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Cost and Management Accounting

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Cost & Management Accounting (MGT-402)
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LESSON-33
WHAT IS A BUDGET?
A budget is a plan expressed in quantitative, usually monetary terms, covering a specific period of
time, usually one year. In other words, a budget is a systematic plan for the utilization of
manpower and material resources. In a business organization a budget represents an estimate of
future costs and revenues. Budgets may be divided into two basic classes; Capital Budgets and
Operating Budgets, Capital budgets are directed towards proposed expenditures for new projects
and often require special financing (this topic is discussed in the next Unit). The operating budgets
are directed towards achieving short-term operational goals of the organization, for instance,
production or profit goals in a business firm. Operating budgets may be sub-divided into various
departmental or functional budgets. The main characteristics of a budget are:
It is prepared in advance and is derived from the long, term strategy of the organization.
It relates to future period for which objectives or goals have already been laid down.
It is expressed in quantitative form, physical or monetary units, or both.
Different types of budgets are prepared for different purposes e.g. Sales. Budget, Production
Budget. Administrative Expense Budget, Raw material Budget, etc. All these sectional budgets are
afterwards integrated into a master budget- which represents an overall plan of the organization. A
budget helps us in the following ways:
1. It brings about efficiency and improvement in the working of the organization.
2. It is a way of communicating the plans to various units of the organization. By establishing
the divisional, departmental, sectional budgets, exact responsibilities are assigned. It thus
minimizes the possibilities of buck-passing if the budget figures are not met.
3. It is a way or motivating managers to achieve the goals set for the units.
4. It serves as a benchmark for controlling on going. Operations.
5. It helps in developing a team spirit where participation in budgeting is encouraged.
6. It helps in reducing wastage's and losses by revealing them in time for corrective action.
7. It serves as a basis for evaluating the performance of managers.
8. It serves as a means of educating the managers.
Budgetary control
No system .of planning can be successful without having an effective and efficient system of
control. Budgeting is closely connected with control. The exercise of control in the organization
with the help of budgets is known as budgetary control. The process of budgetary control includes
(i) preparation of various budgets (ii) continuous comparison of actual performance with budgetary
performance and (iii) revision of budgets in the light of changed circumstances.
A system of budgetary control should not become rigid. There should be enough scope for
flexibility to provide for individual initiative and drive. Budgetary control is an important device for
making the organization more efficient on all fronts. It is an important tool for controlling costs
and achieving the overall objectives.
Installing a budgetary control system
Having understood the meaning and significance of budgetary control in an organization, it will be
useful for you to know how a budgetary control system can be installed in the organization. This
requires, first of all, finding answers to the following questions in the context of an organization:
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Cost & Management Accounting (MGT-402)
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What is likely to happen?
What can be made to happen?
What are the objectives to be achieved?
What are the constraints and to what extent their effects can be minimized?
Having found answers to the above questions, the following steps may be taken for installing an
effective system of budgetary control in an organization.
Organization for budgeting
The setting up of a definite plan of organization is the first step towards installing budgetary
control system in an organization. A Budget Manual should, be prepared giving details of the
powers, duties, responsibilities and areas of operation of each executive in the organization.
Responsibility for budgeting
The responsibility for preparation and implementation of the budgets may be fixed as under:
Budget controller
Although the Chief Executive is finally responsible for the budget programme, it is better if a large
part of the supervisory responsibility is delegated to an official designated as Budget Controller or
Budget Director. Such a person should have knowledge of the technical details of the business and
should report directly to the President or the Chief Executive of the organization.
Budget committee
The Budget Controller is assisted 'in his work by the Budget Committee. The Committee may
consist of Heads of various departments, viz., Production, Sales. Finance Personnel, Purchase, etc.
with the Budget Controller as its Chairman. It is generally the responsibility of the. Budget
Committee to submit discusses and finally approves the budget figures. Each head of the
department should have his own Sub-committee with executives working under him as its
members.
Fixation of the Budget Period
Budget period' means the period for which a budget is prepared and employed. The budget period
depends upon the nature of the business and the control techniques. For example, a seasonal
industry will budget for each season, while an industry requiring long periods to complete work
will budget for four, five or even larger number, of years. However, it is necessary for control
purposes to prepare budgets both for long as well as short periods.
Budget procedures
Having established the budget organization and fixed the budget period, the actual work or
budgetary control can be taken upon the following pattern:
Key factor
It is also termed as limiting factor. The extent of influence of this factor must first be assessed in
order to ensure that the budget targets are met It would be desirable to prepare first the budget
relating to this particular factor, and then prepare the other budgets. We are giving below an
illustrative list of key factors in certain industries.
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Industry
Key factor
Motor Car
Sales demand
Aluminum
Power
Petroleum Refinery
Supply of crude oil
Electro-optics
Skilled technicians
Hydral Power generation
Monsoon
The key factors should be correctly identified and examined. The key factors need not be a
permanent nature. In the long run, the management may overcome the key factors by introducing
new products, by changing material mix or by working overtime or extra shifts etc.
Making a Forecast
A forecast is an estimate of the future financial conditions or operating results. Any estimation is
based on consideration of probabilities. An estimate differs from a budget in that the latter
embodies an operating plan or an organization. A budget envisages a commitment to certain
objectives or targets, which the management seeks to attain on the basis of the forecasts prepared.
A forecast on the other hand is an estimate based on probabilities of an event. A forecast may be
prepared in financial or physical terms for sales, production cost, or other resources required for
business. Instead of just one forecast a number of alternative forecasts may be considered with a
view to obtaining the most realistic overall plan.
Preparing budgets
After the forecasts have been finalized the preparation of budgets follows. The budget activity
starts with the preparation of the said budget. Then, production budget is prepared on the basis of
sales budget and the production capacity available. Financial budget (i.e. cash or working capital
budget) will be prepared on the basis of sale forecast and production budget. All these budgets are
combined and coordinated into -a master budget- The budgets may be revised in the course of the
financial period if it becomes necessary to do so in view of the unexpected developments, which
have already taken place or are likely to take place.
Choice between Fixed and Flexible Budgets
A budget may be fixed or flexible. A fixed budget is based on a fixed volume of activity, 11 may
lose its effectiveness in planning and controlling if the actual capacity utilization is different from
what was planned for any particular unit of time e.g. a month or a quarter. The flexible budget is
more useful for changing levels of activity, as it considers fixed and variable costs separately. Fixed
costs, as you are aware, remain unchanged over a certain range of output such costs change when
there is a change in capacity level. The variable costs change in direct proportion to output if
flexible budgeting approach is adopted, the budget controller can analyze the variance between
actual costs and budgeted costs depending upon the actual level of activity attained during a period
of time.
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Cost & Management Accounting (MGT-402)
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Objective of Budget
Profit maximization.
Maximization of sales.
Volume growth.
To compete with the competitors.
Development of new areas of operation.
Quality of service.
Work-force efficiency.
Divisions of Budget
Division of Budgets
Functional Budget
Master Budget
Functional Budget
Sales Budget
Production Budget
Raw material
Labor
Factory
overhead
Cost of goods
sold
Selling &
General &
Financial
distribution
Administrative
charges
expenses
expenses
budget
budget
budget
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Table of Contents:
  1. COST CLASSIFICATION AND COST BEHAVIOR INTRODUCTION:COST CLASSIFICATION,
  2. IMPORTANT TERMINOLOGIES:Cost Center, Profit Centre, Differential Cost or Incremental cost
  3. FINANCIAL STATEMENTS:Inventory, Direct Material Consumed, Total Factory Cost
  4. FINANCIAL STATEMENTS:Adjustment in the Entire Production, Adjustment in the Income Statement
  5. PROBLEMS IN PREPARATION OF FINANCIAL STATEMENTS:Gross Profit Margin Rate, Net Profit Ratio
  6. MORE ABOUT PREPARATION OF FINANCIAL STATEMENTS:Conversion Cost
  7. MATERIAL:Inventory, Perpetual Inventory System, Weighted Average Method (W.Avg)
  8. CONTROL OVER MATERIAL:Order Level, Maximum Stock Level, Danger Level
  9. ECONOMIC ORDERING QUANTITY:EOQ Graph, PROBLEMS
  10. ACCOUNTING FOR LOSSES:Spoiled output, Accounting treatment, Inventory Turnover Ratio
  11. LABOR:Direct Labor Cost, Mechanical Methods, MAKING PAYMENTS TO EMPLOYEES
  12. PAYROLL AND INCENTIVES:Systems of Wages, Premium Plans
  13. PIECE RATE BASE PREMIUM PLANS:Suitability of Piece Rate System, GROUP BONUS SYSTEMS
  14. LABOR TURNOVER AND LABOR EFFICIENCY RATIOS & FACTORY OVERHEAD COST
  15. ALLOCATION AND APPORTIONMENT OF FOH COST
  16. FACTORY OVERHEAD COST:Marketing, Research and development
  17. FACTORY OVERHEAD COST:Spending Variance, Capacity/Volume Variance
  18. JOB ORDER COSTING SYSTEM:Direct Materials, Direct Labor, Factory Overhead
  19. PROCESS COSTING SYSTEM:Data Collection, Cost of Completed Output
  20. PROCESS COSTING SYSTEM:Cost of Production Report, Quantity Schedule
  21. PROCESS COSTING SYSTEM:Normal Loss at the End of Process
  22. PROCESS COSTING SYSTEM:PRACTICE QUESTION
  23. PROCESS COSTING SYSTEM:Partially-processed units, Equivalent units
  24. PROCESS COSTING SYSTEM:Weighted average method, Cost of Production Report
  25. COSTING/VALUATION OF JOINT AND BY PRODUCTS:Accounting for joint products
  26. COSTING/VALUATION OF JOINT AND BY PRODUCTS:Problems of common costs
  27. MARGINAL AND ABSORPTION COSTING:Contribution Margin, Marginal cost per unit
  28. MARGINAL AND ABSORPTION COSTING:Contribution and profit
  29. COST VOLUME PROFIT ANALYSIS:Contribution Margin Approach & CVP Analysis
  30. COST VOLUME PROFIT ANALYSIS:Target Contribution Margin
  31. BREAK EVEN ANALYSIS MARGIN OF SAFETY:Margin of Safety (MOS), Using Budget profit
  32. BREAKEVEN ANALYSIS CHARTS AND GRAPHS:Usefulness of charts
  33. WHAT IS A BUDGET?:Budgetary control, Making a Forecast, Preparing budgets
  34. Production & Sales Budget:Rolling budget, Sales budget
  35. Production & Sales Budget:Illustration 1, Production budget
  36. FLEXIBLE BUDGET:Capacity and volume, Theoretical Capacity
  37. FLEXIBLE BUDGET:ANALYSIS OF COST BEHAVIOR, Fixed Expenses
  38. TYPES OF BUDGET:Format of Cash Budget,
  39. Complex Cash Budget & Flexible Budget:Comparing actual with original budget
  40. FLEXIBLE & ZERO BASE BUDGETING:Efficiency Ratio, Performance budgeting
  41. DECISION MAKING IN MANAGEMENT ACCOUNTING:Spare capacity costs, Sunk cost
  42. DECISION MAKING:Size of fund, Income statement
  43. DECISION MAKING:Avoidable Costs, Non-Relevant Variable Costs, Absorbed Overhead
  44. DECISION MAKING CHOICE OF PRODUCT (PRODUCT MIX) DECISIONS
  45. DECISION MAKING CHOICE OF PRODUCT (PRODUCT MIX) DECISIONS:MAKE OR BUY DECISIONS