After reading this chapter, you should be able to understand:
A budget (from the old French word bougette, meaning purse) is generally a list of all planned expenses and revenues. It is a plan for saving and spending. In other terms, a budget is an organizational plan stated in monetary terms. A budget is a financial document used to project future income and expenses. It can be prepared by either an individual or a firm.
The term budget is derived from the French word bougette, which means ‘little bag’ or a container of documents and accounts. A budget is an economic plan for a given period of time.
It is a quantified plan for future activities. It puts in black and white a quantitative plan to coordinate and control the use of resources for a specified period. It is defined as ‘the quantitative and financial interpretation of the future plans of operation’, and as the ‘overall financial plan for future activities’. It is viewed as a systematic plan for the utilization and coordination of materials, labour and other resources for the process by which plans for resource allocation are made.
Accounting terminology, published by the Canadian Institute of Chartered Accountants, explains budgeting in the following words:
An operating or financial plan comprising a detailed estimate of future transactions either in terms of quantities or money values, or both. In business, budgets are designed according to the types of transactions, e.g., cash or financial budgets, operating budgets, capital budgets. Budgets are also described as fixed or flexible, depending on whether the emphasis is placed on a rigid target such as specified sales volume, or on the relationship of the various items with the budgeted amounts being altered as volume changes.
A budget is a detailed statement of forecast.
Budgets are the individual objectives of a department.
A budget is a quantitative statement, prepared and approved prior to a particular period of time.
Budgeting is the act of building budgets.
Budgetary control is defined as ‘the establishment of budgets relating to the responsibilities of executives to the requirements of a policy’. It is a system of achieving a firm's objectives with minimum possible cost.
The purposes of budgeting are as follows:
Budgetary control is defined by the Institute of Cost and Management Accountants (CIMA) as follows: ‘The establishment of 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 objective of that policy, or to provide a basis for its revision.’
The salient features of a budgetary control system are the following:
The advantages of a budgetary control system to an enterprise are as follows:
Limitations of the budgetary control system are as follows:
Budget period depends on the type of business and the control aspect. In the case of seasonal industries, the budget period should be a short one. In the case of industries with heavy capital, the budget period should be a long one.
A fixed budget is a budget designed to remain unchanged irrespective of the level of activity actually attained. This is prepared for a definite production and capacity level. Fixed budgets are not effective tools of cost control.
A flexible budget is the opposite of a static budget; it shows expected costs at a single level of activity. Therefore, a flexible budget is one that is designed to change (flex) in accordance with the level of activity actually attained. In contrast to planning around one target volume, it employs a range of activities. It can be defined as a ‘concise statement of how costs are related to changes in the chosen activity volume’. Thus, a flexible budget has the following main distinguishing features:
The formulation of a flexible budget begins with analysing the overhead into fixed and variable costs and determining the extent to which variable costs vary within the normal range of activities. It is a budget designed to change in accordance with the level of activity actually attained. This budget is prepared in such a manner as to present budget cost for different levels of activity. While preparing a flexible budget, the expenses are classified into three categories:
Semi-variable expenses are further segregated into fixed and variable expenses.
Flexible budget is also called ‘variable budget’ or ‘sliding scale budget’. Fixed costs are related mostly to the period of time and are not concerned with the level of production or volume of sales. Variable costs vary in direct proportion to the level of production or volume of sales. At zero-level activity, variable costs are not in existence. Semi-variable costs occupy an in between position between fixed and variable costs. A part of these costs is variable and the rest is fixed.
A need for preparing flexible budgets arises under the following circumstances:
Table 14.1 shows the distinction between fixed and flexible budgets.
Table 14.1 Distinction Between Fixed and Flexible Budgets
Fixed budget | Flexible budget |
---|---|
1. It does not change with the actual volume of activity achieved. Thus, it is known as rigid or inflexible budget. | It can be recasted on the basis of the activity level to be achieved. Thus, it is not rigid. |
2. It operates on one level of activity and under one set of conditions. It assumes that there will be no change in the prevailing conditions, which is unrealistic. | It consists of various budgets for different levels of activity. |
3. Here, as all costs like fixed, variable and semi-variable costs are related to only one level of activity, variance analysis does not give useful information. | Here, analysis of variance provides useful information as each cost is analysed according to its behaviour. |
4. If budgeted and actual activity levels differ significantly, then aspects like cost ascertainment and price fixation do not give a correct picture. | Flexible budgeting at different levels of activity facilitates the ascertainment of cost, fixation of selling price and tendering of quotations. |
5. Comparison of actual performance with budgeted targets is meaningless especially when there is a difference between the two activity levels. | It provides a meaningful basis for the comparison of actual performance with budgeted targets. |
Budgets that relate to the individual functions of an organization are known as functional budgets. The various types of functional budgets to be prepared for a business vary according to the size and nature of the business. Some important functional budgets are discussed in Sections 14.5.4.1 through 14.5.4.6.
Sales budget is an estimate of future sales, often broken down into both units and dollars. It is used to create company sales goals.
The process of budgeting starts with sales forecasting. It is the forecasting of sales for a period in terms of both quantity and value. It is prepared by the sales manager. Such a forecast requires an assessment of the number of units of each product that can be sold, sales territories to be covered and prices at which sales can be effected. Besides these, the following factor should also be taken into account: Sales budget represents the total sales in physical quantities and values for a future budget period. Some important factors like products, areas, salespersons and types of customers should be kept in mind when preparing a sales budget. The following factors have to be considered when preparing the sales budget:
Product-oriented companies create production budgets, which estimate the number of units that must be manufactured to meet sales goals. A production budget also estimates the various costs involved in manufacturing such units, including labour and material.
The purchase budget sets out the quantity and volume of different types of materials to be purchased during the budget period, taking into consideration levels of production activity and inventory levels. While preparing a material budget, the following factors must be taken into account:
In order to ensure regular supply of raw materials for production, a budget is prepared. In this budget only direct materials are taken into account and indirect materials are considered under overheads. This budget helps in the proper planning of purchases.
Cash budget is a cash plan for a defined period of time. It provides a summary of monthly receipts and payments. Hence, it highlights monthly surpluses and deficits of actual cash. Main uses of a cash budget are as follows:
Receipts of cash may come from one of the following:
Payments of cash can be for one or more of the following:
Cash-flow budget is a prediction of future cash receipts and expenditures for a particular time period. It usually covers a period in the short-term future. A cash-flow budget helps a business in determining when income will be sufficient to cover expenses and when the company will need to seek outside financing.
Cash budget represents the cash requirements of the business during the budget period. It is prepared after all the functional budgets are prepared. A cash budget does the following: ensures sufficient cash for the business, proposes arrangements to be made in the case of cash shortage and reveals the surplus amount.
Personnel are a highly costly item in the operation of an enterprise. It is, therefore, essential that, like the other factors of production, managements determine in advance personnel requirements for various jobs in enterprises. This budget may be classified into labour requirement budget and labour recruitment budget. The labour requirements in various job categories such as unskilled, semi-skilled, skilled and supervisory categories are determined with the help of various departmental heads. Labour recruitment is done keeping in view the requirements of a job and its specifications, degree of skill and experience required, and rates of pay.
A company might have a master budget or profit plan for the upcoming year. The master budget includes a projected income statement and balance sheet. Budgets such as sales budget, production budget, marketing budget, administrative budget and budgets for departments operate within the master budget. In addition, there is a cash budget and a capital expenditures budget.
Master budget is the summary of all budgets. Once all the necessary functional budgets are prepared, the budget officer prepares the master budget. This budget includes the budgeted position of profit and loss as well as balance sheet.
Budget ratios provide information about performance level, that is, the extent of deviation of actual performance from budgeted performance and whether the actual performance is favourable or unfavourable. If the ratio is 100% or more the performance is considered favourable, and if the ratio is less than 100% the performance is considered unfavourable. The ratios discussed in Sections 14.6.1 through 14.6.5 are usually used by managements to measure development from budget.
The capacity usage ratio shows the relationship between the budgeted number of working hours and the maximum possible number of working hours in a budget period.
Example:
Budgeted number of working hours after deducting the hours expected to be lost because of surplus capacity = 4,000
Maximum possible number of working hours in a budget period before deduction of surplus capacity = 5,000
In ascertaining both the levels of hours, normal idle time should be deducted.
The standard capacity employed ratio indicates the extent to which facilities are actually utilized during the budget period.
Example:
Actual hours worked = 3,600
Budgeted hours = 4,000
The level of activity ratio may be defined as the number of standard hours equivalent to work produced that is expressed as a percentage of the budget of standard hours.
Example:
Actual production converted into standard hours = 5,600
Budgeted production converted into standard hours = 6,000
The level of activity ratio is arrived at by comparing actual production with the anticipated production shown in the budget. The standard capacity employed ratio does not consider either actual or estimated production; it only measures actual hours worked.
Efficiency ratio may be defined as standard hours equivalent of work produced expressed as a percentage of the actual hours spent working.
Example:
Standard hours equivalent of work produced = 5,600
Actual hours worked = 5,000
Calendar ratio may be defined as the relationship between the number of working days in a period and the number of working days in the relative budget period.
Example:
Actual working days = 26
Budgeted working days = 25
Illustration 1
A factory manufactures two types of products, X and Y. Manufacture of product X requires 5 hours and that of Y requires 10 hours. In a month of 25 effective days having 8 hours a day, 1,000 units of X and 700 units of Y were produced. The company employs 65 workers in the production department. Budgeted hours are 1,14,000 hours for the year. Calculate capacity ratio, activity ratio and efficiency ratio.
Solution:
Actual hours worked = 65 workers × 25 days × 8 hours = 13,000 hours
Standard hours for actual production:
Alternatively,
Activity Ratio |
= Capacity × Ratio × Efficiency Ratio |
= 1.3684 × 0.923 | |
= 1.2630, multiply by 100, we get | |
= 126.3% |
Illustration 1a
Two articles X and Y are manufactured in a department. Their specifications show that two Xs or eight Ys can be produced in 1 hour. The budgeted production for June 1998 is 300 Xs and 600 Ys. The actual production at the end of the month was 300 Xs and 530 Ys, and the actual hours spent on this production were 350. Find the capacity, activity and efficiency ratios for June 1998. Also find the calendar ratio if the actual working days during the month are 27 corresponding to 25 days in the budget.
Solution: Standard budgeted hours for June 1998
Standard hours for actual production:
Illustration 2
A Ltd produces two commodities, Good and Better, in one of its departments. Each unit takes 7 hours and 12 hours as production times, respectively. 1,000 units of Good and 600 units of Better were produced during March. Actual manhours spent in this production were 12,000. Yearly budgeted hours are 1,02,000. Compute the various control ratios.
Solution: Yearly budgeted hours = 1,02,000
Standard hours for actual output = 1,000 × 7 + 600 × 12 = 14,200
Actual hours worked = 12,000 hours
Alternatively,
Activity ratio |
= Capacity ratio × Efficiency ratio |
= 1.4117 × 1.1833 | |
= 1.6704 | |
= 1.375 is multiplied with 100, we get, | |
= 167.04%. |
Illustration 3
The budgeted output of a factory specializing in the production of a single product at the optimum capacity of 6,400 units per annum amounts to Rs 1,76,048 as detailed here:
Rs | Rs | |
---|---|---|
Fixed costs | — | 22,000 |
Power | 1,440 | |
Repairs and so on | 1,700 | |
Miscellaneous and so on | 540 | |
Direct materials | 49,280 | |
Direct labour | 1,02,400 | 1,55,360 |
1,77,360 |
Taking into consideration possible impact on sales turnover by market trends, the company decides to have a flexible budget with a production of 3,200 and 4,800 units (the actual quantity proposed being left to a later date before commencement of budget period). Prepare a flexible budget for production levels at 50% and 75%. Assuming that the sales per unit is maintained at Rs 45 at present, indicate the effect on net profit. Administration, selling and distribution expenses continue at Rs 3,600.
Solution: Flexible budget
With the following data for a 60% activity, prepare a budget for production at 80% and 100% activity:
Production at 60% activity—600 units | |
---|---|
Materials | Rs 100 per unit |
Labour | Rs 40 per unit |
Expenses | Rs 10 per unit |
Factory expenses | Rs 40,000 (40% fixed) |
Administration expenses = Rs 30,000 (60% fixed)
[Ans: Rs 1,60,000 (60%); Rs 2,02,000 (80%); Rs 2,44,000 (100%)]
Illustration 4
Prepare a flexible budget for overheads on the basis of the following data. Ascertain the overhead rates at 50%, 60% and 70% capacity;
At 60% capacity (Rs) | |
---|---|
Variable overheads | |
Indirect material | 9,000 |
Indirect labour | 21,000 |
Semi-variable overheads | |
Electricity (40% fixed, 60% variable) | 30,000 |
Repairs (80% fixed, 20% variable) | 3,000 |
Fixed overheads | |
Depreciation | 16,500 |
Insurance | 4,500 |
Salaries | 15,000 |
Total overheads | 99,000 |
Estimated direct labour hours | 1,86,000 |
Solution: Flexible budget and overhead rates
Prepare a flexible budget for overheads on the basis of the data given. Ascertain overhead rates at 50%, 60% and 70% capacity
At 60% capacity (Rs) | |
---|---|
Fixed overheads | |
Depreciation | 16,500 |
Insurance | 4,500 |
Salaries | 15,000 |
Variable overheads | |
Indirect material | 6,000 |
Indirect labour | 18,000 |
Semi-variable overheads | |
Electricity (40% fixed, 60% variable) | 30,000 |
Repairs and maintenance (80% fixed, 20% variable) | 3,000 |
Total overheads | 93,000 |
Estimated direct labour hours = 1,86,000 hours
[Ans: Rs 85,900 (50%); Rs 1,00,100 (70%)]
Illustration 5
Draw up a flexible budget for overhead expenses on the basis of the following data and determine the overhead rates at 70%, 80% and 90% plant capacity:
Solution: Flexible budget
The expenses of producing 1,800 units in a factory having a capacity of producing 2,400 units are as follows:
Rs | |
---|---|
Materials | 4 per unit |
Labour | 3 per unit |
Factory expenses | |
Fixed | 720 |
Variable | 900 |
Variable selling expenses | 450 |
Office and administration expenses | 1,800 (fixed) |
What is the cost of production per unit if actual output and normal capacity are taken into consideration?
[Ans: Rs 9.15 and Rs 8.80]
Illustration 6
Prepare a manufacturing overhead budget and ascertain the manufacturing overhead rates at 50% and 70% capacities. The following particulars are given for 60% capacity:
Solution: Manufacturing overhead budget and ascertainment of overhead rates
Selling and Distribution Cost Budget Biscuit division
The expenses budgeted for the production of 10,000 units in a factory is as follows:
Rs (per unit) | |
---|---|
Materials | 70 |
Labour | 25 |
Variable overheads | 20 |
Fixed overheads (1,00,000) | 10 |
Variable overheads (direct) | 5 |
Selling expenses (10% fixed) | 13 |
Administration expenses (Rs 50,000) | 5 |
Distribution expenses (20% fixed) | 7 |
155 |
Prepare a budget for the production of (a) 8,000 units and (b) 6,000 units. Assume that the administration expenses are rigid for all levels of production.
[Ans: (a) Rs 12,75,400; (b) Rs 10,00,800]
Illustration 7
A department of company X attains sales of Rs 6,00,000 at 80% of its normal capacity and its expenses are as follows
Administration costs | |
Office salaries | Rs 90,000 |
General expenses | 2% of sales |
Depreciation | Rs 7,500 |
Rates and Taxes | Rs 8,750 |
Selling costs | |
Salaries | 8% of sales |
Travelling expenses | 2% of sales |
Sales office | 1% of sales |
General expenses | 1% of sales |
Distribution costs | |
Wages | Rs 15,000 |
Rent | 1% of sales |
Other expenses | 4% of sales |
Draw up flexible administration, and selling and distribution costs budget, operating at 90%, 100% and 110% of normal capacity.
Solution: Flexible budget of department
Draw up a flexible budget for overhead expenses on the basis of the following data and determine overhead rates at 70%, 80% and 90% capacity levels
At 80% capacity | |
---|---|
Variable overheads | |
Indirect labour | Rs 12,000 |
Indirect material | Rs 4,000 |
Semi-variable overheads | |
Power (30% fixed and 70% variable) | Rs 20,000 |
Repairs and maintenance (60% fixed and 40% variable) | Rs 2,000 |
Fixed overheads | |
Depreciation | Rs 11,000 |
Insurance | Rs 3,000 |
Others | Rs 10,000 |
Total overheads | Rs 62,000 |
Estimated direct labour hours | 1,24,000 hours |
[Ans: Overhead rate of recovery = Re 0.54 at 70%, Re 0.50 at 80% and Re 0.47 at 90%]
Illustration 8
A company expects to have Rs 37,500 as cash in hand on 1 April and requires you to prepare an estimate of the cash position during the three months April, May and June. The following information is supplied:
Other information is as follows:
Solution: Cash budget
The company needs overdraft facilities in May and June to the extent of Rs –1,06,050 and Rs 1,32,870, respectively.
A company wishes to arrange overdraft facilities with its bankers during the period April to June when it will be manufacturing mostly for stock. Prepare a cash budget for this period from the following data, indicating the extent of bank facilities the company will require at the end of each month:
50% of credit sales are realized in the month following sales and the remaining 50% in the following month. Creditors are paid in the month following the month of purchase. Wages are paid on the first of every next month.
Cash at bank on 1 April = Rs 25,000
Illustration 9
Prepare a cash budget for three months ending on 30 June from the following information:
Sales/debtors: 10% sales are on cash, 50% of credit sales are collected in the next month and the balance in the following month.
Materials, 2 months |
Wages, ¼ month |
Overheads, ½ month |
Solution: Cash budget
Wages = 75% of current month + 25% of previous month
Overheads = 50% of current month + 50% of previous month
ABC Company Ltd has given the following particulars. You are required to prepare a cash budget for the three months ending on 31 December 1997:
Sales/debtors: 10% sales are on cash basis, 50% of the credit sales are collected next month and the balance in the following month:
Creditors | — | Materials, 2 months |
— | Wages, 1/5 month | |
— | Overheads, 1/2 month |
[Ans: Closing balance in October = Rs 7,390; closing balance in November = Rs 8,180; bank overdraft for December = Rs 3,910]
Hint: Collection from debtors: October—Rs 18,450; November—Rs 19,800; and December—Rs 21,600.
Illustration 10
From the following budgeted figures, prepare a cash budget for three months till 30 June:
Expected cash balance on 1 April is Rs 25,000.
Other information:
Solution: Cash budget (April–June)
Illustration 11
Prepare a profit and cash budget for the first quarter (April–June) for A.B. Industries Ltd from the following information for the coming year:
Sale price | Material content | |
---|---|---|
Product A | Rs 75,000 | 60% of sales price |
Product B | Rs 25,000 | 60% of sales price |
Product A | Product B | |
---|---|---|
April | 50 | 50 |
May | 60 | 60 |
June | 70 | 50 |
Production for January, February and March was at 80% of the level of production in April.
Solution:
Budgeted income statement of A.B. Industries Ltd for the first quarter (April–June; amount in lakhs of rupees):
Working notes and assumptions:
Comment: The firm's operations are expected to generate a cash surplus of Rs 34,50,000 during the quarter. This surplus should be used to pay off the bank loan.
Illustration 12
Based on the following information, prepare a cash budget for ABC Ltd:
The company desires to maintain a cash balance of Rs 15,000 at the end of each quarter. Cash can be borrowed or repaid in multiples of Rs 500 at an interest of 10% per annum. Management does not want to borrow more cash than what is necessary and wants to repay it as early as possible. In any event, loans cannot be extended beyond four quarters. Interest is computed and paid when the principal is repaid. Assume that borrowings take place at the beginning and repayments are made at the end of the quarters.
Solution:
Illustration 13
From the following data, prepare a cash budget for the quarter October–December. Draft a note from the management accountant and financial controller to accompany this statement
Rs | ||
---|---|---|
Sales: from the months of August | August | 20,000 |
September | 25,000 | |
October | 30,000 | |
November | 30,000 | |
December | 32,000 |
Department A (Rs) | Department B (Rs) | |
---|---|---|
October | 3,000 | 4,000 |
November | 3,000 | 4,000 |
December | 3,200 | 3,800 |
The aforementioned estimates include the quarter's provision for depreciation amounting to Rs 900 for department A and Rs 750 for department B.
Solution: Cash budget for the period of receipts
Checked by:
Date:
Notes:
Illustration 14
A manufacturing company submits the following figures for product X for the first quarter of 2001:
Sales (in units) | January | 50,000 |
February | 40,000 | |
March | 60,000 | |
Selling price per unit = Rs 100 | ||
Targets for first quarter of 2002 | ||
Sales quantity increase = 25% | ||
Sales price increase = 20% |
Prepare a sales budget for the first quarter of 2002.
Solution: Sales budget for the first quarter of 2002
Illustration 15
A manufacturing company submits the following figures relating to product X for the first quarter of 1998
Sales targets | January | 65,000 units |
February | 50,000 units | |
March | 75,000 units | |
Stock position | 1 January 2001 (percentage of January 2001 sales) | –50% |
Stock position | 31 March 2001 | –40,000 units |
Stock position | End January, and February | –50% |
(Percentage of subsequent month's sales)
You are required to prepare the production budget for the first quarter of 2001.
Solution: Production budget for the first quarter of 1998
Illustration 16
Draw up a materials requirement budget (quantitative) from the following information:
Estimated sales of a product are 40,000 units. Each unit of the product requires 5 units of material A and 7 units of material B. Estimated opening balances at the commencement of the next year: finished product = 5,000 units; material A = 12,000 units; material B = 20,000 units; material on order—material A = 7,000 units and material B = −11,000 units. The desirable closing balances at the end of next year: finished product = 7,000 units; material A = 15,000 units; material B = 25,000 units; material on order: material A = 8,000 units and material B = 10,000 units.
Solution: Estimated production during the next year is not given in the question. It is calculated as follows: Estimated production = expected sales + desired closing stock of finished goods – estimated opening stock of finished goods – estimated opening stock of finished goods = 40,000 units + 7,000 units – 5,000 units = 42,000 units
Materials requirement budget (quantitative)
Material A (units) | Material B (units) | |
---|---|---|
Material required to meet the production target | 2,10,000 | 2,94,000 |
Material A at 5 units for 42,000 finished units | ||
Material B at 2 units for 42,000 finished units | ||
Desired closing balances of materials at the end of the budget period | 15,000 | 25,000 |
Estimated units of materials to be on order at the end of the budget period | 10,000 | 12,000 |
Total | 2,35,000 | 3,31,000 |
Less: estimated opening balances of materials at the beginning of the period | (12,000) | (20,000) |
2,23,000 | 3,11,000 | |
Less: estimated units of materials on order at the beginning of the budget period | 7,000 | 11,000 |
Total | 2,16,000 | 3,00,000 |
Illustration 17
The following details apply to an annual budget for a manufacturing company:
Calculate the budgeted figures quarterly and the annual purchases of raw material by weight and value.
Solution: Raw materials purchase budget (by weight and value)
Quarter I = 65 × 100 × 4 = 26,000 kg |
II = 60 × 110 × 4 = 26,400 kg |
III = 55 × 120 × 4 = 26,400 kg |
IV = 60 × 105 × 4 = 25,200 kg |
**Purchases |
Quarter I = 30% of 1,02,000 = 30,600 kg |
II = 30% of 1,02,000 = 30,600 kg |
III = 40% of 1,02,000 = 40,800 kg |
Illustration 18
Three articles X, Y and Z are produced in a factory. They pass through two cost centres A and B. From the data furnished here, compile a statement for budgeted machine utilization in both the centres:
Cost centres | ||
---|---|---|
A | B | |
X | 25 | 75 |
Y | 100 | 100 |
Z | 25 | 50 |
Cost centre | |
---|---|
A | 284 |
B | 256 |
Total | 540 |
Solution:
Calculation of units of production of different products:
Production = sales + closing stock − opening stock
X = 7,200 + 1,200 − 600 = 7,800 units
Y = 3,600 + 600 − 300 = 3,900 units
Z = 3,600 + 600 − 300 = 3,900 units
Machine utilization budget
Illustration 19
A glass manufacturing company requires you to calculate and present the budget for the next year from the following information
Sales | |
---|---|
Toughened glass | Rs 3,00,000 |
Bent toughened glass | Rs 6,00,000 |
Direct material cost | 60% of sales |
Direct wages | 20 workers at Rs 150 per month |
Factory overheads | |
Indirect labour works manager: Rs 500 per month | |
Foreman | Rs 400 per month |
Stores and spares | 2½% on sales |
Depreciation on machinery | Rs 12,600 |
Light and power | Rs 5,000 |
Repairs and maintenance | Rs 8,000 |
Other sundries | 10% on direct wages |
Administration, selling and distribution expenses | Rs 16,000 per year |
Solution: Master budget
The use of zero-base budgeting (ZBB) as a managerial tool has become increasingly popular since the early 1970s. It first came into existence when ex-President Jimmy Carter of the United States of America introduced it as a means of controlling state expenditure The underlying idea of ZBB is that there is no given base figure for a budget. A fresh budgeted figure is to be determined keeping in mind the circumstances and requirements.
The basic concept of ZBB is simple; budgeting starts from attach or zero. That is, every activity in an organization must be considered and its results evaluated. It is a method whereby all activities are re-evaluated each time a budget is formulated.
It implies that
From this chapter, one can understand the need to plan for the future and express the same in numbers so that projections are accurate. It also enables readers to understand the different types of budgets. It is not possible to have a fixed budget all the time, and at times business houses must rely on flexible budgets.
Objective-type questions
I. State whether the following statements are true or false
[Ans: 1—false, 2—false, 3—true, 4—false, 5—false, 6—true, 7—false, 8—false, 9—false, 10—true]
II. Choose the correct answer
Ans: (d)
Ans: (a)
Ans: (b)
Ans: (c)
Ans: (b)
Ans: (c)
Ans: (b)
Ans: (b)
Ans: (a)
Ans: (d)
Short answer-type questions
Essay-type questions
Control ratios
[Ans: capacity ratio = 111.11%; activity ratio = 122.22%; efficiency ratio = 110%)
[Ans: capacity ratio = 116.67%; activity ratio = 105%; and efficiency ratio = 90%]
Cash budgets
The company desires to maintain a cash balance of Rs 15,000 at the end of each quarter. Cash can be borrowed or repaid in multiples of Rs 500 at an interest of 10% per annum. Management does not want to borrow more cash than what is necessary and wants to repay borrowed cash as early as possible. In any event, loans cannot be extended beyond four quarters. Interest is computed and paid when the principal is repaid. Assume that borrowings take place at the beginning and repayments are made at the end of the quarters.
Hint: Interest is calculated only when the principal is repaid. Therefore, interest is calculated at the end of the third and fourth quarters when the principal is repaid.
Other information: Period of credit allowed by suppliers is 2 months; 25% of sales is for cash and the period of credit allowed to customers for credit sale is 1 month; delay in payment of wages and expenses allowed is 1 month; and income tax of Rs 25,000 is to be paid in June 1994.
[Ans: balance of cash in hand: April—Rs 53,000; May—Rs 81,000; June—Rs 91,000]
Sales/debtors: 10% sales are on cash basis, 50% of the credit sales are collected next month and the balance is collected in the following month:
Creditors | — | Materials, 2 months |
— | Wages, 1/5 month | |
— | Overheads, 1/2 month |
[Ans: Closing balance for October = Rs 7,390; Closing balance for November = Rs 8,180; Bank overdraft for December = Rs 3,910]
Hint: Collection from debtors: October—Rs 18,450; November—Rs 19,800; December—Rs 21,600.
1. A factory manufactures two types of products, X and Y. Product X takes 5 hours to make and Y requires 10 hours In a month of 25 effective days with 8 hours a day, 1,000 units of X and 600 units of Y were produced. The company employs 50 workers in the production department. The budgeted hours are 1,02,000 for the year. Calculate capacity ratio, activity ratio and efficiency ratio.
1a. Two articles X and Y are manufactured in a department. Their specifications show that 2 Xs or 8 Ys can be produced in 1 hour. The budgeted production for June 1998 is 200 Xs and 400 Ys. The actual production at the end of the month was 250 Xs and 480 Ys, and the actual hours spent on production were 160. Find the capacity, activity and efficiency ratios for June 1998. Also, find the calendar ratio if the actual working days during the month be 27 corresponding to 25 days in the budget.
2. Narayan Ltd produces two commodities, Good and Better, in one of its departments. Each unit takes 5 hours and 10 hours as production times for Good and Better, respectively. 1,000 units of Good and 600 units of Better were produced during March. Actual manhours spent in this production were 10,000. Yearly budgeted hours are 96,000. Compute the various control ratios.
3. The budgeted output of a factory specializing in the production of a single product at an optimum capacity of 6,400 units per annum amounts to Rs 1,76,048 as detailed here:
Rs | Rs | |
---|---|---|
Fixed costs | — | 20,668 |
Power | 1,440 | |
Repairs and so on | 1,700 | |
Miscellaneous and so on | 540 | |
Direct materials | 49,280 | |
Direct labour | 1,02,400 | 1,55,360 |
Total | 1,76,048 |
Due to possible impact on sales turnover by market trends, the company decides to have a flexible budget with a production of 3,200 and 4,800 units (the actual quantity proposed to be produced being left to a later date before the commencement of budget period). Prepare a flexible budget for production levels at 50% and 75%. Assuming the sales per unit is maintained at Rs 40 at present, indicate the effect on net profit. Administration, selling and distribution expenses continue at Rs 3,600.
4. Prepare a flexible budget for overheads on the basis of the following data. Ascertain the overhead rates at 50%, 60% and 70% capacity.
At 60% capacity (Rs) | |
---|---|
Variable overheads | |
Indirect material | 6,000 |
Indirect labour | 18,000 |
Semi-variable overheads | |
Electricity (40% fixed, 60% variable) | 30,000 |
Repairs (80% fixed, 20% variable) | 3,000 |
Fixed overheads | |
Depreciation | 16,500 |
Insurance | 4,500 |
Salaries | 15,000 |
Total overheads | 93,000 |
Estimated direct labour hours | 1,86,000 |
5. Draw up a flexible budget for overhead expenses on the basis of the following data and determine the overheads rates at 70%, 80% and 90% plant capacity:
6. Prepare a manufacturing overhead budget and ascertain the manufacturing overhead rates at 50% and 70% capacities. The following particulars are given at 60% capacity:
Variable overheads | |
Indirect material | Rs 6,000 |
Indirect labour | Rs 18,000 |
Semi-variable overheads | |
Electricity (40% fixed) | Rs 30,000 |
Repairs and maintenance (20% variable) | Rs 3,000 |
Fixed overheads | |
Depreciation | Rs 16,500 |
Insurance | Rs 4,500 |
Salaries | Rs 15,000 |
Total overheads | Rs 93,000 |
Estimated direct labour hours | 1,86,000 hours |
7. A department of Company X attains sales of Rs 6,00,000 at 80% of its normal capacity; its expenses are as follows:
Administration costs | |
Office salaries | Rs 90,000 |
General expenses | 2% of sales |
Depreciation | Rs 7,500 |
Rates and taxes | Rs 8,750 |
Selling costs | |
Salaries | 8% of sales |
Travelling expenses | 2% of sales |
Sales office | 1% of sales |
General expenses | 1% of sales |
Distribution costs | |
Wages | Rs 15,000 |
Rent | 1% of sales |
Other expenses | 4% of sales |
Draw up flexible administration, selling and distribution costs budget, operating at 90%, 100% and 110% of normal capacity.
8. A company expects to have Rs 37,500 as cash in hand on 1 April and requires you to prepare an estimate of its cash position during the three months April, May and June. The following information is supplied:
Other information:
Prepare a cash budget for the three months ending on 30 June from the following information:
Sales/debtors: 10% sales are on cash, 50% of the credit sales are collected next month and the balance in the following month.
Creditors | Materials, 2 months |
Wages, ¼ month | |
Overheads, ½ month |
10. From the following budgeted figures, prepare a cash budget for the three months till 30 June:
Expected cash balance on 1 April is Rs 20,000.
Other information:
11. Prepare a profit and cash budget for the first quarter, April–June, for A.B. Industries Ltd from the following information for the coming year:
Sales price | Material content | |
---|---|---|
Product A | Rs 75,000 | 60% of sales price |
Product B | Rs 25,000 | 60% of sales price |
Product A (units) | Product B (units) | |
---|---|---|
April | 50 | 50 |
May | 60 | 60 |
June | 70 | 50 |
Production for January, February and March was at 80% of the level of April's production.
12. Based on the following information, prepare a cash budget for ABC Ltd:
The company desires to maintain a cash balance of Rs 15,000 at the end of each quarter. Cash can be borrowed or repaid in multiples of Rs 500 at an interest of 10% per annum. Management does not want to borrow more cash than what is necessary and wants to repay the amount as early as possible. In any event, loans cannot be extended beyond four quarters. Interest is computed and paid when the principal is repaid. Assume that borrowings take place at the beginning and repayments are made at the end of the quarters.
13. From the following data, prepare a cash budget for the quarter October–December. Draft a note from the management accountant and financial controller to accompany this statement.
Rs | ||
---|---|---|
(a) Sales: from the months of August | August | 20,000 |
September | 25,000 | |
October | 30,000 | |
November | 30,000 | |
December | 32,000 |
Department A (Rs) | Department B (Rs) | |
---|---|---|
October | 3,000 | 4,000 |
November | 3,000 | 4,000 |
December | 3,000 | 3,800 |
The aforementioned estimates include the quarter's provision for depreciation amounting to Rs 900 for department A and Rs 750 for department B.
14. A manufacturing company submits the following figures for product X for the first quarter of 2001:
Sales (in units) | January | 50,000 |
February | 40,000 | |
March | 60,000 |
Selling price per unit = Rs 100
Targets of first quarter 2002:
Sales quantity increase by 20%
Sales price increase by 10%
Prepare sales budget for the first quarter of 2002.
15. A manufacturing company submits the following figures for product X for the first quarter of 1998:
Sales targets | January | 60,000 units |
February | 48,000 units | |
March | 72,000 units | |
Stock position | 1 January 2001 (percentage of January 2001 sales) | –50% |
Stock position | 31 March 2001 | –40,000 units |
Stock position | End January, and February | –50% |
(Percentage of subsequent month's sales)
You are required to prepare production budget for the first quarter of 2001.
16. Draw up a material requirement budget (quantitative) from the following information:
Estimated sales of a product are 40,000 units. Each unit of the product requires 3 units of material A and 5 units of material B.
Estimated opening balances at the commencement of the next year: finished product = 5,000 units; material A = 12,000 units; material B = 20,000 units; material on order: material A = 7,000 units and material B = −11,000 units.
Desirable closing balances at the end of next year: finished product = 7,000 units; material A = 15,000 units; material B = 25,000 units; material on order: material A = 8,000 units and material B = 10,000 units.
17. The following details apply to an annual budget for a manufacturing company:
Calculate the budgeted figures for quarterly and annual purchases of raw material by weight and value.
18. Three articles X, Y and Z are produced in a factory. They pass through two cost centres A and B. From the data furnished, compile a statement for budgeted machine utilization in both the centres:
Cost centres | ||
---|---|---|
A | B | |
X | 30 | 70 |
Y | 200 | 100 |
Z | 30 | 20 |
Cost centre | |
---|---|
A | 284 |
B | 256 |
Total | 540 |
19. A glass manufacturing company requires you to calculate and present the budget for the next year from the following information:
Sales | |
Toughened glass | Rs 3,00,000 |
Bent toughened glass | Rs 5,00,000 |
Direct material cost | 60% of sales |
Direct wages | 20 workers at Rs 150 per month |
Factory overheads | |
Indirect labour works manager: Rs 500 per month | |
Foreman | Rs 400 per month |
Stores and spares | 2½% on sales |
Depreciation on machinery | Rs 12,600 |
Light and power | Rs 5,000 |
Repairs and maintenance | Rs 8,000 |
Other sundries | 10% on direct wages |
Administration, selling and distribution expenses | Rs 14,000 per year |
3.14.131.180