Module 14. Budgeting Dr. Varadraj Bapat 1 Index Introduction - - PowerPoint PPT Presentation

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Budgeting

• Dr. Varadraj Bapat

Module 14.

Management Accounting Dr. Varadraj Bapat, IIT Mumbai

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Index

 Introduction  Objectives  Advantages  Components of Budgetary

Control System

 Types of Budget  Zero Base Budgeting

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Budget

Budget refers to an estimated

• statement. It is prepared by

companies as well as government. It is for the purpose

• f

attaining some goal.

Management Accounting Dr. Varadraj Bapat, IIT Mumbai

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Budget

Budget

can be defined 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.

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Budget

It may include income, expenditure and employment

• f capital. It is often used for

control purpose.

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It is a process in which budget is set and actual is compared with budget to analyse variances.

Budgetary Control

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It means the establishment of budgets relating the responsibilities of executives to the prerequisite of policy and the continuous evaluation of actual with budgeted results

Budgetary Control

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either to secure by individual action the objective of that policy or to provide a base for its revision.

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Objectives

• f Budget

Planning:

A set of targets/goals is often essential to lead and focus individual and group actions. Planning not only motivates the employees but also improves

• verall decision making.

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Directing:

Business is very complex and requires more formal direction and

• coordination. Once the budgets are

in place they can be used to direct and coordinate operations in order to achieve the stated targets.

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Controlling:

The actual performance can be

compared with the planned targets. This provides prompt feedback about performance. budget also prevents unplanned adhoc expenditure.

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Advantages

• f Budgetary

Control System

 Enables

the managers/ administrators to conduct activities in efficient manner.

 Provides yardstick for measuring

and evaluating the performance of individuals and their departments.

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 Reveals the deviations, from the

budget by comparing with actuals; Helps in prompt review process

 Creates suitable conditions for the

implementation of standard costing system

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 Acts

as systematic base for framing future policies and targets

 Inculcates

the feeling

• f

cost consciousness and goal orientation

 Leads to effective utilization of

various resources, as the activities are planned and executed effectively.

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Components of Budgetary Control System

The policy of a business for a defined period is represented by the master budget, the details of which are given in a number of individual budgets called functional budgets.

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These functional budgets are broadly grouped as physical, cost and profit budgets.

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 Physical Budgets- Those budgets

which contains information in terms of physical units about sales, production etc. for example, quantity

• f

sales, quantity

• f

production, inventories and manpower budgets are physical budgets.

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 Cost

budgets- Budgets which provides cost information in respect of manufacturing, selling, administration etc. for example, manufacturing cost, selling cost, administration cost and research and development cost budgets are cost budgets.

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Profit budgets- Budgets which

enables in the ascertainment

• f profit, for example, sales

budget, profit and loss budget, etc.

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Fixed Budget Vs. Flexible Budget Functional Vs. Master Budget Long-Term Vs. Short-Term Budget/ Current Budget ZBB

Types of Budget

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A fixed budget is the budget

designed to remain unchanged irrespective of level of activity actually attained. Such budget is suitable for Fixed Expenses. It is also known as Static budget.

Fixed Budget

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A fixed budget is not suitable in

dynamic environment and for a longer period because of its

• rigidity. It is not suitable where

labour cost, material cost and

• ther

factors are constantly changing.

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Flexible budget show the expected results of responsibility centre for several activity level. Flexible budget is the series of static budgets for different level

• f activity.

Flexible Budget

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While preparing flexible budget the revenues and expenses are classified into Fixed, Variable and Semi-variable categories.

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In most cases, the level of activity

during the period varies from period to period due to change in demand

• r

seasonal nature

• r

changing

• circumstances. In such industries/

government

• rganisations

flexible budget is suitable.

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Budgets

which relate to the individual function/task in an

• rganisation

are known as Functional Budgets. For example, purchase budget, sales budget, production budget, plant utilization budget, cash budget.

Functional Budget

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It is a consolidated summary of

the various functional budgets. It is based on goals set. It serves as the basis upon which budgeted P & L A/c and forecasted Balance Sheet are built up.

Master Budget

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The budget which are prepared for

periods longer than a year are called long-term budget. Such budgets are helpful in business forecasting and strategic planning. E.g. Capital expenditure budget, Research and Development budget.

Long-Term Budget

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Budgets which are prepared for

periods less than a year are known as short term budgets. E.g. Cash

• Budget. Such budgets are prepared

regular comparison and action to bring variation under control.

Short-Term Budget

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A budget which is established for use over a short period of time and is related to the current conditions is called current budget.

Current Budget

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It refers to budgeting from scratch.

Zero Base Budgeting (ZBB)

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ZBB is a method of budgeting

which requires each cost element to be specifically justified, as though the activities to which the budget relates were being undertaken for the first time.

ZBB

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To

receive funding during budgeting process, each activity must be justified in terms of continued usefulness.

Under ZBB, the budget for virtually

every activity is initially set to zero.

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Advantages

 Provides a systematic approach for

evaluation of different activities and ranks them in

• rder
• f

preference for allocation of scare resources.

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 Ensures that the every activity/

function undertaken is critical for the achievement of objectives.

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 Provides an opportunity to allocate

resources for various activities / functions

• nly

after having a thorough cost benefit analysis.

 Wasteful expenditure can be easily

identified and eliminated.

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• Ex. Material

purchase budget

 Calculate the raw material required

to be purchased: Budgeted sales: 5000 units stock of finished stock in hand is 500 units Material A and B units (per finished stock unit) : 12 and 10 respectively

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Opening stock of Raw material in

hand A: 5000 units B:3500 units Closing stock

• f

1000 units

• f

finished goods and RM A and B, is required to maintain.

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Solution

Budgeted Sales 5000 + Desired Closing Stock 1000 Total Requirement of finished stock 6000

• Opening Stock

(500) Units to be produced 5500

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Raw Material A B 5500 x 12 66000 5500 x 10 55000

• Opening Stock

(5000) (3500) + Closing Stock +1000 +1000 Raw Material Purchase Budget 62000 52500

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Standard Costing and Variance Analysis

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Module 15

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Standard Costing

 Definition  Steps in standard costing  Types of Standards  Variance  Types of variance  Variance Analysis  Advantages & disadvantages of

Standard costing

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Standard Costing

 Standard

cost is a pre- determined cost which is calculated from management’s standards of efficient operation and the relevant necessary

• expenditure. It may be used as a

basis for price fixing and for cost control through variance analysis.

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In simple words it is a budget for the production of one unit of product or service. It is chosen to serve as a benchmark in the budgetary control system.

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Steps in Standard Costing

Study the actual cost Cost variance Analysis Set standard Cost

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 Set the standard cost

 A predetermined or standard

cost per unit is set.

 Budgeted cost determined by

using standard cost.

• Study the actual cost

 Calculate actual cost incurred in

the production process

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 Cost variance

 Comparison of the actual cost

with the budgeted cost.

 The cost variance is used in

controlling cost.

 Fix responsibilities to control cost  Take suitable action and create

effective control system .

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Types of standards

• Ideal Standards:

These represents the level of performance attainable when prices for material and labour are most favorable, when the highest

• utput is achieved with the best

equipment and layout and when maximum efficiency in utilization

• f resources results in maximum
• utput with minimum cost.

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• Normal Standards: These are the

standards that may be achieved under normal

• perating
• conditions. The normal activity

has been defined as number of standard hours which will produce normal efficiency sufficient goods to meet the average sales demand over a term of years.

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• Basic or Bogey standards: These

standards are use only when they are likely to remain constant or unaltered over long period. According to this standard, a base year is chosen for comparison purposes in the same way as statistician use price indices. When basic standards are in use, variances are not calculated as the difference between standard and

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actual cost. Instead, the actual cost is expressed as a percentage of basic cost.

• Current

Standard: These standards reflect the management’s anticipation

• f

what actual cost will be for the current period. These are the costs which the business will incur if the anticipated prices are

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paid for goods and services and the usage corresponds to that believed to be necessary to produce the planned output.

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Variance

The difference between standard cost and actual cost of the actual

• utput is defined as Variance. A

variance may be favourable or

• unfavourable. If the actual cost

is less than the standard cost, the variance is favourable and if the actual cost is more than

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the standard cost, the variance will be unfavourable. It is not enough to know the figures of these variances infact it is required to trace their origin and causes of occurrence for taking necessary remedial steps to reduce / eliminate them.

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Controllable and uncontrollable Variance

The purpose of standard costing reports is to investigate the reasons for significant variances so as to identify the problems and take corrective action. Variances are broadly of two types, namely, controllable and uncontrollable.

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Controllable variances are those which can be controlled by the departmental heads whereas uncontrollable variances are those which are beyond their control. If uncontrollable variances are

• f

significant nature and are persistent, the standards may need revision.

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Variance Analysis

Variance analysis is the analysis

• f the cost variance into its

component parts with appropriate justification of such variances, so that we can approach for corrective measures. Variances of Efficiency:

 Variance due to the effective or

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ineffective use

• f

material quantities, labour hours, once actual quantities are compared with predetermined standards. Variances of Price Rates:

 Variances arising due to change

in unit material prices, standard labour hour rates and standard allowances for indirect costs.

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Variances of Due to volume:

 Variance

due to effect

• f

difference between actual activity and the level of activity assumed when the standard was set.

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Analysis of Variance Material Variance Labour Variance Overhead Variance Sales Variance

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Reasons of Material Variance

 Change in Basic price  Fail

to purchase anticipated standard quantities at appropriate price

 Use of sub-standard material  Ineffective use of materials  Pilferage

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Material Variance

 Material Cost Variance= (Standard

Quantity X Standard Price) – (Actual Quantity X Actual Price)

 Material Price Variance= Actual

Quantity (Standard Price - Actual Price)

 Material Usage Variance=Standard

Price (Standard Quantity - Actual Quantity)

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Reasons of Labour Variance

 Change in design and quality

standard

 Poor working conditions  Improper scheduling  Improper placement of labour  Increments / high labour wages  Overtime

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Labour Variance

 Labour Cost Variance=(Standard

Hrs X Standard Rate Per Hour) – (Actual Hrs X Actual Rate Per Hour)

 Labour Rate Variance=Actual Hrs

(Standard Rate - Actual Rate)

 Labour

efficiency Variance= Standard Rate (Standard Hrs - Actual Hrs worked)

 Idle Time Variance= Idle Hours X

Standard Rate

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Reasons of Overheads Variance

 Improper planning  Under or over absorption of fixed

• verheads

 Reduction of sales  Breakdowns  Power Failure

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Variable Overheads (OH) Variance

 Variable

OH Cost Variance= (Standard Hrs X Standard Variable OH Rate) – Actual OH Cost

 Variable OH Expenditure Variance=

(Actual Hrs X Standard Variable OH Rate) – Actual OH Cost

 Variable OH Efficiency Variance=

(Standard Hrs - Actual Hrs) X Standard Variable OH Rate

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Fixed Overheads (OH) Variance

 Fixed OH Cost Variance= Absorbed

OH – Actual Fixed OH Cost

 Fixed OH Expenditure Variance=

(Budgeted Hrs X Standard Fixed OH Rate) – Actual Fixed OH Cost

 Fixed

OH Volume Variance= (Standard Qty - Actual Qty) X Standard Fixed OH Rate

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Reasons of Sales Variance

 Change in price  Change in Market size  Change in Market share

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Sales Variance

 Sales Value Variance =

Budgeted Sales – Actual Sales

 Sales Price Variance =

Actual Quantity (Actual Price - Budgeted Price)

 Sales Volume Variance =

Budgeted Price (Actual Quantity - Budgeted Quantity)

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Advantages & Disadvantages of Standard costing

Advantages

 Basis

for sensible cost comparisons

 Employment of

management by exception Disadvantages

 Too

comprehensive to be useful

 Precise

estimation

• f

prices or rate to paid is not possible

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 Means

• f

performance evaluation for employees

 Result in more

stable product cost

 May

not be useful if frequent change in technology

 Focus on cost

minimization rather than quality

• r

service.