profit planning, activity-based budgeting, and e-budgeting
TRANSCRIPT
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Budgeting
Dr. Varadraj Bapat
Module 14.
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Management Accounting Dr. Varadraj Bapat, IIT Mumbai 2
Index
Introduction
Objectives
Advantages
Components of Budgetary Control System
Types of Budget
Zero Base Budgeting
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Budget
Budget refers to an estimated statement. It is prepared by companies as well as government. It is for the purpose of attaining some goal.
Management Accounting Dr. Varadraj Bapat, IIT Mumbai
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Budget
Budget can be defined as a financial and / or quantitative statement prepared and approved prior to a defined period of time of the policy to be pursued during that period for the purpose of attaining a given objective.
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Budget
It may include income, expenditure and employment of capital. It is often used for control purpose.
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It is a process in which budget
is set and actual is compared with budget to analyse variances.
Budgetary Control
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It means the establishment of
budgets relating the responsibilities of executives to the prerequisite of policy and the continuous evaluation of actual with budgeted results
Budgetary Control
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either to secure by individual action the objective of that policy or to provide a base for its revision.
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Objectives of Budget
Planning: A set of targets/goals is often
essential to lead and focus individual and group actions. Planning not only motivates the employees but also improves overall decision making.
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Directing: Business is very complex and
requires more formal direction and coordination. Once the budgets are in place they can be used to direct and coordinate operations in order to achieve the stated targets.
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Controlling: The actual performance can be
compared with the planned targets. This provides prompt feedback about performance. budget also prevents unplanned adhoc expenditure.
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Advantages of Budgetary Control System
Enables the managers/ administrators to conduct activities in efficient manner.
Provides yardstick for measuring and evaluating the performance of individuals and their departments.
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Reveals the deviations, from the budget by comparing with actuals; Helps in prompt review process
Creates suitable conditions for the implementation of standard costing system
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Acts as systematic base for framing future policies and targets
Inculcates the feeling of cost consciousness and goal orientation
Leads to effective utilization of various resources, as the activities are planned and executed effectively.
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Components of Budgetary Control System
The policy of a business for a defined period is represented by the master budget, the details of which are given in a number of individual budgets called functional budgets.
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These functional budgets are broadly grouped as physical, cost and profit budgets.
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Physical Budgets- Those budgets which contains information in terms of physical units about sales, production etc. for example, quantity of sales, quantity of production, inventories and manpower budgets are physical budgets.
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Cost budgets- Budgets which provides cost information in respect of manufacturing, selling, administration etc. for example, manufacturing cost, selling cost, administration cost and research and development cost budgets are cost budgets.
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Profit budgets- Budgets which enables in the ascertainment of profit, for example, sales budget, profit and loss budget, etc.
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Fixed Budget Vs. Flexible Budget
Functional Vs. Master Budget
Long-Term Vs. Short-Term Budget/ Current Budget
ZBB
Types of Budget
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A fixed budget is the budget
designed to remain unchanged irrespective of level of activity actually attained. Such budget is suitable for Fixed Expenses. It is also known as Static budget.
Fixed Budget
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A fixed budget is not suitable in
dynamic environment and for a longer period because of its rigidity. It is not suitable where labour cost, material cost and other factors are constantly changing.
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Flexible budget show the expected results of responsibility centre for several activity level. Flexible budget is the series of static budgets for different level of activity.
Flexible Budget
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While preparing flexible budget the revenues and expenses are classified into Fixed, Variable and Semi-variable categories.
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In most cases, the level of activity
during the period varies from period to period due to change in demand or seasonal nature or changing circumstances. In such industries/ government organisations flexible budget is suitable.
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Budgets which relate to the
individual function/task in an organisation are known as Functional Budgets. For example, purchase budget, sales budget, production budget, plant utilization budget, cash budget.
Functional Budget
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It is a consolidated summary of
the various functional budgets. It is based on goals set. It serves as the basis upon which budgeted P & L A/c and forecasted Balance Sheet are built up.
Master Budget
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The budget which are prepared for
periods longer than a year are called long-term budget. Such budgets are helpful in business forecasting and strategic planning. E.g. Capital expenditure budget, Research and Development budget.
Long-Term Budget
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Budgets which are prepared for
periods less than a year are known as short term budgets. E.g. Cash Budget. Such budgets are prepared regular comparison and action to bring variation under control.
Short-Term Budget
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A budget which is established for use over a short period of time and is related to the current conditions is called current budget.
Current Budget
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It refers to budgeting from scratch.
Zero Base Budgeting (ZBB)
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ZBB is a method of budgeting
which requires each cost element to be specifically justified, as though the activities to which the budget relates were being undertaken for the first time.
ZBB
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To receive funding during budgeting process, each activity must be justified in terms of continued usefulness.
Under ZBB, the budget for virtually every activity is initially set to zero.
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Advantages
Provides a systematic approach for evaluation of different activities and ranks them in order of preference for allocation of scare resources.
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Ensures that the every activity/ function undertaken is critical for the achievement of objectives.
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Provides an opportunity to allocate resources for various activities / functions only after having a thorough cost benefit analysis.
Wasteful expenditure can be easily identified and eliminated.
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Ex. Material purchase budget
Calculate the raw material required to be purchased:
Budgeted sales: 5000 units
stock of finished stock in hand is 500 units
Material A and B units (per finished stock unit) : 12 and 10 respectively
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Opening stock of Raw material in
hand A: 5000 units B:3500 units Closing stock of 1000 units of finished goods and RM A and B, is required to maintain.
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Solution
Budgeted Sales 5000
+ Desired Closing Stock 1000
Total Requirement of finished stock
6000
- Opening Stock (500)
Units to be produced 5500
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Raw Material A B
5500 x 12 66000
5500 x 10 55000
- Opening Stock (5000) (3500)
+ Closing Stock +1000 +1000
Raw Material Purchase Budget 62000 52500
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1
Standard Costing and Variance Analysis
Dr. Varadraj Bapat
Module 15
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Standard Costing
Definition
Steps in standard costing
Types of Standards
Variance
Types of variance
Variance Analysis
Advantages & disadvantages of Standard costing
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Standard Costing
Standard cost is a pre-determined cost which is calculated from management’s standards of efficient operation and the relevant necessary expenditure. It may be used as a basis for price fixing and for cost control through variance analysis.
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In simple words it is a budget for the production of one unit of product or service. It is chosen to serve as a benchmark in the budgetary control system.
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Steps in Standard Costing
Study the actual cost
Cost variance Analysis
Set standard
Cost
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Set the standard cost
A predetermined or standard cost per unit is set.
Budgeted cost determined by using standard cost.
•Study the actual cost
Calculate actual cost incurred in the production process
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Cost variance
Comparison of the actual cost with the budgeted cost.
The cost variance is used in controlling cost.
Fix responsibilities to control cost
Take suitable action and create effective control system .
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Types of standards
Ideal Standards: These represents the level of
performance attainable when prices for material and labour are most favorable, when the highest output is achieved with the best equipment and layout and when maximum efficiency in utilization of resources results in maximum output with minimum cost.
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Normal Standards: These are the standards that may be achieved under normal operating conditions. The normal activity has been defined as number of standard hours which will produce normal efficiency sufficient goods to meet the average sales demand over a term of years.
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Basic or Bogey standards: These standards are use only when they are likely to remain constant or unaltered over long period. According to this standard, a base year is chosen for comparison purposes in the same way as statistician use price indices. When basic standards are in use, variances are not calculated as the difference between standard and
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actual cost. Instead, the actual cost is expressed as a percentage of basic cost.
Current Standard: These
standards reflect the management’s anticipation of what actual cost will be for the current period. These are the costs which the business will incur if the anticipated prices are
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paid for goods and services and the usage corresponds to that believed to be necessary to produce the planned output.
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Variance
The difference between standard cost and actual cost of the actual output is defined as Variance. A variance may be favourable or unfavourable. If the actual cost is less than the standard cost, the variance is favourable and if the actual cost is more than
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the standard cost, the variance will be unfavourable. It is not enough to know the figures of these variances infact it is required to trace their origin and causes of occurrence for taking necessary remedial steps to reduce / eliminate them.
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Controllable and uncontrollable Variance
The purpose of standard costing reports is to investigate the reasons for significant variances so as to identify the problems and take corrective action. Variances are broadly of two types, namely, controllable and uncontrollable.
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Controllable variances are those which can be controlled by the departmental heads whereas uncontrollable variances are those which are beyond their control. If uncontrollable variances are of significant nature and are persistent, the standards may need revision.
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Variance Analysis
Variance analysis is the analysis of the cost variance into its component parts with appropriate justification of such variances, so that we can approach for corrective measures.
Variances of Efficiency: Variance due to the effective or
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ineffective use of material quantities, labour hours, once actual quantities are compared with predetermined standards.
Variances of Price Rates: Variances arising due to change
in unit material prices, standard labour hour rates and standard allowances for indirect costs.
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Variances of Due to volume: Variance due to effect of
difference between actual activity and the level of activity assumed when the standard was set.
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Analysis of Variance
Material Variance
Labour Variance
Overhead Variance
Sales Variance
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Reasons of Material Variance
Change in Basic price
Fail to purchase anticipated standard quantities at appropriate price
Use of sub-standard material
Ineffective use of materials
Pilferage
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Material Variance Material Cost Variance= (Standard
Quantity X Standard Price) –(Actual Quantity X Actual Price)
Material Price Variance= Actual Quantity (Standard Price - Actual Price)
Material Usage Variance=Standard Price (Standard Quantity - Actual Quantity)
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Reasons of Labour Variance
Change in design and quality standard
Poor working conditions
Improper scheduling
Improper placement of labour
Increments / high labour wages
Overtime
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Labour Variance
Labour Cost Variance=(Standard Hrs X Standard Rate Per Hour) –(Actual Hrs X Actual Rate Per Hour)
Labour Rate Variance=Actual Hrs (Standard Rate - Actual Rate)
Labour efficiency Variance= Standard Rate (Standard Hrs - Actual Hrs worked)
Idle Time Variance= Idle Hours X Standard Rate
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Reasons of Overheads Variance
Improper planning
Under or over absorption of fixed overheads
Reduction of sales
Breakdowns
Power Failure
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Dr. Varadraj Bapat 26
Variable Overheads (OH) Variance
Variable OH Cost Variance= (Standard Hrs X Standard Variable OH Rate) – Actual OH Cost
Variable OH Expenditure Variance= (Actual Hrs X Standard Variable OH Rate) – Actual OH Cost
Variable OH Efficiency Variance= (Standard Hrs - Actual Hrs) X Standard Variable OH Rate
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Dr. Varadraj Bapat 27
Fixed Overheads (OH) Variance
Fixed OH Cost Variance= Absorbed OH – Actual Fixed OH Cost
Fixed OH Expenditure Variance= (Budgeted Hrs X Standard Fixed OH Rate) – Actual Fixed OH Cost
Fixed OH Volume Variance= (Standard Qty - Actual Qty) X Standard Fixed OH Rate
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Dr. Varadraj Bapat 28
Reasons of Sales Variance
Change in price
Change in Market size
Change in Market share
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Dr. Varadraj Bapat 29
Sales Variance
Sales Value Variance =
Budgeted Sales – Actual Sales
Sales Price Variance =
Actual Quantity (Actual Price - Budgeted Price)
Sales Volume Variance =
Budgeted Price (Actual Quantity - Budgeted Quantity)
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Dr. Varadraj Bapat 30
Advantages & Disadvantages of Standard
costing Advantages
Basis for sensible cost comparisons
Employment of management by exception
Disadvantages Too
comprehensive to be useful
Precise estimation of prices or rate to paid is not possible
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Dr. Varadraj Bapat 31
Means of performance evaluation for employees
Result in more stable product cost
May not be useful if frequent change in technology
Focus on cost minimization rather than quality or service.