men X 144 hours 5,184

Shortfall 816


Comments: From the Direct Labor Budget it can be seen that the direct labor hours

available are not sufficient and hence there is shortage of 816 Hours. Therefore it will

be necessary to work overtime, as well as improvement in the efficiency.

CASH BUDGET

Cash Budget: a cash budget is an estimate of cash receipts and cash payments

prepared for each month. In this budget all expected payments, revenue as well as

capital and all receipts, revenue and capital are taken into consideration. The main

purpose of cash budget is to predict the receipts and payments in cash so that the firm

will be able to find out the cash balance at the end of the budget period. This will help

the firm to know whether there will be surplus or deficit at the end of budget period. It

will help them to plan for either investing the surplus or raise necessary amount to

finance deficit. Cash budget is prepared in various ways, but the most popular form of

the same is by method of Receipt and Payment method.

DEFINITION OF 'CASH BUDGET'

An estimation of the cash inflows and outflows for a business or individual for

a specific period of time. Cash budgets are often used to assess whether the entity has

sufficient cash to fulfill regular operations and/or whether too much cash is being left

in unproductive capacities.

EXPLANATION:

Cash budget is a detailed plan showing how cash resources will be acquired and used

over some specific time period.

Cash budget is composed of four major sections.

1. The receipts section.

2. The disbursements section

3. The cash excess or deficiency section


4. The financing section

The cash receipts section consists of a listing of all of the cash inflows, except for

financing, expected during the budgeting period. Generally, the major source of

receipts will be from sales. The disbursement section consists of all cash payment that

are planned for the budgeted period. These payments will include raw materials

purchases, direct labor payments, manufacturing overhead costs, and so on as

contained in their respective budgets. In addition, other cash disbursements such as

equipment purchase, dividends, and other cash withdrawals by owners are listed.

The cash excess or deficiency section is computed as follows:

Cash balance beginning

Add receipts

Total cash available

Less disbursements

Excess (deficiency) of cash available over disbursements

XXXX

XXXX

--------

XXXX

XXXX

--------

XXXX

If there is a cash deficiency during any period, the company will need to borrow

funds. If there is cash excess during any budgeted period, funds borrowed in previous

periods can be repaid or the excess funds can be invested.

The financing section deals the borrowings and repayments projected to take place

during the budget period. It also includes interest payments that will be due on money

borrowed. Generally speaking, the cash budget should be broken down into time

periods that are as short as feasible. Considerable fluctuations in cash balances may be

hidden by looking at a longer time period. While a monthly cash budget is most

common, many firms budget cash on a weekly or even daily basis.

Example of Cash Budget:

http://www.accounting4management.com/direct_labor_definition.htm

http://www.accounting4management.com/raw_materials_definition.htm


Hampton Freeze, Inc.

Cash budget for the

year

Other

budget

ref.

1 2 3 4 Year

Cash balance,

beginning

$42,500 $40,000 $40,000 40,500 42,500

Add receipts:

Collections

from customers

See sales

budget

230,000 480,000 740,000 520,000 1,970,00

0

Total cash

available

272,500 520,000 780,000 560,500 2,012,50

0

Less

disbursements:

Direct materials material

budget

49,500 72,300 100,050 79,350 301,200

Direct labor Labor

budget

84,000 192,000 216,000 114,000 606,000

Manufacturing

overhead

Overhea

d budget

68,000 96,800 103,200 76,000 344,000

Selling and

Administrative

sell.&

adm.

budget

93,000 130,900 184,750 129,150 537,800

Equipment

purchases

50,000 40,000 20,000 20,000 130,000

Dividends 8,000 8,000 8,000 8,000 32,000

----------

--

----------

--

----------

--

----------

--

----------

--

Total

disbursements

352,500 540,000 632,000 426,500 1,951,00

0

---------- ---------- ---------- ---------- ----------

http://www.accounting4management.com/selling_and_admn_expenses_budget.htm



http://www.accounting4management.com/overhead_budget.htm


http://www.accounting4management.com/labor_budget.htm


http://www.accounting4management.com/material_budget.htm


http://www.accounting4management.com/sales_budget.htm



-- -- -- -- --

Excess/

deficiency of

cash available

over

disbursements

(80,000

)

(20,000) 148,000 134,000 61,500

Financing:

Borrowings (at

beginning)*

120,000 60,000 - - 180,000

Payments (at

beginning)

- - (100,00) (80,000) (180,00)

Interest** - - (7,500) (65,00) (14,000)

------------ ----------

--

----------

--

----------

--

----------

--

Total financing 1200,000 (60,000) (107,50) (86,500) (14,000)

------------ ----------

--

----------

--

----------

--

----------

--

Cash balance,

ending

$40,000 $40,000 $40,500 $47,500 $47,500

====== ====== ====== ====== ======

*The company requires a minimum cash balance of $40,000. Therefore, borrowing

must be sufficient to cover the cash deficiencies of $80,000 in quarter 1 and to

provide for the minimum cash balance of $40,000. All borrowings and repayments

of principal are in round $1,000 amount.

**The interest payment relate only to the the principle being repaid at the time it is

repaid. For example, the interest in quarter 3 relates only to the interest due on the

$100,000 principle being repaid from quarter 1 borrowing:


$100,000 × 10% per year × 3/4 year = $7,500

The interest paid in quarter 4 is computed as follows:

$20,000 × 10% per year × 1 year $2,000

$60,000 × 10% per year × 3/4 year 4,500

---------

Total interest paid $6,500

======

Explanation of cash budget for Hampton Freeze Inc.

Cash budget builds on the other budgets ( sales budget , material budget, Labor

budget, Overhead budget, sell. & adm. budget) and on some additional data that are

provided below:

The beginning cash balance is $42,500

Management plans to spend $130,000 during the year on equipment

purchases: $50,000 in the first quarter; $40,000 in the second quarter; $20,000

in the third quarter; $20,000 in the fourth quarter.

The board of directors has approved cash dividends of $8,000 per quarter.

Management would like to have a cash balance of at least $40,000 at the

beginning of each quarter for contingencies.

Assume Hampton Freeze will be able to get agreement from a bank for an

open line of credit. This would enable the company to borrow at an interest

rate of 10% per year. All borrowings and repayments would be in round

$1,000 amount. All borrowings would occur at the beginning of the quarters

and all repayments are made and only on the amount of principal that is

repaid.

http://www.accounting4management.com/management_definition.htm








The cash budget is prepared one quarter at a time, starting with the first quarter.

Management began the cash budget by entering the beginning balance of cash for the

first quarter of $42,500--a number that is given above. Receipts--in this case, just the

$230,000 in cash collection from customers--are added to the beginning balance to

arrive at the total cash available of $272,500. Since the total disbursements are

$352,500 and the total cash available is only $272,500, there is short fall of $80,000.

Since management would like to have a beginning cash balance of at lease $40,000

for the second quarter, the company would need to borrow $120,000.

Required borrowing at the end of the first quarter

Desired ending cash balance $40,000

Plus deficiency of cash available over disbursements 80,000

----------

Required borrowings $120,000

======

The second quarter of cash budget is handled similarly. Note that the ending cash

balance of the first quarter is brought forward as the beginning cash balance for the

second quarter. Also note that additional borrowing is required in the second quarter

because of the continued cash shortfall.

Required borrowing at the end of the 2nd quarter

Desired ending cash balance $40,000

Plus deficiency of cash available over disbursements 20,000

------------

Required borrowings $60,000

======

In third quarter, the cash flow situation improves dramatically and the excess of cash

available over disbursement is $148,000. This makes it possible for the company to

repay part of its loan from the bank, which now totals $180,000. How much can be

http://www.accounting4management.com/cash_budget_definition.htm


repaid? The total amount of the principle and interest that can be repaid is determined

as follows:

Total maximum feasible loan payments at the end the third quarter

Total maximum feasible loan payments at the end of the third quarter

Excess of cash available over disbursement $148,000

Less desired ending cash balance 40,000

-------------

Maximum feasible principle and interest payment $108,000

======

The next step--figuring out the exact amount of loan payment--is tricky since interest

must be paid on the principle amount that is repaid. In this example, the principle

amount that is repaid must be less than $108,000, so we know that we would be

paying of part of the loan that was taken out at the beginning of the first quarter. Since

the repayment would be made at the end of the third quarter, interest would have

accrued for three quarters. So the interest owed would be 3/4 of 10% or 7.5%. Either a

trial and error or an algebraic approach will lead to the conclusion that the maximum

principle repayment that can be made is $100,000. The interest payment would be

7.5% of this amount, or $7,500--making the total payment $107,500.

In the fourth quarter, all of the loan and accumulated interest are paid off. If all loans

are not repaid at the end of the year and budgeted financial statements are prepared,

then interest must be accrued on the unpaid loans. This interest will not appear on the

cash budget (since it has not yet been paid), but it will appear as interest expense on

the budgeted income statement and as a liability on the budgeted balance sheet.

As with the production budget and raw materials budget, the amounts under the year

column in the cash budget are not always the sum of the amounts for the four

quarters. In particular, the beginning cash balance for the year is the same as the

beginning cash balance for the first quarter and the ending cash balance for the year is

the same as the ending cash balance for the fourth quarter.

http://www.accounting4management.com/direct_materials_budget_definition.htm

http://www.accounting4management.com/production_budget_definition.htm


ZERO BASES BUDGETING (ZBB)

ZBB was first introduced by Peter A. Pyhrr, a staff control manager at Texas

Instruments Corporation, U.S.A. He developed this technique and implemented it

for the first time during the year 1969-70 in Texas in the private sector and

popularized its wider use. He wrote an article on ZBB in Harvard Business Review

and later wrote a book on the same. The ZBB concept was first applied in the State of

Georgia, U.S.A. when Mr. Jimmy Carter was the Governor of the State. Later after

becoming the President of U.S.A. Mr. Jimmy Carter introduced and implemented

the ZBB in the country in the year 1987. ZBB has a wide application in the

Government Departments but also in the private sector in a variety of business. In

India, the ZBB was applied in the State of Maharashtra in 80s and early 90s.

DEFINITION OF 'ZERO-BASED BUDGETING - ZBB'

A method of budgeting in which all expenses must be justified for each new

period. Zero-based budgeting starts from a “zero base” and every function within an

organization are analyzed for its needs and costs. Budgets are then built around what

is needed for the upcoming period, regardless of whether the budget is higher or lower

than the previous one.

ZBB allows top-level strategic goals to be implemented into the budgeting process

by tying them to specific functional areas of the organization, where costs can be first

grouped, then measured against previous results and current expectations.

Zero Base Budgeting is method of budgeting whereby all activities are revaluated

each time budget is formulated and every item of expenditure in the budget is fully

justified. Thus the Zero Base Budgeting involves from scratch or zero. Zero Base

Budgeting actually emerged in the late 1960s as an attempt to overcome the

limitations of incremental budgeting. This approach requires that all activities are

justified and prioritized before decisions are taken relating to the amount of resources

allocated to each activity. In incremental budgeting or traditional budgeting, previous

year’s figures are taken as base and based on the same the budgeted figures for the


next year are worked out. Thus the previous year is taken as the base for preparation

of the budget. However the main limitation of this system of budgeting is that as

activity is continued in the future only because it is being continues in the past. Hence

in Zero Base Budgeting, the beginning is made from scratch and each activity and

function is reviewed thoroughly before sanctioning the same and all expenditures are

analyzed and sanctioned only if they are justified. Besides adopting a ‘Zero Base’

approach, the Zero Base Budgeting also focuses on programs or activities instead of

functional departments based on line items, which is a feature of traditional

budgeting. It is an extension of program budgeting. In program budgeting, programs

are identified and goals are developed for the organization for the particular program.

By inserting decision packages in the system and ranking the packages, the analysis is

strengthened and priorities are determined.

APPLICATIONS OF ZERO BASE BUDGETING:

The following stages/ steps are involved in the application of Zero Base Budgeting.

1. Each separate activity of the organization is identified and is called as a decision

package. Decision package is actually nothing but a document that identifies and

describes an activity in such a manner that it can be evaluated by the management and

rank against other activities competing for limited resources and decide whether to

sanction the same or not.

2. It should be ensured that each decision package is justified in the sense it should be

ascertained whether the package is consisted with the goal of the organization or not.

3. If the package is consisted with the overall objectives of the organization, the cost

of minimum efforts required to sustain the decision should be determined.

4. Alternatives for each decision package are considered in order to select better and

cheaper options.


5. Based on the cost and benefit analysis a particular decision package should be

selected and resources are allocated to the selected package.

BENEFITS FROM ZBB CAN BE SUMMARIZED AS FOLLOWS.

i. ZBB facilitates review of various activities right from the scratch and a

detailed cost benefit study is conducted for each activity. Thus an activity

is continued only if the cost benefit study is favorable. This ensures that an

activity will not be continued merely because it was conducted in the

previous year.

ii. A detailed cost benefit analysis result in efficient allocation of resources

and consequently wastages and obsolescence is eliminated.

iii. A lot of brainstorming is required for evaluating cost and benefits arising

from an activity and these results into generation of new ideas and also a

sense o involvement of the staff.

iv. ZBB facilitates improvement in communication and coordination amongst

the staff.

v. Awareness amongst the managers about the input costs is created which

helps the organization to become cost conscious.

vi. An exhaustive documentation is necessary for the implementation of this

system and it automatically leads to record building

LIMITATIONS OF ZERO BASE BUDGETING.

i. It is very detailed procedure and naturally is time consuming and lot of paper

work is involved in the same.


ii. Cost involved in preparation and implementation of this system is very high.

iii. Morale of staff may be very low as they might feel threatened if a particular

activity is discontinued.

iv. Ranking of activities and decision-making may become subjective at times.

v. It may not advisable to apply this method when there are non financial

considerations, such as ethical and social responsibility because this dictate

rejecting a budget claim on low ranking project

FACTORY OVERHEADS BUDGET

A manufacturing overhead budget contains all the costs, other than raw materials and

labor that will be incurred by a manufacturing company or department during a fiscal

year. These ongoing costs are a valid part of manufacturing expenses you incur and

should be calculated as part of your manufacturing budget. Review the elements that

make up manufacturing overhead to make sure you are counting these in your

manufacturing overhead budget.

Factory Overhead Factory overhead, also called "manufacturing overhead" or "factory

burden," comprises the indirect expenses associated with the operations of a

manufacturing plant; these costs cannot be directly charged to a specific product or

project. All expenses that fall under factory overhead are divided into three different

sub categories: indirect material, indirect labor and other indirect costs.

INDIRECT MATERIAL + INDIRECT LABOR + OTHER INDIRECT COST =

FACTORY OVERHEADS


CHAPTER: 4

CONCLUSION

Budgets are the blue print which speaks about the probable future course of action.

The primary objective of budgetary control is to help the management in systematic

planning and controlling with proper communication network. a properly prepared

and implemented budget reaps many advantages to the organisation,

ultimately ,resulting in achieving the main target of profit maximization. But, it

should be cost effective, prepared in realistic manner and implemented properly.

However, a proper organization is essential for the successful preparation,

maintenance and administration of budgets.

There must be an organizational chart showing the hierarchy with the chief executive

at the apex, who appoints a Budget officer assisted by a Budget committee consisting

of all functional heads. They decide the Budget Period, Budget Center, and also

prepare a Budget Manual with the spells out the duties and responsibilities of various

executive in the organisation.


The purpose of budget setting starts with the Sale Budget. Production Budget follows,

which in turn, necessitates budget for Material, Direct labour and Overheads. These

and other budgets are assembled into a Master Budget to become a governing

document and virtually forecasted profit and loss account. Best

Budget are the ones which are prepared on standard costs. To be meaningful, budget

have to be flexible rather that static. A flexible budget is prepared for several levels of

activity, but, at minimum, it is for at least three levels viz., most optimistic, the most

pessimistic and the most likely levels.

Zero Based Budgeting is the latest technique of budgeting and it has an increased use

as a management tool. Zero Based Budgeting (ZBB) is budgeting with the base zero.

All existing program have to be justified in the same way as the new proposals.

The current activities will have to be compared with the alternative uses for available

resources. It is the opposite of “incremental budgeting process” where, line-by- line

approval is accorded to specific categories of expenditure. Every on going activity is

also scrutinized in the same manner like a new one proposed to be under taken.

Therefore, it provided the rational method and allows reallocation of resources form

low to high priority programs.


BIBLIOGRAPHY

BOOKS REFERRED:-

Management Accounting – Debarshi Bhattacharyya and Lata Sharma

Cost Accounting –Jawahar lal and Seema Srivastav

Advanced Management Accounting – Jawahar lal

WEBSITES VISITED:-

www.fao.org/docrep/W4343E/w4343e05.htm

www.businessdictionary.com/definition/budgetary-control.html

http://www.fao.org/docrep/W4343E/w4343e05.htm


www.amcy5.com/projects/marketing/index.htm

www.investopedia.com/terms/z/zbb.asp#ixzz28gK5rrBi\

www.mu.ac.in/myweb-rest

http://www.mu.ac.in/my

http://www.investopedia.com/terms/z/zbb.asp#ixzz28gK5rrBi%5C

http://www.amcy5.com/projects/marketing/index.htm

final projact of cost butget.docx

Documents

Transcript of final projact of cost butget.docx