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5. Loans from financial institutionsCapitalization:

It is the amount at which the companys business can be valuedWhen the book valueof the companys shares is greater than realvalue the company is over capitalized. On

the other hand if book value of the share is less than real value then the company is

undercapitalized.

Two concepts of capitalization:

1. Over capitalization2. Under capitalization1. Over capitalization:

Company raises more capital than resources

Indicators of over capitalization:

1. Capital raised is much higher than its earning capacity/power2. Low earnings3. Company pays low dividend4. Book value of shares is greater than real value5. Existence of ideal capacity

Causes /Reasons for Over capitalization:

1. Promotion during boom(more prices for fixed assets)2. Heavy expenses on advertisements and intangible assets.3.

Shortage of funds/borrowing at high rate of interest.

4. Defective financial planning (issued more shares than needed)5. Faulty depreciation policy6. Liberal dividend policy7. Payment of heavy taxes8. Over estimation of earnings9. Delay in execution of projects


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Consequences /effect of over capitalization:

1. Company cannot pay timely dividend due to low profits2. Decline in credit rating of the company3. Manipulation of accounts4. Compelled to borrow more funds at high rate interest5. Company may go into liquidation6. Shareholders lose confidence7.

Companies may charge higher price to customers

8. Company may find difficult to obtain bank loan.Under Capitalisation:

Profit earning rate is much higher as compared to rate of profit earned

by similar companies in similar company (book value of shares and real

value)

Causes of under capitalization

1. Under estimation of future earnings2. Company promoted during depression(assets at low price)3. Conservative dividend policy followed(high reserves)4. Company use its past savings5. Liberal depreciation policy6. Benefit of favorable business conditions7. Rise in the price level8. Use of retained profit for expansionEffects of under capitalization:

1. High profit encourages other companies to enter themarket(competition)

2. Workers demand higher wages3. Strict government control4. Rise in the equity share price


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5. Speculation in the market(may be created)6. Exploitation of consumersCHAPTER2 :SOURCES OF FINANCE

Definition of Finance:

BusinessFinance is a activity concerned with acquisition and

conservation of capital funds in meeting the financial needs and

overall objectives of business enterprise(B.O.Wheeler)

Need of BusinessFinance

1. Promotional finance(preliminary expenses)2. Long term finance(acquisitioned permanent/fixed asssets)3. Short-term finance(current day to day expenses)4. Development finance-expansion/modernization and rationalization

Of business.

Principles of BusinessFinance

1. Strategic principle (corporate objective)2. Optimization principle3. Risk return principle (balance between risk and return)4. Marginal principle (marginal revenue equal to marginal cost)

(marginal revenue is greater than marginal cost)

5. Suitability principle6. Flexibility principle7. Timing principle8. Ploughing back principle9. Principle of Diversification10.Review principleSources of finance:

1. Internal- savingsreserves plus in back of profits

2. External sourcesbanks

financial institutions


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capital market

issued shares and debentures

Objectives of finance:

1. Obtaining funds at reasonable cost2. Profit maximization3. Risk management (unforseen risk)4. Financial control (inflow and outflow of funds)5. Capital budgeting(long financial decisions)6. Working capital management(short term survival is essential

Recruitment for long term success)

7. Disposing of profit(fair dividend policy)8. Wealth maximization (valued assets/shares)

Term lending institutions:

Banks

1. IFCI (Industrial Financial Corporation 1-7-1948)To provide medium long term loan to industries

2. IDBI (1-7-1964) by govt of India to co-ordinate regulate andSupervise the activities of other financial institutions

IFCI,ICICI,UTI,LIC and Commercial Banks

To plan and promise key industries

To devise system of industrial growth

ICICI industrial credit Investment Corporation of India

established on 5

th

Jan 1955 started by Govt of India, world bankAnd private businessmen (Representatives of private industries)

Objectives:

1. To assert in formation, expansion and modernization ofindustrial units in private sector.

2. To stimulate and promote the participation of private capital3. To encourage expansion of investment in india4.

To give technical and managerial aid to increase productionand employment opportunities.


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CHAPTER 3 :ELEMENTS OF COSTING

CONTENTS:

A. INTRODUCTIONB. DIRECT COSTC. INDIRECT COSTD. FORMAT OF COST SHEETE. QUESTIONS

A. INTRODUCTION:Cost refers to the expenses incurred in the manufacture of a product.

These are different types of cost

Total cost of goods + profits= selling price

cost

direct

labour material overheads

indirect

factory

primecost

office

factorycost/workingcost

selling &distribution

cost ofproduction


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B. DIRECT COSTFixed expenses incurred on manufacture, sale, distribution andproduction

Classified as:

1. Factory overheads indirect material/ labour2. Office overheadsoffice salary, lighting, telephone.3. Selling and distribution overheads salaries to salesmen,

Advertising cost, commission, rent etc

C. INDIRECT COST

Fixed expenses incurred on manufacturing, distribution & sale of

the product. They are classified as under

(a) Factory Overheads Indirect Material like lubricants supervision

etc.

(b) Office Overheads office rent, salary , lighting etc.

(c) Selling & Distribution Overheads Sales promotion experts

salary to salesman commission, rent of show room.

D. ELEMENTS OF TOTAL COST

In every manufactured product or operation, there are threecost elements (or its integral). These are materials, laboursand overhead. These primary elements provide managementwith information necessary for income measuring andproduct pricing. These are being explained as under:

Materials

Materials indicate principal substances used in production.Examples are cotton, jute, iron-ore. silicon, etc. The cost ofmaterial is further divided into direct and indirect materials.

Direct materials.These include all material directly used inproduction and easily traceable to a finished product. Inother words, it is the material which can be measured andcharged directly to the cost of the product. Direct materialincludes the following:

1.All materials specially purchased for a particular job, orderor process. 2.All materials including primary materials and raw materialspurchased and subsequently issued from the stores for


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particular job, order, etc.

3.Components purchased or produced.4.Materials passing from one operation or process toanotherparty finished goods.

5.Primary packing materials, e.g. cartons, wrappings,cardboard boxes, etc.Items such as import duties, dock charges, transport of

materials, storing of materials, cost of purchasing andreceiving materials and cost of rectifying materials are addedto the invoice price of materials and it is at this enhancedinitial cost that the material is charged.

Indirect materials.These are materials which are usedancillary to manufacture and cannot be traced into the

finished product. These form a part of manufacturingoverhead. Examples are glue, thread, nails, consumablestores, printing and stationery material, etc.

Labour

Labour is the physical or mental effort expended on theproduction of an item. It is the active factor of production asagainst material which is a passive factor. The cost of labouris further divided into direct and indirect labour.

Direct labour.Direct labour cost consists of wages paid to

workers directly engaged in manufacturing or handling aproduct or engaged in a particular job or process. It can beassociated directly with the product. It is also known asprocess, labour, productive labour or operating labour.

Indirect labour.This includes wages paid for all labour whichis not directly engaged in changing the shape or compositionof raw materials. It cannot be traced directly to the product.Like indirect material, indirect labour forms part of themanufacturing overheads. Examples of indirect labour costare wages paid to foremen, supervisors, store-keepers, time-keepers, salaries of office executives and the commission

payable to sales representatives.The above direct and indirect classification is not strict

enough. The classification of cost based on relationship tothe product will change as the relationship changes. Forexample, iron and steel used in the manufacture of anautomobile is direct material but that used in containers forshipping them is an indirect material cost. So is themaintenance and supervisory personnel in a manufacturingplant as their function is not directly related to production.But the maintenance personnel employed in a company thatprovides maintenance services to others would be considereda direct costs.


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Direct Expenses

Direct expenses, also known as "chargeable expenses',include any expenditure other than direct material or directlabour directly incurred on a specific cost unit. Examples ofdirect expenses are as follows:

1.Hire of a special machinery or equipment for a particularorder or product.2.Cost of special layout, designs or drawings.3.Maintenance cost of such equipment.Indirect Expenses

Indirect expenses are those incurred for the business as awhole rather than for a particular order, job or product.Examples of such expenses are rent, l ighting, insurancecharges, etc.

Overheads

Overheads may be defined as the aggregate of indirectmaterial, indirect labour and indirect expenses. Thus, allindirect costs are overheads.These cannot be associateddirectly with specific products. Hence, the amount ofoverheads has to be allocated and apportioned to productsand services on some reasonable basis. The synonymous termis 'burden'. Overheads may be subdivided into the followinggroups:

1.Factory overheads.2.Administrative overheads.3.Selling and distribution overheads.Factoryoverheads.These include indirect material, indirectlabour and indirect expenses incurred in the factory til l that

stage when goods are ready for despatch. Examples of factoryoverheads are as follows:

1.Indirect material such as consumable stores, cotton waste,grease and oil, small tools, etc.

2.Indirect wages such as salary of the f actory manager, wagesof the foremen, supervisors, time-keepers, store-keepers,etc.

Administrative overheads.These consist of all the expensesincurred in connection with the management functions ofplanning, directing and controlling the operations of anorganisation. The examples of administrative overheads areas follows:


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2.Indirectlabour such as salaries of clerks, secretaries andaccountants, general manager, directors, executives, etc.

3.Indirect expenses such as office rent, l ighting, heating andair-conditioning, depreciation, repairs and maintenance ofoffice machines, legal charges, bank charges, audit fees, etc.

Administrative overheads are also known as office on cost,establishment expenses, etc.

Selling and distribution overheads

Selling Overheads .These are costs incurred to create andstimulate demand for the product, to secure orders etc. Itincludes catalogues and price lists salaries and commission ofsales manager, travellers and agents, showroom expenses,advertising, cost of preparing tenders andestimates for special selling projects, after-sale service, etc.

Distribution Overheads.Under this heading would be includedwarehouse expenses, carriage outwards, upkeep and runningof delivery vehicles, packing cases, wages of despatch clerksand labourers, etc.

Selling and distribution overheads are also known asmarketing cost and are generally grouped together becauseof the overlapping nature of the two functions. The elementsof cost are shown diagrammatically in Fig. 2.5.


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Fig. 2.5 Elements of cost.

Notes: 1.Figure 2.5 is based on the absorption costingprinciple.

2. In the case of marginal costing, the amount ofproduction overhead absorbed would relate to the variableelement only.

TOTAL COST COMPONENTS

The computation of total cost of a product or service passesthrough several stages. The successive stages through whichthe costs flow give rise; to major divisions of cost are givenbelow:

(i) Prime cost. Also called basic, f irst or flat cost, it consistsof costs of direct material, direct labour and direct orchargeable expenses.

( i i)Factory cost.Also known as works cost or manufacturing

cost, it includes prime cost and the proportionate factoryoverheads.


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( i i i)Office cost.Also called cost of production or gross cost, itis made up of factory cost plus office and administrativeoverheads.

(iv) Total cost. Cost of production and selling and distribution

overheads constitute the cost of sales or total cost.

COST SHEET

The statement of cost according to element-wise is known ascost sheet. The preparation of cost-sheet is one of the mostimportant and primary function of cost accounting. Thestatement discloses the following:

1.Prime cost2.Work cost3.Cost of production4.Total costWhen the total cost is divided by the number of unitsproduced, quotient is the average cost per unit of the workperformed. Separate columns could be provided for the totaland unit cost of each clement of cost. Columns could also bedrawn for the current and the past periods. Cost sheet isprepared at weekly, monthly or other intervals. The specimenof a cost sheet is given in Fig. 2.6.

COST SHEET FOR THE PERIOD...


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CHAPTER 4: BUDGETARY CONTROL

Budgetary Control

Budgetfurnishes a device for correlated planning and a

means whereby authority maybe broadly delegated without

loss of control"

Koontz &O'Donell

LEARNING OBJECTIVES

Objective of Budgetary Control System Procedure to be followed in Designing and Operating Budgetary Control System Essentials of Good Budgetary Control System Meaning of Fixed Budget and Flexible BudgetVarious kinds of Functional BudgetLimitations of Budgeting Control Systems Planning and BudgetConcept of Budget and Budgeting ControlNature of Budget and Budgeting ControlObjectives of Budget and Budgeting ControlAdvantages of Budget and Budgeting ControlClassification of Budgets Limitations of Budget and Budgeting ControlEssentials of Effective Budgeting INTRODUCTION

A budget is defined as a quantitative and/or financialstatement prepared prior to a defined period period of timereflecting the policy to be pursued during that period for thepurpose of attaining a given objective.

Budgetary control is the establishment of budgets relatingto the responsibilities of the executives to the requirementsof a policy and the continuous comparison of actual withbudgeted result, either to securebyindividual action theobjectives of that policy or to provide a basis of its revision.

Budget is thus, the plan of operations in form of statement in

financial terms. Budgeting involves the preparation of

budgets. Budgeting should be departmentalized in order to

attract personal interest of the departmental heads. To

illustrate, the production department should prepare

production budget while salesdepartment should prepare

sales budget. Thus,


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1. BUDGET: It is a detailed plan and operations for some specificfuture date. It is prepared in advance and based on future

plan of action.

2. CONTROL: Comparing current performance with some pre-determined plan. It helps to know about proper utilization of

available resources.

3. BUDGETARY CONTROL : It is the system of managementcontrol and accountancy in which all operations are

forecasted as far as possible and the actual results copared

with the forecasted and planned ones.

It involves:

(i)Preparation of budget.

( i i) Continuous comparison of actual with budget figures.

( i i i) Revision of budget in the liquid charged circumstances.

Thus when budget and budgeting becomes a means of

planning and controlling the operations of an enterprise it is

called as budgetary control.

OBJECTIVE OF BUDGETARY CONTROL SYSTEM

Following are the main objectives of a budgetary controlsystem:

1.To forecast operating activities. It provides definite targetsfor income and expenditure of eachdepartment.

2.To provide co-ordination of the various activities of thebusiness. Various divisions of a business like production,sales, etc., are co-ordinated by co-ordinating the activities ofdifferent functional heads. The system, thus provides

valuable service to the co-ordination function ofthemmanagement.

3.To serve as an ideal means of communication.4.To serve as a measure of performance. The system setsdown plans of integration of departmental performances.

5.To serve as a means of control.The system thus contributes very much in the co-ordination,communication and control functions the management.


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Procedures to be Followed in Designing and OperatingBudgetary

Control System

Before mentioning the procedures to be followed for thedesign and operation of the Budgetary Control System, let usclear the following two matters:

(i) Procedures vary from one business to another. Undermentioned are merely the general procedures to be followed.

( i i) The commencement of procedures presupposes theexistence of positive backing by directors and managers withactive participation of all key personnel in computingforecast and budgets.

Procedures to be Followed

A. To make Forecasts for the following

1.Sales of product or services2.Production3.Stock4.Production cost, Selling and Distribution cost,Administration cost and Development cost5.Cash6.Credit - Debtors and Creditors7.Purchasing8.Capital Expenditure9. Profitand LossForecast10.

BalanceSheetForecast

B. To compare Alternative Combination of Forecast

This involves,

1.The consideration of principal budget factor (if any) andlimiting factors (key factors)2.The actions needed to overcome them3.Cost of such actions4.Selection of the optimum combination of forecasts Underthis step, it would not be out of place to mention some of theprinciple budget factors (alsoknown as limiting or governingfactors)

I. Materials:

1.Availability of supply2.Restriction imposed by license, Quota etc.


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II.Labour

i . General shortageii. Shortage in Key processes

III.Sales:

i . Low market Demandii. Shortage of experienced salesmeniii.Insufficient advertising

IV.Capacity of plant:

i . Lack of capitalii.Lack of placeiii.Lack of markets

V.Management:

i . Lack of capitalii. Lack of know-how iii.Insufficientexecutive etc

C. To prepare Budgets

This step can be taken only after aforementioned steps havebeen taken. Following points should be noted in this

connection:

i . They should be prepared with as much accuracy as possible.

i i . They should be departmentalised.

i i i . They should be prepared on the basis of reliable estimatesof the past and present factors.

iv. They should be prepared either on a flexible or on a fixedbasis.

D. To set up Organisation for Budgetary Control

The proper operation of the Budgetary Control systemgenerally involves the following matters:

1.Establishment of budget centres: alternatively cost centres. Abudget related to a particular budget centre is referred to adepartmental budget. There should be a departmental budgetfor each department.

2.Preparation of an organisation chart defining functionalresponsibility of each member of management. Such a chartdepends upon the nature and size of the businessundertaking.

3.Establishment of a Budget Committee to formulate aprogramme for preparing budgets and to exercise overallcontrol.


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4.Introduction of appropriate accounting system. Accountsshould be suitably classified. There should be a chart ofaccounts corresponding with the budget centres. Thereshould be a mechanism for various analysis and reportingthereon. Moreover, there should be regular andcontinuouscomparisons of budgeted and actual figures.

5. Preparation of Budget Manual setting out :

1.The responsibilities of the persons concerned2.Form and reports.

6. Determination of the key factor for priorities in functionalbudgets.

7.Establishment of normal level of activity. After consideringkey factor and the net probability, the management decidesand lays down the normal level of activity which is importantfor productionplanning.

8.Determination of Budget period. Before the budgets areactually prepared, the length of periodfor which they are tobe prepared should be determined.

BB ESSENTIALS OF GOOD BUDGETARY CONTROL SYSTEM

There should be effective budgetary control system.Following are the essential requirements of aneffectivesystem.

1.Plan of operation should be well-defined.2. There should be adequate system of Financial and Cost

Accounting. The system should be accurate. 3. Budgets should be prepared in the light of what is calledbusiness policy. Both the Planning and Budgeting should bemade within the frame world afforded by policy.

4. Budgeting should be supported by Top Management. Asmentioned earlier, the budgets should have positive backingby directors and managers. There should be activeparticipation of all key personnel.

5. All these persons who are concerned with the operation ofthe system should be properly and continuously instructedwith all the techniques of the system.

6.Budgets should be responsible executive.7. There should be adequate provisions for the comparison ofbudgeted and actual figures. In other words, the actual

expenses and actual output, should be constantly comparedwith pre-determined costs.

8.There should be complete co-ordination between all levelsof management.

9. Procedures for the design and operation of the system shouldbe properly established (keeping in view the nature ofbusiness, organisationetc) and followed.

10. The system should be flexible, it should provide for all

possible unforeseen circumstances.

Budget Centre


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Budget centres (or Cost centres) are the areas selected forthe purpose of controlling the costs at the point at whichthey are incurred.Following points should be noted whileselecting the budget centre:

1. Areas to be selected should be suitable for the purpose. Incase of production cost, control point lies at supervisor andoperator level.

2. Budget or cost centres should not be too large.3. Areas to be selected should comply with the natural

responsibilities of supervisors and executives.4. Budget should be prepared for each budget centre. Such a

budget is referred to as a departmental budget.

Budget Committee

It is generally established in case of large companies wherepersonal touch is impossible without coordination. It is the

budget committee that maintains the necessary co-ordination.

The committee consists of the Chief Executive (may beChairman, the Budget Controller or Budget Officer or theCommittee Secretary).

The Committee consists of the Chief Executive (may beChairman, General Manager, etc) of the Company, the Bu dgetController (or Budget Officer or the Committee Secretary)and heads of each functional division of the business (i.eSales Manager, Production Manager etc)

The Chief Executive of the company guides on the matterand delegates the responsibility for operating the system tothe Budget Officer.The Committee should be of reasonablesize. A very large committee may become unproductive.

Functions of the Committee are as follows:

1.To put the policy determined by the Board of Directors intopractical terms.2.To ensure the achievement of the objectives.3.To plan, operate, co-ordinate and control the activities.4.To receive forecasts and budgets and to discuss them5.To discuss the periodic results for the budgets6.To consider special problems (for example, fall in sales,increase in cost etc).7.To advise and also act upon the capital expenditureprojects.

The main functions of budget officer (who in BudgetCommittee, stands next to the Chief Executive of a Company)are as follows:

1. To prepare schedules of estimates, revised budget schedulesand budget report and also to review the periodic budget

report.2. To arrange for meeting of the Budget Committee and the

preliminary programme for the compilation of the budgets.


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3. To co-ordinate the budget data of all the divisions anddepartments.4. To confer with the executives of functional divisions as to the

results shown in periodic budget reports.5. To deliberate with the chief executive or Board of Directors

as regards the policies to be pursued after review andinterpretation of the budget reports.

Budget Manual

It has been defined as a document which sets out theresponsibilities of persons engaged in the routine of and theforms and records required, for budgetary control.

Budget manual may be in the form of a document, scheduleor booklet. It shows, in written form, the budgetingorganisation and procedures. Following are the requirements

of a good budget manual.1.It should be well-written2.It should be indexed for quick and easy location oninformation3.It should be divided into distinct sections to facilitate theissue of appropriate section to the executives of functionaldivisions or departments.4.It should be on loose leaf form to facilitate.i .Alterations to be made as and when requiredi i .Division into distinct sectionsi i i .Distribution to the persons effected.

Budget manual includes the information on the followingmatters: (List of only most important matters is given below).

1.Explanation of the principles of the budgetary controlsystem.

2.Description of the objectives of the Budgetary ControlSystems and the benefits to be different from its use.

3.Procedure to be adopted for the operation of the budgetarycontrol system.

4.Definition of the responsibilities of functional

anddepartmental budget centres.

5.Statement of the authority given to each manager.

6.Time tables for all stages of budgeting.

7. Forms, number, copies and the purposes of the Reportsand Statements to be employed.

8. Definition of the budget periods and control periods.

9. The accounts code and classification to be employed.Considering the above, we may say that theBudget Manual


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renders valuable services to the management in budgeting. Itis an invaluable document in the Budgetary Control System.

Budget Period

Budget period is a period covered by Budget. We may notform rigid rules on the length of period to becovered bybudgets, as we may not be sure about the stability of thebusiness. Selection of budget period depends upon manyfactors, l ike external economic conditions, internalcircumstances, nature of the plan?to be made, etc. However, we may generally write on budgetperiods as follows1. Some forecasts like capital expenditure may be made for along period i.e.upto 10 years or more. Hence it is obviousthat long-term budget period is necessary for them. However,in actual practice % the budget period is restricted to a yearin such cases also. And this step, is no doubt advisable; Itdoes not mean that long-term forecasts are in this connectionrestricted to relatively short-term but the process ofbudgeting them is carried out annually.

2. Viewing from the standing point of certainty which may bethe limiting factor for the budget period, the budget periodshould be short in case of the uncertainty. It should be notedthat )greater the uncertainty, the shorter should be thelength of the budget period. Longer period of i the budgetmay not give the reliable results (except in the case where

fluctuations are averaged I out in long period this sometimeshappens). Instead shorter the period, the more reliable willbe the figures obtained.

3.Selection of the budget period also depends upon theaccounting year of a concern (which is usually a year). That iswhy the budgets are generally prepared for a period which iseither a year or a multiple of a year.

4.Under the static budgets plan, the budget period is usuallya year, similarly, in case of flexible budgets, (explained in thischapter), the budget period is generally a year.

Budgets may be classified in the light of the budget periodsuch as long-term budget (budget period of 5 to 10 years),short-term budget (a year or two) and current budget (lessthan a year i.e. in months).

Control Periods

After selection of budget period, say a year, the division ofbudget into quarters is done and in turn, each quarter is sub-divided into its respective three separate months.

The division of the budget period into shorter periods is

made for the purpose of achieving control. Such shorterperiods are known as control period. In case of budgetsprepared for every quarter, the control periods may be one


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month which may, in turn be sub-divided into four respectiveseparate weeks. Again here also, there are no rigid rules inthis connection. For more accuracy (i.e to avoid the effect ofholidays, etc.), some accountants determine the length ofcontrol period by dividing the net working days in a year bytwelve (instead of using one calendar month as a monthly

control period). This again requiresthe calculation of calendarvariances to adjust the differences in the number of workingdays from one period to another period.

To conclude, the Control Period may be a quarter, a week,a day or even in hours. In actual practice, a combination ofperiods of different lengths is used after consideration of thenature of costs from the viewpoint of control. For example,direct labour, materials etc. may often be matched daily,while overhead costs may be controlled each four-weekly,period.

Key Factor Net Probability

Key factor, also called principal budget factor, is of greatimportance in the process of budgeting. Budgets should beprepared after considering all the key factors. For example,in the case of materials, availability of supply or restrictionsimposed by licenses, quotas etc. may act as limiting factor.Similarly, advertisement capacity, demand of goods inmarket are the limiting factors to be considered whilepreparing sales budget. Examples of key factors under eachaspect (i.e Material labour etc.), have already beenmentioned. Sales demand is the most important key factor to

be considered in budgeting. The extents of the influence ofthis factor must first be assessed.

Net Probability

Net probability is the number of products that can beproduced or sold after considering the extent of influence ofthe limiting factor. This is why the word probability is joinedwith the adjective Net.

For example. Net Probability for the following two products(A&B) will be 4,000 units and 10,000 units respectively:

TABLE 20.1


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SSMEANINGOF FIXED BUDGET AND FLEXIBLE BUDGET

Budgets may be classified in the light of the flexibility asFixed Budget and Flexible Budget.

Fixed Budget is based on rigidly fixed targets. Such budgetis designed to remain unchanged irrespective of the level ofactivity attained. It shows only one volume of output andrelated costs. Such budgets are prepared in advance (1 to 3months advance) of the budget period covered by them. Incase of uncertainty, fixed budgets may not enable costs to becontrolled effectively as the volume ascertained in thebudget may not remain the same in practice. Fixed budget isalso known as Static Budget.

Flexible Budget is a budget which is designed to change inaccordance with the level of activity attained. It is alsoknown as variable budget or sliding scale budget. It takes into

account, the probable levels of activities. For example,possible output at 60 per cent level of activity, at 80 per centlevel of activity and so on. In case of uncertainty, flexiblebudget is prepared as it is the only type of budget which canenable costs to be controlled effectively.

Technique of flexible budget requires the classification ofthe related expenses into fixed, variable semi-variable. Incase, there are semi-variable expenses, these would beseparated into fixed expensesand variable expenses, byadopting various methods e.g. least squares regression orscatter graph chart.

In practice, it is advisable to use both type of budges. Fixedbudgets are prepared in case the sales of the concern can bemost accurately forecast. In case of uncertainty, flexiblebudgets are preferred. For the purpose of control, theflexible budget is the only way a concern or a firm, may also,at first prepare fixed budgets only and then may split themup into short-term flexible budgets.

VARIOUS KINDS OF FUNCTIONAL BUDGET

Fol lowing are the commonly used funct ional budgets:

1. Sales Budget: I t shows tota l ant ic ipated sa les ( in quant it ies and invalue). Classi f ied according to groups of products, sa lesmen of geographical locat ions.

2.Sell ing and Distr ibut ion Cost Budget: I t shows the est imated costof sel l ing and d istr ibut ionofgoods.

3.Manufactur ing Budget: This budget may be sub-divided into the

fol lowing budgets: (a) Product ion Budget(b) Purchase Budget(c) Personnel Budget (d) Factory overhead Budget (e) Research Budget( f) Office and Administrat ion Budget


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(g)Capita l Budget (h)Plant Ut i l izat ion Budget

These are described as below:

1. Production Budget I t i s a forecast of product ion based on sa les,product ive capacity , inventor ies etc.

2. Purchase Budget I t shows the purchases required for theant ic ipated sa les and product ion. Purchases include both d irect andindirect mater ia ls . '3. Personnel Budget This shows the est imates of remunerat ionpayable to workers both d irect and indirect .

4. Factory overhead Budget I t covers a l l factory overheads. I tc lassi f ies factory overheads into F ixed; Var iable and semi-Var iablefactory overheads.

5. Research Budget I t inc ludes research costs incurred in developingand proving the products.

6. Office and Administrat ion Budget I t covers a l l administrat iveexpenses such as staff sa lar ies l ight ing etc.

7. Capital Budget This is general ly a long-term budget and coverscapita l expenditure on replacement of obsolescent p lant , acquis i t ionof new machinery etc.

8. Plant Uti l isat ion Budget This budgets showsthe requirements of p lant and machinery to meet the budgeted product ion.

9. Cash Budget It shows anticipatedreceipts and payments of cash. It is based on the operatingbudgetand the statement of financial position at the beginning ofthe budget period.

10. Master Budget It is an integration of separate budgetsand include the estimated profit and lossaccount for the future period and the estimated balancesheet at the end of that period. As its name

indicates, it is a summary of all other principal budgets.

BENEFITS AND WEAKNESSES OF THE BUDGETARY CONTROLSYSTEM

There are various benefits to be derived from the budgetarycontrol system. These are mentioned below:

1. The system co-ordinates and controls the policy, plans andaction. This facilitates an achievement of the budget goal.2.Existence of efficient budgetary control system is anindication of sound management.

3.All personnel know the part they have to play to achievethe targets set.4. Corporate planning and budgetary control can be linked.


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(That is why an efficient budgetary control system is anindication of sound management). Planning does not coverthe present, but also covers the future. In other words, ittakes into account the past results with an eye to the future.

5.Budgetary control system is very helpful in the standardcosting system.

6. On account of an efficient operation of the system, the costsmay be reduced and wastage in manpower and material maybe eliminated.

7. Comparison of alternative courses of action, constantmaximum utilisation of resources, comparison of the actualoutput and expenses with the budgeted figuresall thesehelp in achieving the maximum profits.

8. On account of budgetary control system, the concern may beable to utilise the liquid capital in a proper manner.9.The system serves as an effective control over stores andstocks.

10.The Cash Budget enables the management to know the needfor additional cash or the availability of excess cash. Thishelps the management to arrange for the credit (bankoverdraft, etc) or to invest surplus cash in advance, (as thecase may be).

11.The sale forecast enables the management to key theeconomic balance between plant and machinery, storage,warehouse and inventories.

Weaknesses (or Limitations) of the System

Every system may not bestow all the advantages mentioned

above. This is due to the following reasons:

1.All the systems may not be equally efficient.2.Person operating the systems may also vary in efficiency.

3. The concern operating the system may have some problemslimiting the efficiency of the concern.

Thus, efficiency of the system itself, (its organisation etc.),efficiency of the persons handling the system, and also theproblems related to the concern, may limit the advantages oradd to the weaknesses of the system.

Inaccuracy

Absolute accuracy is impossible in the budget plan. In actualpractice, the forecasting and budgetingarenot as easy as onemay think. However, a high standard should always be aimedat. All pertinent facts should be considered before settingthe targets. Targets set should be realistic. In the absence ofreality in the budgeted figures, the system is likely to be ofvery limited value.

Lack of Support

Budgetary control system, in order to be successful, musthave the whole hearted support of management. The successof budgetary control system is dependent upon the energies


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and efforts of the management. Mere operation of Budgetarycontrol system in an organisation does not ensure its success.Similarly,does not guarantee future profits. Instead, thesystem is only a way or a medium that brings to light the factthat a mistake has been made and allows corrective action tobe taken within a reasonable time. It is then the duty of the

management to concentrate on the mistake enlightened bythe system and to takecorrective action within a reasonabletime. If no steps are taken in this connection, the systemitself willnever avoid the mistakes. Thus, the budgetarycontrol system comparing does not replace soundmanagement. It is only an impersonal approach.

One should understand the fact that mere passing theexamination and getting the degree does not give usanything, it is upto the degree holder to achieve themaximum benefit of this degree. If he does not at all take anychances enlightened by his degree, the degree itself then

becomes of a very limit value from the viewpoint of thedegree holder. Similar is the case with the budgetary controlsystem comparing the system with the degree and themanagement with degree holder.

Excessive Cost

The cost of installing and operating the budgetary controlsystem sometimes limits the utility of the system. The cost ofthe system should always be considered in the light ofbenefits to be received from the system. No hard and fastrules can be laid down, for this depends on the size andnature of the activities of the individual business. However,the following may be done to minimise cost:

i. To fix a percentage for comparing the total cost of the

accounting function with the direct labourcost or with the

value of sales (keeping in view the size and nature of

business)

ii. Also to obtain comparative costs through a tradeassociation from other business.

ii i. To employ qualified men and women who understandbudgeting.

iv. To mechanise the accounting function (again keeping inview the size and nature of the business.

The cost of mechanisation

should also be considered.

Lack of Compromise between Flexibility and Rigidity

To become useful, the budgetary control system should allow

flexibility in its structure keeping in view the changingbusiness conditions. Degree of flexibility should always beconsidered. The system should not be too rigid nor it should


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be too much flexible. The following may be noted in thisconnection.i. It should be flexible enough to allow the implementationof any decisions to be made.ii. Plans should be made very carefully in order to avoid

frequent changes therein.iii. Budgets should be revised only if there are significantchanges in conditions and circumstances.

The above rules are important to note as the system loses itsusefulness on account of too much rigidity and too muchflexibility may also result in loss of control. Hence, thereshould be a compromise between the two.

Overlapping of Duties

In Budgetary Control System, the responsibilities of the

executives and personnel for the achievement of the policyare defined. Theoretically, this may be one of the advantagesof the system. But, in actual practice, the task of putting theappropriate responsibilities on the executive and personnel isnot so simple as one may assume. Quite often, there may beoverlapping of responsibilities. Improper definition ofresponsibilities causes many problems and limits theefficiency of the system. It should, therefore, be noted thatresponsibilities should be clearly understood and stated.

I l lustration 1: Assuming the following overhead expenses in afactory when operating at 50% of normal capacity draw up a

flexible budget on the basis of 75%, 100% and 125% ofnormal capacity.

Against each expense, indicate the principle upon whichyou have revised it, if at all for the different operatingvolumes.

TABLE 20.2

Foreman

Assistant foremanInspectorsShop LabourersMachinery repairsDefective workConsumable StoresMachine depreciation

6004006504001,000

250200

1,10Rs.4,600

FLEXIBLE BUDGET

(For overhead expenses)

Cost Centre Machine Shop Month


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Normal Capacity (Units)


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A] CASH FLOW STATEMENT

CASH FLOW STATEMENT IS PREPARED AT THE END OF THE YEARS & ITS

ADDITION TO FINAL ACCOUNT.

CSSH FLOW STATEMENT SHOW THE MOVEMENT OFCASH & CASH EQUIVALENT

DURING THE YEARS

CASH EQUIVALENT MEANS HIGHLY LIQUID INVESTMENT WHI CH CAN BE EASY

COVERTED INTO CASH . CASH FLOW STATEMENT IS COMPUSOLY FOR ALL THE

COMPAY. IT NEED TO PREPARED ALONG WITH FINAL ACCOUNT AND IT IS TO

SSUPPILES BY WAY OF INFORMATION

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