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 managements 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.
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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.
ii.
iii.
iv.

It should reflect the managerial plans and achieve business goals

and objectives.
It is expressed either in monetary terms or quantitative terms or
both.
It is a comprehensive plan for a definite future period.
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.

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CHAPTER: 2
BUDGETARY CONTROL
MEANING 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.
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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 firms activities is known as budgeting control. Budgetary
control has the following main objectives:
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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.

ii.

iii.

Performance Evaluation: It is the most effective tool to the

management for the performance evaluation of all the business
activities of the organization.
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.
Coordinating: Coordinating is a managerial function under which all
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factors of production and all department activities are balanced and
integrated to achieve the objectives of the organisation.
iv.

v.

vi.

vii.

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.
Communicating: It also acts as an effective communicative device of
the business on objectives among the different levels of employees
of an organization.
Motivating: It also acts as useful motivating device to perform
clearly the defined responsibilities of different executives of the
organization.
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.
ii.
iii.

Budget plans are based on estimates which may not be accurate in

all cases.
It plays a limited role in the process of controlling various business
activities.
Budgetary Control System introduced in an organization may be
resisted by some employees who are not as much efficient as
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iv.
v.
vi.

others.
Intodu8ction of budgetary Control System in an organization is an
expensive programmer.
Though it acts as an effective tool of the management, it is not a
substitute of the management.
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:
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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.
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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
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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.
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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
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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

A] Number of Units
B]Selling Price Per Unit

Capacity

Capacity

Capacity

Utilization

Utilization

Utilization

50%

60%

80%

10,000
200

12,000
196

16,000
190

Rs.100

Rs.102

Rs.105

Rs.30

Rs.30

Rs.30

Rs.18

Rs.18

Rs.18

Rs.10

Rs.10

Rs.10

C] Variable Cost Per

Unit
Direct Material
Direct Labor
Factory
Overheads[60%]

Administrative
Overheads[50%]

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D]Total Variable Cost Rs.158

Rs.160

Rs.163

Per Unit
E] Total Variable Cost [A Rs.15,80,000

Rs.19,20,000

Rs.26,08,000

Rs.2,20,000

Rs.2,20,000

Rs.2,20,000

[Rs.12 + Rs.10 =
Rs.22 per unit at
existing level
10,000 units.]
G] Total Cost[E + F]

Rs.18,00,000

Rs.21,40,000

Rs.28,28,000

H] Sales Revenue

Rs.20,00,000

Rs.23,52,000

Rs.30,40,000

Rs.2,00,000

Rs.2,12,000

Rs.2,12,000

X D]
F] Fixed Costs

[A X V]
I] Profits/ Losses
[H G ]

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
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determines the success of budgeting exercises. The following points
should be taken into account while preparing Sales Budgets.
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
ix.
x.

Sales figures
Assessment of sales
Availability of key factor
Seasonal fluctuation
Availability of financers
General trade prospects
Order book position
Market intelligence
External environment
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.

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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
Forecasted unit sales
x Price per unit
Total gross sales
Sales
discounts
allowances
= Total net sales

Quarter 1
5,500
$10
$55,000
& $1,100
$53,900

Quarter 2
6,000
$10
$60,000
$1,200

Quarter 3
7,000
$11
$77,000
$1,540

Quarter 4
8,000
$11
$88,000
$1,760

$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
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X

400 units @ Rs.9

600 units @

300 units @ Rs.21

500 units @

Rs. 9
Rs.21
Actual sales for the current year were:
Product

East

West

500 units @ Rs.9

700 units @

200 units @ Rs.21

400 units @

Rs. 9
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

+10%

+5%

+20%

+10%

With the help of an intensive advertisement campaign, the following

additional sales above the estimated sales of divisional manager are
possible;

Product
X (units)
Y (units)

East

West

60

70

40

50
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Your are required to prepare a budget for sales incorporating the
above estimates and show the budgeted and actual sales of the
current year.
Y
600 20
500 21
400 21
120
105
840
00
00
0
Total

130
0

190
00

110
0

159
00

110
0

147
00

Total X

120 10
0
20
100
0

120
00

100 9
0
21
800

900
0

120 9
0
21
600

108
00

220
0

320
00

180
0

258
00

180
0

234
00

Total

200
00

168
00

126
00

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
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March
April
May

12,200
10,400
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 months
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
I] Sales

Januar
y
10,800

Februar
y
15,600

March
12,200

II] Estimated Closing Stock

3,900

3,050

2,600

III] Gross
Requirements[I+II]
IV] Opening Stock

14,700

18,650

14,800

2,700

3,900

3,050

V] Net Requirements[IIIIV]

12,000

14,750

11,750

Materials Requirement Budget [Quantitative]

Material a- January March 2011
Particulars

January

February

March

Production [As per Production Budgetunits]

12,000

14,750

11,750

Requirement for Production: 4 kg per

unit

48,000

59,000

47,000

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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
Particulars

January
12,000

Februar
y
14,750

Production [As per Production

Budget-units]

March
11,750

Requirement for Production: 5 kg

per unit
Add: Desired Closing Stock

60,000

73,750

58,750

36,875

29,375

25,625

Gross requirements

96,875

84,375

Less: Opening Stock

30,000

1,03,12
5
36,875

Net Requirements

66,875

66,250

55,000

29,375

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.
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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:

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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

Budgeted sales
(see sales budget)
Add desired ending
inventory of
finished goods*

Total needs
Less Beginning
inventory of
finished goods**

Required
production

1
10,000

2
30,000

3
40,000

4
20,000

Year
100,000

6,000

8,000

4,000

3,000

3,000

----------16,000
2,000

----------38,000
6,000

----------44,000
8,000

-----------

-----------

23,000
4,000

103,000
2,000

----------14,000

----------32,000

----------36,000

----------19,000

----------101,000

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

=
=
=

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

*Twenty percent of the next quarters 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
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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
1,400

I] Sales Forecast
II] Estimated Closing Stock
III] Gross Requirement [I + II]
IV] Opening Stock

140
1,540
100

V] Net Production Requirement [III IV] Good

Production
VI] Wastage [ 10% of total production assumed]
VII] Total Production Requirement[ V + VI]

1,440
160
1,600

Direct Labor Budget

Particulars
Total Standard Hours Required: 1,600 units X 3

No. of hours
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
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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.
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The cash excess or deficiency section is computed as follows:
Cash balance beginning

XXXX

Add receipts

XXXX

Total cash available

--------

Less disbursements

XXXX
XXXX

Excess (deficiency) of cash available over disbursements

--------

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:

Hampton Freeze, Inc.
Cash budget for the
year
Other
budge
t ref.

Cash balance,
beginning

Year

$42,500

$40,000

$40,000

40,500

42,500

230,00
0

480,000

740,000

520,000

1,970,0
00

272,50
0

520,00
0

780,00
0

560,50
0

2,012,5
00

Add receipts:

Collections
from
customers
Total cash
available
Less

See
sales
budget

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disbursement
s:
Direct
materials
Direct labor
Manufacturin
g overhead
Selling and
Administrativ
e
Equipment
purchases
Dividends

materia
l budget
Labor
budget
Overhe
ad
budget
sell.&
adm.
budget

72,300

84,000

192,00
0
96,800

68,000

100,05
0
216,00
0
103,20
0

79,350
114,00
0
76,000

301,20
0
606,00
0
344,00
0

93,000

130,90
0

184,75
0

129,15
0

537,80
0

50,000

40,000

20,000

20,000

8,000
----------352,50
0

8,000
----------540,00
0

8,000
----------632,00
0

8,000
----------426,50
0

130,00
0
32,000
----------1,951,0
00

----------(80,00
0)

----------(20,000
)

----------148,00
0

----------134,00
0

----------61,500

120,000

60,000

180,00
0

(100,00 (80,000
)
)
(7,500) (65,00)

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

----------(60,000
)
----------$40,00
0
====

----------(107,50
)
----------$40,50
0
====

Total
disbursement
s

Excess/deficie
ncy of cash
available over
disbursement
s
Financing:
Borrowings
(at
beginning)*
Payments (at
beginning)
Interest**

49,500

Total
financing

1200,00
0
------------

Cash balance,
ending

$40,000
=====

----------(86,500
)
----------$47,50
0
====

(180,00
)
(14,000
)
----------(14,000
)
----------$47,50
0
====
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=

==

==

==

==

*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
$60,000 10% per year 3/4 year
Total interest paid

$2,000
4,500
--------$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
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beginning of the quarters and all repayments are made and only on
the amount of principal that is repaid.
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
Plus deficiency of cash available over disbursements

$40,000
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
Plus deficiency of cash available over disbursements

$40,000
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 repaid? The total amount of the
principle and interest that can be repaid is determined as follows:
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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
Less desired ending cash balance

$148,000
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.

ZERO BASES BUDGETING (ZBB)

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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. Zerobased 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 years 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
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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.

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VIVEK COLLEGE OF COMMERCE

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
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VIVEK COLLEGE OF COMMERCE

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,
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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.

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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
www.amcy5.com/projects/marketing/index.htm
www.investopedia.com/terms/z/zbb.asp#ixzz28gK5rrBi\
www.mu.ac.in/myweb-rest

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