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14

Budgetary Control

Planning is an important function in any sphere of life or organization or government. Planning is the road map to movement without which it cannot be possible to reach the desired destination. Likewise, financial planning is very essential starting from home, business, up to the level of government. This financial plan is popularly known as “budget”. It is a plan for the future action. It is expressed in monetary terms. A household budget is a plan, item by item, with respect to sources of income and how much out of this can be spent for various activities of a family such as food, cloth, household expenses, health, children education, travelling, recreation and so on. Similarly, a business entity’s budget is a plan enumerating details of how funds would be spent on raw materials, labour, capital goods, expenses of various departments and so on, as well as how the necessary funds are to be obtained to meet the expenses. This chapter deals with the significance of budgets, different types of budgets and preparation of different budgets pertaining to business enterprises.

14.1 MEANING AND DEFINITION OF BUDGET, BUDGETING AND BUDGETARY CONTROL

Budget: A budget is plan for some specific future period. It is an estimate, expressed in monetary terms in advance. The terminology of CIMA defines a budget as, “a plan quantified in monetary terms prepared and approved prior to a defined period of time usually showing planned income to be generated and/or expenditure to be incurred during that period and the capital to be employed to attain a given objective”. The essential ingredients of a budget are:

1. It is a plan for future action, in monetary terms.
2. It is prepared in advance, for a defined future period.
3. It is approved prior to the commencement of the specified period.
4. It defines the objectives of the firm.
5. It prescribes guidelines to achieve the objectives.
6. It is also used for control.

Budgeting: The process of preparation, implementation and the operation of budgets is referred to as budgeting. Its main features are:

1. It is a method of thinking ahead for a specified time.
2. It tries to solve the problems that may arise.
3. Its main objective is to fixing and achieving goals for different levels of business organizations.
4. Goals are forecast and summarized in the form of projected financial statements.
5. Budgeting is a process of allocation of resources.

Budgetary control: Budgetary control is a system of planning and controlling costs. The terminology of CIMA defines as follows: “Budgetary control is 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 following are the steps involved in budgetary control:

1. Establishment of budgets.
2. Measurement of actual performance.
3. Comparison of actual performance with budgeted performance.
4. Analysis of the causes of variations.
5. Reporting to take right action at the right time, thereby fixing responsibility to achieve the goals.
6. Revision of budgets, if necessary.

Budgetary control may be exercised either financially or physically. It adopts the principle of “management by exception”.

Interplay these three factors—budget, budgeting and budgetary control—that is, their relationship with one another may be explained as follows:

“Budgets are the individual objectives of the department, whereas budgeting may be said to be the act of building budgets. Budgetary control embraces all this and in addition includes the science of planning the budgets themselves and the utilization of such budgets to effect and overall management tool for the business planning and control”.

14.2 FORECAST AND BUDGET

Following are the differences between budget and forecast:

Basis of Distinction	Budget	Forecast
1. Meaning	Budget is an operating and financial plan for a management action.	A forecast is an assessment of probable future events.
2. Conditions	Budget is based an planned conditions.	A forecast is made for anticipated conditions.
3. Period of time	A budget is prepared for a defined and specific period of time.	A forecast can be made for any time period.
4. Tool	A budget is a tool for planning and control.	A forecast is only a planning device.
5. Monetary terms	A budget is expressed in monetary terms.	A forecast may or may not be expressed in monetary terms.
6. Ends and means	A budget begins where forecasting ends. Elements of forecasting are included in budgets.	Forecasting is the beginning step for budget. It ends with the forecast of likely events.
7. Scope	Budgets have limited scope.	Forecasts have wider scope. These can be made even in the areas where budgets cannot be prepared.

14.3 OBJECTIVES OF BUDGETARY CONTROL

The objectives of budgetary control are as follows:

1. Basic purpose: A budgetary control system serves the basic purposes, namely, planning, coordination and control.
2. Cooperative spirit: Different levels of management act in a unified and co-operative manner to achieve the goals set by the budget. Budgetary control facilitates this task.
3. Maximum profitability: Another important objective of budgetary control is to achieve a maximum profit-ability by planning.
4. Centralized control: It facilitates a centralized control with delegation of authority as well as responsibility.
5. Optimum use of resources: Budgetary control aims at an optimum usage of resources to derive a maximum monetary gain.
6. Coordination: The budgetary control facilitates coordination among various levels of activities, like purchase, production, administration, and selling and distribution in order to achieve the targeted plan of action.
7. Execution: Another objective of budgetary control is to see that all activities are moving in the same direction to achieve the goals and to detect any deviation from it. It aims at a proper execution by comparing the actual performance against the budget.
8. Remedial measures: If any deviation is noticed, the role of budgetary control is to take a remedial action at the proper time.
9. Revision: If remedial measures are not adequate, it facilitates the task of revision of budgets.

14.4 ADVANTAGES OF BUDGETARY CONTROL

1. Planning: Budgetary control, by proper planning utilizes capital and resources to maximize profits.
2. Control: As a device of control, by correcting deviations and making remedial measures immediately.
3. Coordination: The task of managerial coordination is facilitated (between various departments) by the use of budgetary control.
4. Delegation of authority: A budgetary control system facilitates delegation of authority. Delegation of authority without responsibility is futile. Here, budgetary control acts as an effective tool of responsibility accounting.
5. Criteria for evaluation: As the nature of evaluation criteria are more objective, the performance in each area of a manager’s operation is measured objectively without any bias.
6. Communication: A budgetary control facilitates the task of communication among the departments, due to proper coordination.
7. Management by exception: It facilitates management by exception. Reports are provided under this principle of management by exception. Only deviations are looked into through variance analysis.
8. Motivation: Generally, the performance of managers is judged against budgets. Managers are properly motivated to accomplish the target. Executives are forced to think, act and achieve the goal.
9. Review: It corrects the deviations from the pre-determined target by reviewing at various stages. At times, it helps to restate and revise its fundamental goals, policies and procedures.
10. Fore-runners of standard costs: A budgetary control creates favourable conditions to adopt the principle of standard cost in all divisions except the production division.

14.5 LIMITATIONS OF BUDGETARY CONTROL

Although the budgetary control system is a powerful tool of planning and control, it suffers from serious limitations which are as follows:

1. Based on estimates: Budgetary control starts with the formulation of budgets. Budgets are mere estimates. Hence, a system which is merely based on estimates may not be accurate.
2. Conflict of goals: Often, budget goals are set without considering the overall atmosphere of the business entities, which at times are at cross roads. When such goals contradict each other, the real target cannot be shot at precisely.
3. Changing economy: Planning well in advance may fail to take into account, the economic scenario (inflation or deflation) and policies of the government. Such factors cannot be predetermined with accuracy. Hence, estimates cannot be accurate which may land in undesirable consequences.
4. Ambitious targets: Due to overenthusiasm, the targets set may be unachievable. Because of such targets, the productivity would fall ruining the efficiency.
5. Rigidity: A budget having too many details, too many regulations and a very strict implementation may be counter-productive. It should be flexible and simple to implement.
6. Time factor: The time limit set by budgets may not be realistic. During economic recession and some unforeseen situations, giving too much importance to time factor may mar the entire activities of the enterprises.
7. Costly: Generally, the cost of operation of a budgetary system is high. Benefits may upbeat the cost.

14.6 PRE-REQUISITES FOR THE ADOPTION OF BUDGETARY CONTROL SYSTEM

The following preliminaries are to be considered for the effective implementation of a sound system of budgetary control:

Pre-requisites for a successful implementation of budgetary control system:

1. Organizational structure: An organization chart setting out in unequivocal terms the responsibilities of each executive should form the basis of a budgetary control system. The strength of the edifice depends to a large extent on the well-laid organization chart. A structure of hierarchy clearly showing the lines of authority, powers delegated, responsibility, each one’s position in relation to others forms an important part in a good budgetary control system.
2. Budget centres: A section of the organization carried out with the specific purpose of attaining goals set up, is referred to as a budget centre. Budget centres have to be established with proper planning, and separate budgets have to be prepared for each such budget centres.
3. Clear goals: Budgetary control system is a tool to achieve the goals of an organization. Hence, the goals should be crystal clear and well defined in unambiguous terms.
4. Budget committee: Usually, the preparation of budgets will be taken by Cost and Works Accountant in smaller organizations. But in a larger enterprise, this responsibility falls on the shoulders of a budget committee. Hence, a proper constitution of a budget committee is a vital factor for the successful functioning of this system.
5. Key factor (or) Budget factor: In the preparation of budgets, the principal budget factor is the starting point as all the budgets must be centred on it. As the key factors are large and vary with activities of an organization, care should be taken for proper identification and ways of overcoming of the key factors.
6. Budget manual: A document which sets out, inter alia the responsibilities of the executives engaged in the required forms and records that are necessary for budgetary control is known as “budget manual”. A proper budget manual is necessary which serves as a guide for all the functional heads. It usually enlists plan, procedure of operation, time, and so on.
7. Budget period: Specifying the time within which the goals are to be achieved is another requirement for an efficient system of budgetary control. If the period is a longer one, it is better to be supplemented by a short-term, periodically. This depends on (i) the nature of business and (ii) the factor of control.
8. Level of activity: Establishing a normal level of activity is essential to prepare any budget. A satisfactory level of an activity has to be determined by taking into account the past results, efficiency of labour and other working conditions.
9. Accounting system: Without proper accounting system, no tangible and meaningful results can be achieved. As such an efficient system of accounting is indispensable to record data in tune with budgetary control system.
10. Communication: Proper system of communication and reporting between various levels of management is another important pre-requisite for the adoption of budgetary control system.

14.7 INSTALLATION OF BUDGETARY CONTROL SYSTEM

Steps required for installing an effective budgetary control system are as follows:

Step 1: The first step is setting up of a definite plan of an organization. For this, a well-defined organizational chart should be prepared. An organizational chart will define the functional representatives of executives who are responsible for accomplishment of organizational executives. This will show the lines of responsibility of each executive in relation to others. A sample of organizational chart is shown as follows:

 

Organizational chart shows:

1. Hierarchical position of executives in an organization.
2. Functional responsibility of a particular executive.
3. Delegation of authority to various levels.
4. Relative position with respect to others.

This chart shows that Chief Executive is the head of this system. He delegates his authority to the Budget Officer. The latter will be responsible for coordinating the activities of other functional managers. All these functional managers are responsible for their respective areas (activities) as shown in the chart. Accountant’s role is of vital importance in the preparation of the budgets of each of these activities.

Step 2: Setting up of a Budget Centre needs greater attention. A budget centre is a section of an organization or an undertaking defined for the purpose of budgetary control.

Budget centres should be established and separate budgets have to be prepared for these centres. The purpose of setting up budget centres is that these centres should watch the sections of the organization and report whether the goal is achieved or not. Separate budgets are to be prepared for each department.

Step 3: Budget Manual is a document which contains standing instructions with respect to the procedures that are to be followed and the time schedules that are to be observed. It is a guide to the Budget Officer and all functional heads. The main contents of budget manual are:

1. The date–time limit for submission of preliminary forecasts and plans.
2. The persons to whom this has to be submitted.
3. Important items for each forecast.
4. Categorization of expenses and the manner of dealing with such expenses.
5. Finalization of functional budgets.
6. Compilation into the master budget.
7. The prescribed forms to make reports and periodicity of reports, to whom the reports have to be sent.
8. Corrective action and remedial action reports.
9. Plan of revision, if necessary.
10. Matters which have to be decided only with the approval of top-level management.

The prime object of this manual is to inform all the executives well in advance regarding the procedures to be followed and the different forms to be used, to avoid frequent instructions from the top of the management.

Step 4: Budget Controller is a person who assists in the preparation of various budgets, their coordination and compiling them into the master budget. He is the chief of the budget committee. He is staff man and hence, his role is not to issue any instructions. His main function is to compile the information relating to various budget centres and report them to the management.

Step 5: Usually, the presentation of budgets is the responsibility of the Cost Accountant in smaller companies, whereas in bigger companies the preparation of budget is entrusted with a group of executives, known as Budget Committee. The Budget Committee is formed by selecting executives of various functions, for example, Purchasing Manager, Production Manager, Sales Manager, and so on. Usually, the Chief Executive acts as the Chairman. Budgets would be prepared by Functional Managers for their respective activities. For approval, it has to be submitted to the Budget Committee. The Budget Committee after a perusal, with adjustments, will coordinate and compile them as the Master Budget. Some of the main functions of the Budget Committee are as follows:

1. To assist the functional (departmental) managers in the preparation of budgets by providing all the necessary information.
2. To receive and review the budgets (estimates) from the respective functions (departments).
3. To resolve the conflicts between departments on the budget matter.
4. To recommend changes and approve the revised budget.
5. To prepare the master budget on the basis of approved functional budgets.
6. To compare the budget with actual performance and make periodic reports.
7. To recommend action to be taken on the basis of variance analysis.
8. To decide the general policies of the management in relation to the budget.
9. To make recommendations for the budget manual.

Step 6: Budget Period refers to the period for which a budget is prepared. CIMA defines budget period as, “the period for which a budget is prepared and used, which then may be subdivided into control periods”. There is no standard yardstick for classification of periods. But the budget periods are influenced by (i) the nature and type of business and (ii) the control aspect. This may be broadly classified into long-term budget, fiscal-period budget and short-term budget.

The factors that determine the length of the budget period are as follows:

1. In case the business is of a seasonal nature, then the budget period should cover one seasonal cycle.
2. In the case of manufacturing concerns with heavy capital expenditures, the budget period should be sufficiently long enough to complete production of various products.
3. The long-term budgets should be supplemented by short-term budgets.
4. The budget period should be long enough to allow for the financing of production quite well in advance of actual needs.
5. The budget period may be determined by the requirements and outlook of person whose activities are planned. For example, a foreman has to exercise his day-to-day control over activities, where very short-term budgets are required, where as a functional executive may not be concerned with short-term budgets at all.
6. The budget period should coincide with the financial accounting period to facilitate the comparison of the actual results with the budgeted estimates.

14.8 BUDGET FACTOR OR KEY FACTOR

The technology of CIMA defines budget factor as, “a factor which will limit the activities of an undertaking and which is taken into account in preparing budgets”. It has been defined as the factor and the extent of whose influence should be assessed to ensure that the functional budgets are reasonably capable of fulfilment. Principal budget factors (key factors or limiting factors) that can influence the targets are as follows:

Raw materials:

1. Shortage of raw materials due to non-availability of supply.
2. Shortage due to restrictions imposed by government agencies such as license, quota, policies of government and so on.

   Labour:

3. General shortage.
4. Shortage of skilled labour.

   Plant capacity:

5. Shortage due to capital requirements.
6. Shortage due to lack of space.
7. Shortage due to capacity of machineries.
8. Shortage due to import restrictions.
9. Bottlenecks in key process.

   Sales activity:

10. Low demand for product.
11. Shortage of efficient salesmen.
12. Insufficient sales-promotion activities.
13. Inadequate warehousing facilities.

    Management:

14. Policies of management.
15. Shortage of inefficient executives.

    Capital or resources:

16. Inefficient use of working capital.
17. Shortage of working capital.

The key factors are of a temporary nature. These can be overcome by appropriate management actions. For example, limitation imposed by sales activities can be overcome by increasing the sales-promotion activities, efficiency of salesmen, after-sales service and so on. Plant capacity may be improved by way of better planning, supervision, work study, product simplification, sub-contracting or expanding plant and the like.

In case a limiting factor cannot be overcome, then the entire budget involving all functions will have to be built around the factor. To put it in other words, in the preparation of budgets, the principal budget factor is the starting point and all the other budgets must be centered around it. For example, a factory has the production capacity of 1,00,000 units per year, whereas the demand is only 50,000 units in the market. In such a situation, the sales demand is the key factor. Hence, the sales budget has to be prepared first and other budgets such as production, plant capacity and so on should follow suit. If there are a number of key factors at the same time of preparation of budgets, the budget committee must assess the relative influence. To maximize the profitability, a key factor must be got over by any means. In case it is not possible to overcome such factors, all efforts have to be made at least to minimize its adverse impact.

14.9 BUDGET REPORTS

Budget reports depict the comparative figures with respect to actual expenditure and budgeted expenditure. They are to be prepared periodically. A budget report should reveal the responsibility of functional heads stating the sufficient reasons for the variances, if any, so as to facilitate the task of taking corrective and remedial action. It is very important that the budget report has to be based on the principle of exception (management by exception). In the budget report, both favourable and adverse variations should be furnished with necessary comments. The variations from budgets for item of expenses have to be determined. Then only it would be easy to identify the responsibility and to make corrective action. Follow-up action is necessary till the desired outcome occurs.

Specimen of budget report is shown as follows:

14.10 CLASSIFICATION OF BUDGETS

There are many categories of budgets. The basis of preparation of one type of budget varies from the other. On the bases adopted, budgets may be classified into different categories. Budgets may be classified on the basis of (a) the coverage; (b) the capacity; (c) the periods; and (d) the conditions. This is diametrically represented as follows:

 

Let us discuss one by one:

14.10.1 Functional and Master Budgets

A functional budget is a budget which is based on any of the functions (activities) in a business organization. e.g., production, sales, administration and so on. All functions are interrelated. When a forecast relating to a function is approved, then it is termed as a “functional budget”. For example, “sales” is an important function (activity). When a forecast of sales for a specified period is approved by sales department, then that functional budget is referred to as the sales budget.

A master budget is nothing but the consolidation of all functional budgets. Master budget is shown in the form of

1. budgeted (targeted) profit and loss account (P&L A/c) and
2. budgeted balance sheet.

14.10.1.1 Functional Budgets

Sales budget:

1. The sales budget is a forecast of total sales, expressed in monetary and/or quantitative terms.
2. The sales budget is prepared first. The sales forecast is the starting point of sales budgeting, where as a sales forecast is basically an estimate, a prediction of the customer’s demand, and a reflection of the market situation.
3. Internal factors to be considered in the preparation of sales forecast are:
   1. Pricing policies.
   2. Trend in sales.
   3. Advertisement and publicity.
   4. New products.
   5. Relative profitability of products.
   6. Size of sales force.
   7. Plant capacity.
   8. Expansion proposals.
4. External factors to be considered in the preparation of sales forecast are:
   1. Population—Composition and purchasing power.
   2. Consumer tastes and habits.
   3. Substitutes available in the market and their price.
   4. Nature and extent of competition.
   5. Economic scenario.
   6. Government regulations – taxes, import and export policies etc.
   7. Seasonal and cyclic fluctuations.
5. A sales forecast may be prepared under the following classifications:
   1. Products or groups of products.
   2. Areas and territories (Geographically).
   3. Sales force.
   4. Types of customers, e.g., government, export, wholesalers, retailers, specified groups etc.
6. Factors to be considered in the preparation of sales budget are:
   1. Orders in hand.
   2. Past sales.
   3. Past sales by competitors.
   4. Sales force resources.
   5. Areas not covered so far.
   6. Movements in aggregate consumer demand and in the market share of the firm.
   7. Movements in aggregate consumer demand and in the market share of competitors.
   8. Plant capacity.

The sales budgets are generally prepared by sales managers and at times by market-research bureaus.

Production budget:

1. It is a forecast of production for the budget period, which is expressed in units or standard hours.
2. Key factors act limiting the volume of production and proper care should be taken to consider some important key factors such as:
   1. Plant capacity.
   2. Raw materials.
   3. Labour.
   4. Power.
3. To minimize the impact of key factor, the following steps are to be undertaken:

   Key Factor	Steps to Minimize Their Impact
   (i) Plant capacity	• change of plant with largest technology.
   	• installation of balancing equipment.
   	• improving the plant layout.
   (ii) Raw materials	• Use of alternate raw material.
   	• Product modification to reduce in-take of raw material.
   	• Redesign the product.
   (iii) Labour	• Overtime working.
   	• Introduction of incentive schemes.
   	• retraining workmen.
   	• replacing labour-oriented device.
   (iv) Power	• Installing captive power units.
   	• Diesel generators for power supply.
   	• Low-power consumption devices.

4. The production budget has to be integrated with the sales budget.
5. An optimum balance has to be struck between sales, production and stock levels.

Materials budget:

• This budget represents the purchases to be made during the budget period, expressed in quantity or money.
• This budget shows the opening stock of each raw material, indirect materials, purchased services, their closing stock and the purchases to be made during the budget period.
• Factors to be considered while preparing the materials budget are:
  1. Production budget.
  2. Inventory policy.
  3. Negotiated landed cost of raw materials, indirect materials, and purchased services.
  4. Available stocks.
  5. Re-order level.
  6. Economic-order quantity.
  7. Standard usage.
• It enables to prepare the purchase schedule, which is, in turn, used for cash budget.

Direct-labour budget:

• This budget shows the number of direct workers required.
• Direct labour is a classified product centre-wise.
• Direct-labour budget must be in agreement with the standard hours of production, as given in the production budget.
• Labour cost is then estimated by multiplying the number of workers in each grade by the standard wage rate and totalling the labour cost of all grades.
• It is of much useful to the personnel department to recruit labour at the needed hours and to provide training programme and allied activities to the labour force.
• It is also useful for preparing cash budget and cost of sales budget.

Factory-overhead budget:

Overheads are generally classified into fixed and variable parts. As fixed overheads do not vary with the volume of production, they can be estimated with ease, while variable overheads tend to vary with the volume of the products, as their estimation requires much labour.

Steps to be taken to prepare this overhead budget are as follows:

1. Classification of expenses into (a) fixed (b) variable and (c) semi-variable categories.
2. Departmentalization of expenses.
3. Determining the level of activity for setting the overhead rates.
4. Computing and setting variable overhead rates.

The factors that should be considered while preparing the factory overhead budget are:

1. Past year’s expenses.
2. Resources – available.
3. Comparison with similar firms.
4. Review of estimate of expenses for each cost centre.

Administration-overhead budget:

• The administrative expenses comprise items of expenditure with respect to higher management functions.
• It includes expenses of the legal, financial accounting and other service departments.
• It is fixed in nature, mostly. Hence, establishing budgets for such items is not difficult.
• The budgeted expenses are determined (i) on the basis of previous year’s figures and (ii) on the minimum requirements of each department.
• A detailed break-up of the total administration cost is shown in the budget.

Selling and distribution of overhead budget:

• Selling expenses include (i) direct-selling expenses for example, salary, wages and commission of sales personnel; (ii) advertisement and publicity expenses; and iii) sales-office-establishment expenses.
• Factors that influence direct-selling expenses are:
  1. Basis of remuneration to sales personnel, e.g., salary or commission on sales or a combination of both.
  2. Appointment of selling agents.
  3. Inclusive schemes for agents as well as the selling personnel.
  4. Expansion of sales to a new area.
  5. Withdrawal of sales from an existing area.
• Selling expenses are to be segregated into fixed and variable elements.
• Distribution expenses refer to those expenses which relate to making the products of the firm available to customers in saleable condition. For example, cost of secondary-packing expenses, warehousing expenses, insurance etc.
• Separate budgets are to be established for fixed or variable selling and distribution expenses.

Till now, we have discussed various operating budgets. Now, let us discuss financial budgets. Financial budgets are those which incorporate financial decisions of an organization. The financial budgets are cash budget, working-capital budget, projected P&L A/c, projected balance sheet and capital budget.

Capital budget:

• This is also known as capital-expenditure budget.
• Capital-expenditure budget is the planned outlay on fixed assets during the budget period.
• The capital expenditure which is to be included in the capital budget should be shown under the following heads:

  (i) Statutory projects; (ii) Replacement projects; (iii) Modernization projects; (iv) Expansion projects; (v) Continuing projects; and (vi) Balancing projects.

• Capital budget shows the amount of original appropriation, expenditure to date, new appropriation made, amount of appropriation not utilized and balance amount carried forward to next year.
• Generally, the budget manuals lay down the various levels of authority for capital expenditure.

We have seen different types of budgets, their inherent nature, factors which affect different categories and the other intricacies involved in them.

Preparation of different categories of budgets is explained step by step by way of illustrations in the forthcoming pages:

Model 1: Sales budget

ABC & Co. Ltd manufactures two products A & B and operate two sales divisions for sales. For the purpose of submission of sales budget to the budget committee, the following information is available:

Budgeted sales for the 6 months that ended on 31 December 2009 were as follows:

Product	Division I	Division II
A	800 @ Rs. 10	1,200 @ Rs. 10
B	400 @ Rs. 9	1,000 @ Rs. 9

Actual sales for the same period are as follows:

Product	Division I	Division II
A	1000 @ Rs. 10	1,400 @ Rs. 10
B	200 @ Rs. 9	800 @ Rs. 9

At the meeting of divisional sales managers, the following decisions have been taken:

1. The price of product A should be increased by 10%, as there is a high potential demand for product A.
2. As the product is not selling at the expected level, the selling price should be reduced by Re 1.

On the basis of these price changes and reports from salesman, the divisional sales managers have made the following estimates:

Product	Division I	Division II
A	20	25
B	10	20

Required: Prepare a sales budget for the 6 months that ended on 30 June 2010.

Solution

NOTE:

1. The necessary columns have to be drawn, to prepare sales budget, as shown in the following.
2. Actual sales for the period that ended on 31 December 2009 has to be entered as given in the question.
3. Budgeted sales for the same period also to be entered as given in the question.
4. But for the budgeted sales for the 6 months that ended need certain changes as per the sales manager’s decision.

Accordingly, for Division I, changes are to be worked out as follows:

Product A → Division I: Percentage increase over previous budget (i.e.) budget figures for the year that ended on 31 December 2009.

Product B → Division I:

 

                  Increase to be made = 10%.

Similarly, for Division II, calculations have to be made and entered in the sales budget.

 

Result

1. Actual and budget sales for 31 December 2009 varies by 200 units with value Rs. 400 (Rs. 33,000 – Rs. 32,600).
2. Value will increase to Rs. 40,180 with increase in units to 4,100 for the period ending 30 June 2010.

Illustration 14.1

Model 2: Production budget

You are required to prepare a production budget for 6 months ending 31 March 2010 for a factory producing four products from the following information:

Solution

Formula:

 

 

Applying this formula, number of units to be produced for each type of product has to be calculated and finally, all are added to find the total units that are to be produced.

 

Illustration 14.2

Model 3: Production budget

From the following information, prepare a production budget for ABC Co. Ltd assuming that

1. There is no loss in production.
2. Normal loss in production – 5% and 10% for products X and Y, respectively.

Information:

Solution

Total number of units to be produced is to be found out in the same manner as discussed in the previous illustration.

Ans:

1. When there is no loss in production:

   Units to be produced: X = 7,650 units & Y = 9,450 units.

2. When there is loss in production:

Illustration 14.3

Model 4: Materials purchased or Procurement budget

The sales director of a manufacturing company reports that he plans to sell 30,000 units of a product in the next year.

The production manager consults the storekeeper and casts his figures as follows:

Two kinds of raw materials X and Y are required to manufacture the product. Each unit of the product requires 3 units of X and 4 units of Y.

The estimated opening balances at the commencement of the next year are:

Finished product: 5,000 units: X = 6,000 units and Y = 7,000 units.

The desirable closing balance at the end of the next year are:

Finished products: 8,000 units: X = 7,500 units and Y = 10,000 units.

You are required to draw up a quantitative chart showing material-purchase budget for the next year.

Solution

NOTE: First, the units to be produced have to be calculated (as in the production budget) by using the formula:

* Units to be produced + Sales – Desired closing stock – Desired opening stock = 30,000 + 8,000 – 5,000 = 33,000 units.

Then, convert this into the needed raw materials and tabulate as follows:

Illustration 14.4

Model 5: Production and purchase budgets

The following are the estimates of a company for 8 months ending 31 December 2009:

Month		Estimated Sales (Units)
1.	April 2009	8,000
2.	May 2009	10,000
3.	June 2009	12,000
4.	July 2009	8,000
5.	August 2009	7,000
6.	September 2009	10,000
7.	October 2009	13,000
8.	November 2009	15,000

As a matter of policy, the company maintains the closing balance of finished goods and raw materials as follows:

 

Stock item	Closing balance of months
Finished goods	50% of the estimated sales for the next months.
Raw materials	Estimated consumption for the next month.

 

Every unit of production requires 2 kg of raw material costing Rs. 10 per kg.

You are required to prepare (a) production budget (in units) and (b) raw-material-purchase budget (in units and cost) of the company for the period ending 30 September 2009.

 

[ICWA – Modified]

Solution

Stage I: Production budget is to be prepared in the usual way.

 

Important Note: Closing stock of previous months = Opening stock of next month.

Stage II: Raw-material-purchase budget has to be prepared as follows:

 

Illustration 14.5

Model 6: Material-purchase budget and Direct (labour) wages budget

XL Co. Ltd manufactures two products using one type of material and one grade of labour. Following is an extract from the company’s working papers for the next period’s budget:

Particulars	Product X	Product Y
Budgeted sales (unit)	6,300	8,400
Budgeted material consumption per product (kg.)	3	5
Budgeted material cost, Rs. 10 per kg.
Standard hours allowed per product
Budgeted wage rate, Rs. 5 per hour	5	3

Overtime premium is 50% and is payable, if a worker works for more than 40 hours a week. There are 100 direct workers.

The target-productivity ratio (or efficiency ratio) for the productive hours worked by the direct workers in actually manufacturing the products is 80%; in addition to the non-productive downtime which is budgeted at 20% of productive hours worked.

There are 12 five-day weeks in the budget period and it is anticipated that sales and production will occur evenly throughout the whole period.

It is anticipated that stock at the beginning of the period will be:

Product X: 1,000 units; Product Y: 2,000 units; and Raw material: 4,000 kg

The target-closing stock, expressed in terms of anticipated activity during budget period, is:

Product X: 15 days sales; Product Y: 20 days sales; and Raw material: 10 days consumption.

Required:

Calculate (a) the material-purchase budget.

(b) the wages budget for direct workers showing the quantities and values, for the next period.

 

[C.A. (Inter) – Modified]

Solution

NOTES: Before initiating the preparation of budgets, the figures required have to be calculated one by one as shown in the following:

*1. Closing stock of products:

1. Budgeted period of sales in days = 5 day × 12 weeks = 60 days.
2. Closing stock of product X for 15 day sales
   
3. Closing stock of product Y for 20 days sales
   

*2. Production budget (Total no. of units to be produced):

	X	Y
Step 1 → Sales in units (60 days) (given) =	6,300	8,400
Step 2 → Add: Closing stock (Ref: Note 1)	1,575	2,800
Less:	7,875	11,200
Step 3 → Anticipated opening balance (given)	1,000	2,000
Step 4 → Total no. of units to be produced:	6,875	9,200

*3. Closing balance of material: (in kg)

1. Total material consumption =

   		X	Y
   Budgeted production in units. Ref: Note 2	=	6,875	9,200
   Material consumption	=	6,875 × 3 kg;	9,200 × 5 kg
   	=	20,625 + 46,000
   	=	66,625 kg

2. Closing balance
   

*4. Standard hours for budgeted production:

 

		X	Y
(i)	Budgeted production in units:	6,875	9,200
(ii)	Standard hours	5	3
(iii)	Total standard hours for budgeted production:	= 6,875 × 5 + 9,200 × 3 hrs
		= 34,375 + 27,600 hrs
		= 61,975 hours
(iv)	Standard hours for budgeted production at targeted 80%-efficiency ratio
		= 77,468.75 hours
		= 77,469 hours

 

Preparation of direct-wage budget

 

Illustration 14.6

Model 7: Manufacturing-overheads budget

From the following average figures of previous quarters, prepare a manufacturing-overhead budget for the quarter ending on 31 March 2010. The budgeted output during this quarter is 5,000 units.

 

	Rs.
Fixed overheads	30,000
Variable overheads	20,000	(Varying@ Rs. 6/unit)
Semi-variable overheads	20,000	(50% fixed and 50% varying@ Rs. 4/unit)

 

Solution

NOTE:

1. Fixed overheads may be taken as it is given in the problem.
2. Variable overheads: Take the output during the budgeted period and multiply it with the cost per unit given in the question: 5000 unit × Rs. 6 = Rs. 30,000.
3. For semi-variable overheads, fixed part enter as it is. For variable part, compare the part for the period and multiply by the cost per unit. Here, semi-variable overhead is Rs. 20,000 and fixed is 50%. 50% of Rs. 20,000 = Rs. 10,000. To find the semi-variable: 5,000 units are the budgeted output during this period. Variable cost per unit given is Rs. 20,000.

Now, the manufacturing-overhead budget has to be prepared as follows:

 

Particulars		Amount Rs.
Step (i) Fixed overheads (given)		30,000
Step (ii) Variable overheads (5,000 units × Rs. 6)		30,000
Step (iii) Semi-variable overheads:
Fixed (50% of Rs. 20,000):	10,000
Variable (5,000 units × Rs. 4):	20,000	30,000
Step (iv) Total overhead costs		90,000

Illustration 14.7

Model 8: Factory-overheads budget

The budget manager of X Ltd is preparing a budget for the accounting year starting from 1 April 2009.

As a part of the budget operations, some items of factory overhead costs have been estimated by him under specified conditions of volume as follows:

Volume of production in (units)	60,000 Rs.	75,000 Rs.
Expenses:
Indirect materials	1,32,000	1,65,000
Indirect labour	75,000	93,750
Maintenance	42,000	51,000
Supervision	99,000	1,17,000
Engineering services	47,000	47,000

You are required to calculate the cost of factory overhead items given above at 80,000 units of production.

 

[B.Com (Hons) Delhi – Modified]

Solution

The fixed and variable element included in each item of the fixed overhead is to be computed as follows:

(a) Indirect material:

Formula to compute the variable cost per unit:

 

∴ Variable indirect material	=	Production × variable cost per unit
	=	Rs. 60,000 units × Rs. 2.20 = Rs. 1,32,000 (given)
	=	Rs. 1,32,000 for 60,000 units.

 

The same figure which is given in the question, i.e., Rs. 1,32,000.

Therefore, no fixed element is involved in the indirect material.

 

(b) Indirect Labour:

Indirect labour for 60,000 units = 60,000 × Rs. 1.25 = Rs. 75,000.

In indirect labour also, there is no fixed element involved.

(c) Maintenance:

Maintenance for 60,000 units = 60,000 × 0.60 = Rs. 36,000.

Fixed element involved = Rs. 42,000 – Rs. 36,000 = Rs. 6,000.

(d) Supervision:

Fixed cost in supervision expenses = Rs. 99,000 – 60,000 × 1.20

 

After segregating fixed and variable part in each item, fixed-overhead budget can be prepared as follows:

 

Particulars	Amount Rs.
Step (i) Indirect material (80,000 units × Rs. 2.20/unit variable cost)	1,76,000
Step (ii) Indirect labour (80,000 × variable @ Rs. 1.25/unit)	1,00,000
Step (iii) Maintenance:
Fixed cost	6,000
Variable @ Re 0.60 for 80,000 units	48,000
Step (iv) Supervision:
Fixed cost	27,000
Variable @ Rs. 1.20 for 80,000 units	96,000
Step (v) Engineering services: (All fixed cost)	47,000
Total factory overheads	5,00,000

Important Note:

1. Overheads are classified into fixed and variable and shown separately.
2. In case the fixed-cost element is absent (as in the case of indirect material and labour), only variable part is to be shown.

Illustration 14.8

Model 9: Selling and distribution-overhead budget

Following are the estimates of a sales department:

	Rs.
Advertisement	17,000
Salaries of sales department	90,000
Expenses of sales department	13,000
Counter-salesmen’s salaries	60,000

Commission to counter-salesmen at 2% of their sales.

Travelling salesmen’s commission at 15% on their sales and expenses at 10% on their sales.

The sales during the period are estimated as follows:

Counter Sales	Travelling Salesmen’s Sales
1,00,000	30,000
6,00,000	1,00,000
9,00,000	2,00,000

You are required to prepare sales-overhead budget.

Solution

NOTE:

1. Fixed overheads—advertisement, salaries and expenses are to be recorded separately (as they remain constant irrespective of volume of sales).
2. Variable overheads, which vary according to volume of sales—commission and travelling expenses are to be calculated for different levels of sale and then shall be shown in the budget.

14.11 CASH BUDGET

14.11.1 Meaning and Definition

• The cash budget is a tool of financial planning.
• The cash budget is a forecast of cash position for a period. It shows how much of cash requirements will be met by retained earnings and how much must be obtained by other sources.
• The cash budget shows the inflows, outflows, opening balance and closing balance of cash.
• The main objectives of preparing cash budget are:
  1. To secure for optimum working capital.
  2. To ease strains on cash shortage.
  3. To plan cash requirements.
  4. To use cash in the most profitable way.
  5. To maintain adequate liquidity.
• The factors to be considered while preparing the cash budget are:
  1. Estimated opening balance.
  2. Monthly sales value in sales budget.
  3. Cash and credit sales ratio, credit sales, and terms.
  4. Monthly purchases.
  5. Supplies credit policy and credit terms.
  6. Amount of salaries, wages and commissions.
  7. Capital budget.
  8. Estimated amounts of operating expenses on the basis of credit terms and timing of disbursement.
  9. Minimum cash balance to be maintained.
• Cash budget consists of two parts:
  1. Cash receipts and
  2. Cash disbursements (expenses)
• The cash budget is phased into shorter periods such as weekly, monthly and quarterly for planning and control of cash requirements.

14.11.2 Preparation of Cash Budget

A cash budget can be prepared in any of the three methods. They are:

1. The receipt-and-payment method
2. The adjusted profit-and-loss method
3. The balance-sheet method

1. Receipt-and-payment method:

• Under this method, the cash receipts and cash payments will have to be taken into consideration.
• With the opening balance of cash, estimated cash and receipts are added. From this, the total of estimated cash payments are deducted. The resultant is the closing balance of the period.
• Expected cash balance (of a period) = Total expected cash payments – total expected cash receipts + opening balance of cash.
• For short-term cash budgets, this is an apt method.
• The cash budget is prepared as follows:
  1. First, the opening balance of the period (months, quarter) has to be computed. The closing balance of the last (previous) period will be the opening balance of the next period.
  2. Cash receipts from customers, based on the sales budget are usually taken into account. The terms of sale and the lag in payment should be considered while estimating the cash receipts from the customers.
  3. Cash receipts from other sources like dividends, rent issue of capital and sale of fixed asset or investments are to be considered.
  4. Cash requirements for materials, labour and overhead costs based on purchasing budget, labour budget and overheads budgets are taken into account. The policy relating to the payment of suppliers’ accounts, the terms of cash discount, the lag in payment of wages and the like factors will be given a careful consideration.
  5. Cash requirements for the capital expenditure based on capital budget and cash requirements for other purposes such as dividend and income tax also have to be taken into account.
  6. To compute the closing balance, the total of cash payments will be deducted from the total of cash receipts with the opening balance.

Illustration 14.9

Model 10: Cash budget

Method I: Receipt-and-payment method

Prepare a cash budget for the months of March, April and May 2009 on the basis of the following information:

1. Income-and-expenditure forecasts:
   
2. Cash balances on 1 March 2009: Rs. 6,000.
3. Plant costing Rs. 12,000 is due for delivery in May, payable at 15% on delivery and the balance after 3 months.
4. Advance tax of Rs. 6,000, each is payable in March and September.
5. Period of credit allowed:
   1. By suppliers – 2 months.
   2. To customers – 1 months.
6. Lag in the payment of manufacturing – month.
7. Lag in the payment of office and selling expenses – 1 month.

Solution

NOTE:

1. Opening balance for March is given in information (2). But for the other months: For April, find the difference between the receipts and payments for the month of March. This will be the closing balance for March. This closing balance will be the opening balance for April. In a similar manner, the opening balance for the other months can be calculated.
2. Credit allowed by suppliers is 2 months. Therefore, the payment of credit purchases in January shall be paid in March and so on.
3. Credit allowed to customers is 1 month. Hence, the amount of credit sales in February shall be collected in March and so on.
4. Lag in payment of manufacturing is month. Manufacturing expenses to be paid in March is expenses of February + expenses of March → to be entered in the manufacturing-expenses column with respect to March (i.e., 50% previous month + 50% current month). Here, the manufacturing expenses for March is calculated as follows: 50% of expenses in February + 50% in March. = 50% of Rs. 2,000 + 50% of Rs. 3,000 = Rs. 1,000 + Rs. 1,500 = Rs. 2,500.

   Similarly, for the other months calculations can be made of.

5. Lag in payment of office-and-selling expenses – 1 month. This means office-and-selling expenses for February will be paid in March and so on.

Method II: Adjusted profit-and-loss method

• Under this method, cash budget is prepared on the basis of opening cash and bank balances, forecasted or projected P&L A/c and changes in the various assets and liabilities.
• Factors to be considered for the preparation of cash budget under this method are:
  1. Non-cash transactions such as depreciation, loss on sale of capital assets and preliminary expenses written off from P&L A/c form part of this budget.
  2. These non-cash items do not affect the cash position as they are added back to the profit or deducted from loss.
  3. Other sources of cash include: new issue of shares, realization from the sale of fixed assets, raising long-term loans and the like.
  4. Application of cash includes purchase of fixed assets, payment of dividends, payment of income tax and so on.
  5. Sources of cash include an increase in current liabilities and a decrease in current asset items.
  6. Similarly, applications of cash include a decrease in current liabilities and an increase in current assets.
  7. The difference between the current assets and the current liabilities is the working capital, at times shown as a separate item in the balance sheet.

Method III: The balance-sheet method

• Under this method, a budgeted balance sheet is prepared for all items excluding cash and bank balances. The balancing figure in the balance sheet represents cash or bank balance.
• First, the other than the cash/bank will have to ascertained for an inclusion in the budgeted balance sheet, which can be made by adjusting the anticipated transactions of the year in the opening balances.
• If liabilities side is larger than the assets side, it represents a cash balance at bank, and if the assets side is greater than the liabilities side, it represents that the cash is overdrawn and the final adjustments will have to be made before the final cash budget is drafted.

Illustration 14.10

Model 11: Cash budget

Method II: Adjusted profit-and-loss method

From the following data, you are required to prepare a cash budget according to the adjusted profit-and-loss methods:

 

Closing balances

Share capital: Rs. 2,00,000; 12% Debentures: Rs. 50,000; Creditors: Rs. 50,000; Debtors: Rs. 50,000; Bills payable: Rs. 22,000; Bills receivable: Rs. 3,000; Plant: Rs. 80,000; and Furniture: Rs. 10,000 (Plant & Furniture proposed to be purchased by the end of the year)

Solution

An easy approach to prepare a cash budget under this method is as follows:

The opening balance of cash is taken as the base. With this, add the items that cause addition or increase to cash and deduct all the items that cause a decrease or reduction in cash. Net result will be the closing balance of cash.

 

	Rs.	Rs.
Step 1 Opening balance of cash (as on 1st Jan 2010) (Given in balance		45,000
sheet as bank)
Step 2 ADD:
(i) Issue of share capital (Rs. 2,00,000 – 1,50,000)	50,000
(ii) Depreciation (Ref: P&L A/C)	17,500
(iii) Decrease in bills receivable (Rs. 5,000– 3000)	2,000
(iv) Increase in bills payable (Rs. 20,000 to 22,000)	2,000
(v) Issue of 12% debentures	50,000
(vi) Decrease in pre-paid commission	1,000
(vii) Net profit for the year	20,000	1,42,500
		1,87,500
Step 3 → Less:
(i) Purchase of plant	80,000
(ii) Purchase of furniture	10,000
(iii) Increase of debtors (Rs. 50,000–Rs. 35,000)	15,000
(iv) Decrease of creditors (Rs. 70,000–Rs. 50,000)	20,000
(v) Increase in closing stock (Rs. 25,000–20,000)	5,000
(vi) Dividends paid	13,000	1,43,000
Step 4 → Closing balance as an 31 Dec 2010 (Step 1 + Step 2 − Step 3)		44,500

Illustration 14.11

Model 12: Cash budget

Method III: Balance-sheet method

By using the same figures given in illustration 10, you are required to prepare a cash budget using the balance-sheet method.

Solution

NOTE: Prepare the balance sheet as on 31 December 2010 in the usual way. On the assets side, the balancing figure will be the closing balance of cash as on 31 December 2010 and is written as bank.

14.12 MASTER BUDGET

Definition, Features and Methods of Preparation

• The master budget has been defined as “the summary budget which incorporates its component functional budgets and which is finally approved, adopted and employed”.
• The master budget is prepared from all functional budgets and summarizes all such functional budgets.
• The master budget sets out plan of operations for all departments for the budget period.
• A master budget commonly takes the form of
  1. Budgeted P&L A/c and
  2. Budgeted balance sheet.
• The master budget is an overall financial plan.
• It is very similar to a general standardized financial statement, the main difference being this budget is prepared on the basis of expected (estimated) future data rather than our historical data.
• The master budget is prepared by the budget committee on the basis of coordinated functional budgets.
• When it gets the approval from the committee, it becomes the target of the company during the budget period.
• The master budget acts as a basis to take decisions on the sales price, volume of production, production mix, volume of sales, labour costs, material costs etc.
• It segregates income, costs and profit by areas of responsibility.
• It is useful in the preparation of forthcoming budgets.

Illustration 14.12

Model 13: Master budget

From the particulars given below, you are required to prepare a budgeted (forecast) P&L A/c for the year ending on 31 December 2010 and a forecast (budgeted) balance sheet as on that date:

3. Additional Information:

1. The present level of activity is 75%. The expected level of activity during the budget period is 90%. However, in order to sell the additional production in the market, the selling price is to be reduced by on the total volume.
2. Market price forecasts indicate that material, labour and variable overhead costs are likely to increase by 5%, 4% and 6%, respectively. Fixed cost other than depreciation are expected to go up by 2% consequent upon annual increments to indirect salaries.
3. Fixed costs include depreciation which is a fixed instalment of Rs. 20,000 per annum charged in full to production overhead.
4. Four months’ requirements of raw materials are to be held in stock. The first-in, first-out (FIFO) method is used in pricing out the issues.
5. All units started for production are expected to be completed and sold in the budget period.
6. Sales and purchases are generally made on two month’s credit.
7. Wages and expenses are paid within the period.
8. Machinery costing Rs. 30,000 is expected to be purchased at the end of December 2010, and payment is to be made on the delivery date itself.
9. Income tax may be taken as 50%.
10. Dividend of 25% may be proposed, if profits permit.

[I.C.W.A. Modified]

Solution

 

NOTE: In the preparation of a master budget, some other important budgets have to be prepared, for which a number of figures are needed that will be explained step by step as follows:

Step 1: Calculation of wages per unit:

 

Total wages	=	Rs. 10,000.
Total units	=	1,000.
Wages per unit	=
Proposed budget	=	4% increase.
4% of Rs. 10	=	0.40.

∴ Proposed (budgeted) wages = Rs. 10 + 0.40    = Rs. 10.40 per unit.

                     For 1,200 units = 1200 x 10.40 Rs. = Rs. 12,480.

 

Step 2: Production overhead:

1. Variable overhead: 40% of Rs. 60,000      = Rs. 24,000.
   
2. Fixed:
   

Step 3: Selling and distribution overhead:

(i) Variable: 50% of Rs. 50,000 = Rs. 25,000

Variable overhead per unit

Add: 6% increase (6% of Rs. 25,000)	=	Rs. 150
		Rs. 26.50.
For 12,00 units: 1200 × Rs. 26.50	=	Rs. 31,800.

(i) Fixed: (50% of Rs. 50,000) Rs. 25,000

Add: 2% increase:	500	Rs. 25,500
Total:		Rs. 57,300.

 

Step 4: Preparation of sales budget:

(i) Sales for the year that ended on 31 December 2009: 1,000 units

(ii) Add: Expected increase: 200 units

(iii) Sales for the budget period = 1,200 units

(iv) Selling price per unit

 

Step 5: Receipts from debtors:

	Rs.
Opening balance (shown in balance sheet):	20,000
Add: Sales value: (Ref: Sales Budget Step: 4):	2,80,000
	3,00,800
Less: Closing balance (2 months credit) (2/12 × Rs. 2,80,800)	46,800	Rs. 2,54,000.

Step 6: Preparation of Purchase Budget:

		Rs.
Step 1 → Consumption of raw materials (given) for 2009		= 40,000
Step 2 → Add: Increase in volume of sale
= units × 100: 20% 20% of Rs. 40,000		= 8,000
Step 3 → Cost of materials required for production (at previous price) (Step 1 + Step 2)		48,000
Step 4 → Add: Stock to be held (Closing stock) (4 months requirement): × 48,000		= 16,000
Step 5 → Total requirements (Step 3+ Step 4)		= 64,000
Step 6 → Less: Opening stock (shown in B/s)		= 34,000
Step 7 → Net requirements		= 30,000
Step 8 → Increase by 5% (given)		= 1,500
Step 9 → Budgeted raw materials total:		= 31,500

Step 7: Payments to creditors:

		Rs.
(i) Opening balance (shown in B/s):		= 16,000
(ii) Add: Purchases (Ref: Purchase budget: Step:6)		= 31,500
		47,500
(iii) Less: Closing balance (2 months credit)		= 5,250
		42,250

Step 8:

Closing stock value:	16,000
Add 5%	800
	16,800

Step 9: Preparation of cash budget (receipt-and-payment method used)

 

	Rs.	Rs.
Step 1 Opening balance (Shown in B/s)		6,000
Step 2 Add: Receipts from debtors (Ref: Step 5)		2,54,000
		2,60,000
Step 3 Less: payments:
(i) Creditors (Ref: Step 7)	42,250
(ii) Wages (Ref: Step 1)	12,480
(iii) Production overhead excluding depreciation. Ref: Step 2 (Rs. 66,848 – Rs. 20,000)	46,848
(iv) Administration overhead (All fixed: 20,000 + 2% increase)	20,400
(v) Selling and distribution overhead (Ref: Step: 3)	57,300
(vi) Income tax (for 2009) (Shown in B/s)	30,000
(vii) Dividend (shown in B/s)	14,000
(Viii) Machinery to be purchased in Dec	30,000	2,53,278
Step 4: Closing balance (Step 2 − Step 3)		6,722

Step 10: Budgeted (forecast) P&L A/c is to be prepared as follows:

 

Step 11: Budgeted balance sheet as on 31 December 2010

14.13 CLASSIFICATION OF BUDGETS

Budgets may be classified into:

1. Fixed budget
2. Flexible budget

14.13.1 Fixed Budget

• The fixed budget is “a budget which is designed to remain unchanged irrespective of the volume of output or turnover attained”.
• Fixed budget is prepared for one level of activity for a definite time period.
• It is not adjusted to the actual levels of activity, when comparisons are made with the actual results of operations.
• These budgets are suitable when expenses are fixed. Hence, its use is limited and is not an effective tool for cost control.

14.13.2 Flexible Budget

1. A flexible budget may be defined as “a budget which by recognizing the difference in behaviour between fixed and variable costs in relation to fluctuations in output, turnover or other variable factors such as no. of employees, is designed to change appropriately with such fluctuations”.
2. It is possible to determine the budgeted costs for any level of activity. It is prepared for a range of expected activity levels.
3. A flexible budget recognizes the difference between variable, semi-variable, and fixed expenses.
4. While preparing a flexible budget, the items of costs are to be analysed individually to ascertain how different the items of cost behave to change in volume.
5. Hence, an in-depth cost analysis and cost identification are essential to prepare flexible budgets.
6. Following are the special features of flexible budget:
   1. It provides a tailor-made budget for a particular volume.
   2. It is prepared for a relevant range.
   3. It is based on a definite knowledge of cost-behaviour analysis.
   4. It acts as a basis for comparison as they are automatically geared to change in volume.
7. Flexible budgets are prepared in any of the following methods:
   1. Tabular method.
   2. Ratio method.
   3. Charting method.
8. Tabular method is most widely used.

Illustration 14.13

Model 14: Flexible budget

With the following data for a 50% activity, prepare a budget at 75% and 100% activity:

Production at 50% capacity – 500 units.

Materials – Rs. 100 per unit.

Labour – Rs. 50 per unit.

Expenses – Rs. 10 per unit.

Factory expenses – Rs. 50,000 (40% fixed).

Administration expenses – Rs. 40,000 (50% fixed).

Solution

NOTE:

• Variable costs for all items have to be computed for all items, for different levels of activity:
• Then, fixed costs pertaining to respective items have to be computed, for different levels of activity.
• Finally, all should be added to get the total costs at various levels of activity.

Illustration 14.14

Model 15: Flexible budget (Marginal cost)

Following are the budgeted expenses for production of an electronic component of TV (10,000 units):

	Rs.
Direct materials	50
Direct labour	20
Variable overheads	20
Fixed overheads (Rs. 1,00,000)	10
Variable expenses (Direct)	5
Selling expenses (10% fixed)	10
Distribution expenses (20% fixed)	5
Administration expenses (Rs. 50,000)	5
Total cost of sale per unit (to make and sell)	125

Prepare a budget for production of (a) 7,000 units and (b) 9,000 units, showing distinctly marginal cost and total cost. Assume that the administration expenses are rigid for all levels of production.

 

[C.A. (Final); I.C.W.A (Inter) –Modified]

Solution

NOTE: 1. Fixed and variable elements have to be segregated as follows:

1. For selling expenses:
   1. Fixed: 10% of Rs. 10 = Re 1.

      For 10,000 units = 10,000 × Re 1 = Rs. 10,000.

   2. Variable: (Rs. 10 – Re 1) = Rs. 9 per unit.
2. For distribution expenses:
   1. Fixed: 20% of Rs. 5 = Re 1.

      For 10,000 units = 10,000 × Re 1 = Rs. 10,000.

   2. Variable = (Rs. 5 – Re 1) Rs. 4 per unit.
3. For the other items, the respective given information have to be taken into account.
4. Marginal costs and total costs have to be compared by preparing flexible budgets as follows:

Illustration 14.15

From the following information prepare a flexible budget to show levels of activity of 80%, 90% and 100%.

1. Sales, based on the normal level of activity of 80% are 80,000 units at Rs. 40 per unit. If the output is increased to 90%, it is thought that the selling price should be reduced by 2½% and if the output reaches 100%, it would be necessary to reduce the original selling price by a further 2½% in order to reach a wider market.
2. Prime costs are:

    

   	Per unit
   	Rs.
   Direct material	4
   Direct labour	4
   Direct expense	2
   	10

    

   If the output reaches at 90% level of activity as above, the quantity discount will be received and this will lead to a reduction of purchase price of raw materials by 5%.

3. Variable overheads: Salesmen’s commission is 5% on the sales value.
4. Semi-variable overheads at the normal level of activity are:

    

   	Rs.
   Supervision	1,60,000
   Power	1,40,000
   Heat & Light	80,000
   Maintenance	1,00,000
   Indirect labour	2,00,000
   Salesmen’s expenses	1,20,000
   Transport	4,00,000
   	12,00,000

    

   Semi-variable overheads are expected to increase by 5% if the output reaches a level of activity of 90%, and by a further 5% if it reaches the 100% level.

5. Fixed overheads are:

    

   	Rs.
   Rent and rates	20,000
   Depreciation	80,000
   Administration	1,50,000
   Sales department	40,000
   Advertising	1,00,000
   General	10,000
   	4,00,000

   [I.C.W.A Adapted]

Solution

NOTE 1: Calculation of semi-variable overhead.

Supervision

1. 90% level of activity: Overheads @ 80% + 5% there of

   = Rs. 1,60,000 + 5% of Rs. 1,60,000

   = Rs. 1,60,000 + Rs. 8,000 = Rs. 1,68,000.

2. 100% level of activity: Overheads @ 90% + 5% there of

   = Rs. 1,68,000 + 5% of Rs. 1,68,000

   = Rs. 1,68,000 + Rs. 8,400 = Rs. 1,76,400.

NOTE 2: Calculation of commission on sales:

 

(i)	80% level of activity:	Rs.
	Sales: 80,000 units @ Rs. 40:	32,00,000.
	Commission: 5% of Rs. 32,00,000:	1,60,000.
(ii)	90% level of activity:
	Sales: 90,000 × Rs. 39:	35,10,000
	Commission: 5% of Rs. 35,10,000:	1,75,500
(iii)	100% level of activity:
	Sales: 1,00,000 × Rs. 38:	38,00,000
	Commission: 5% of Rs. 38,00,000:	1,90,000

 

Illustration 14.16

Model 16: Flexible budget (Contribution & Profit)

Jasemine Ltd. is currently operating at 80% of its capacity. In the past two years, the level of operations were 60% and 70%, respectively. Presently, the production is 80,000 units. The company is planning for 90% capacity level during 2009–2010. The cost details are as follows:

Profit is estimated @ 20% on sales.

The following increases in costs are expected during the year:

	In percentage
Direct materials	10%
Direct labour	8
Variable factory overheads	6
Variable selling overheads	5
Fixed factory overheads	10
Fixed selling overheads	15
Administrative overheads	15

You are required to prepare a flexible budget for the period 2009–2010 at 90% level of capacity. Also ascertain profit and contribution.

 

[C.A. (Inter) Modified]

Solution

• First, the segregation of costs into fixed and variable will be calculated at 60%, 70%, 80% and 90% level with respect to the concerned items.
• Based on this, flexible budget will be prepared.
• Applying marginal-costing technique, contribution and profit will be ascertained.

STAGE I: All workings are tabulated as follows:

STAGE II: Now, flexible budget at 90% capacity level has to be prepared by taking into account the increases in costs for various items.

This is to be prepared as follows:

 

STAGE III: Application of marginal-costing technique

 

Particulars	Amount Rs.
Step 1: Sales (Ref: Stage II (or) Total cost + 25% on cost or 20% on sale for profit)	48,49,750
Step 2: Less: Variable costs (marginal costs) (Ref: Stage II Step (2))	34,26,300
Step 3: Contribution (Step 1 – Step 2)	14,23,450
Step 4: Less: Fixed costs (Ref: Stage II Step (4))	4,53,500
Step 5: Profit	9,69,950

14.14 CONTROL RATIOS

To exercise an effective control over the budgeted results, the management will employ ratio analysis to know whether there are any deviations of actual results from budgeted figures and if there are any deviations that result in favourable or adverse conditions.

These ratios are usually expressed in terms of percentage. If the ratio is more than 100%, such trend is treated as favourable and if it is less than 100% it is to be taken as unfavourable or adverse.

Important ratios used by the management are:

1. Activity ratio
2. Capacity ratio and
3. Efficiency ratio

1. Activity ratio: Generally, it refers to the level of activity attained over a specified period. It is obtained when the number of standard hours equivalent to the work produced is expressed at a percentage of the budgeted hours. Formula to calculate activity ratio is:
   
2. Capacity ratio: It refers to the relationship between the actual hours worked and the budgeted hours, expressed in terms of percentage.

   Formula to compute capacity ratio is:

   
3. Efficiency ratio:

   It reveals the degree of efficiency attained in a period. It is obtained when the standard hours equivalent to the work is produced.

   Formula to compute efficiency ratio is:

   

Illustration 14.17

Model 17: Control ratios

A factory produces 3 units of a commodity in one standard hour. The actual production during 2009 is 21,000 units and the budgeted production for 2009 is fixed at 24,000 units. Actual hours operated are 6,000 hrs. You are required to compute the efficiency and activity ratios.

Solution

Step 1: Standard hour for the actual production has to be found out.

1. 3 units are produced in one standard hour (given).
2. For 21,000 units, standard hours

Step 2: Budgeted hours for 24,000 units:

Step 3:

Step 4:

Step 5: Efficiency ratio: favourable; Activity ratio: unfavourable.

Illustration 14.18

Model 18: Control ratios

The activity ratio of a company is 75% and its capacity ratio is 125%. Compute its efficiency ratio.

Solution

Apply the formula.

Activity ratio = Capacity ratio × Effi ciency ratio

(or)

Illustration 14.19

A factory manufactures two types of products A and B. Product A takes 15 hours to make and product B needs 30 hours. In a month (25 days of 8 hours each), 800 units of A and 500 units of B are produced. The budgeted hours are 18,000 per month. The factory employs 100 men in the department concerned. You are required to compute (i) activity ratio: (ii) capacity ratio; and (3) efficiency ratio.

Solution

Step 1: Calculation of standard hours for actual production:

 

(i)	For A = 800 units × 15 hours	= 12,000 hrs.
(ii)	For B = 500 units × 30 hours	= 15,000 hrs.
	Total	= 27,000 hrs.

 

Step 2: Actual hours worked:

    Total men × days × hours

    100 × 25 × 8 = 20,000 hrs.

Step 3: Budgeted hours

        (given in question) = 18,000 hrs.

Step 4:

Step 5:

Step 6:

Step 7: Result:

All ratios are at favourable conditions as they are greater than 100%.

14.15 RESPONSIBILITY ACCOUNTING

• Responsibility accounting is a system of accounting by delegating and locating the responsibility for costs.
• Responsibility accounting may be defined as “a system of accounting that recognizes various responsibility centres throughout the organization that reflects the plan of action of each of these centres by allocating particular revenues and costs to the one having the pertinent responsibility”.
• Responsibility accounting requires a specific recognition of the individual areas of responsibility in an organization.
• Areas of the responsibility are the organizational units within a firm, e.g., cost centre, profit centre, investment centre and the like.
• These centres are subject to the directions of a manager who has been entrusted with responsibility and delegated authority to achieve the target.
• Essence of responsibility accounting is cost control, not ascertainment of cost. Responsibility falls on the shoulders of an individual (manager or supervisor) and not on the cost element.
• The system of responsibility accounting operates as follows:
  • An organization is classified into many responsibility centres.
  • Each centre is to be manned by an individual (executive).
  • Authority and responsibility of each executive is defined with precision.
  • Each executive is in a position to know (a) what is expected of him and (b) what has been his actual performance.
  • A reporting system has to be set up for communication.
  • The targets are set in advance in the budgets.
  • Targets are communicated to the executives.
  • As there is a continuous system of appraisal, the actual results are communicated to the concerned.
  • Variances if any are to be reported to the high-level management with concerned names of executives to whom it has been entrusted.
  • In turn, the corrective measures or remedial actions are immediately communicated to the concerned executives.
  • In toto, the performance of the executives is being evaluated continuously and constantly.
  • Thus, by giving autonomy (responsibility with authority) on the one hand and on the other by exercising control, the executives (managers) are tuned to achieve high performance, under this system.

14.15.1 Controllable and Uncontrollable Costs

Costs are generally under the control of the person in each area of responsibility. Each cost is controllable under this system of accounting, being no place for uncontrollable costs. For example, the cost relating to raw materials can be controlled by the executive who handles but he cannot control other areas like labour, sales, price and so on. Here comes the role of chief executives who can wield his authority to control the cost. Putting it in other words, one or another in an organization will be in a position to control cost—and that too all costs. One more factor to be considered here is the time factor. These aspects play a crucial role in responsibility accounting.

Management by exception principle is followed to prepare reports. Reports reveal only variances whether they are favourable or unfavourable. The cost and revenue of each segment are included in the specific manager’s report.

14.15.2 Responsibility Centres vs. Cost Centres

• A cost centre is “a location, person or item of equipment (or group of these) for which costs may be ascertained and used for purposes of cost control”.
• Generally, the cost centres emphasise on cost ( jobs, products or processes), whereas in the case of responsibility centres the thrust is on the individual to whom the responsibility and delegation have been entrusted with.
• The concept of cost centre is associated with cost accounting whereas the concept of responsibility centre is associated with responsibility accounting.

Illustration 14.20

Model 19: Responsibility costs

A factory has two production departments, A and B, and two service departments, C and D. A produces the product X′ while department B produces product Y′.

The following are the details of costs incurred during the month of November 2009:

The output of product X’ is 1,000 units while that of product Y’ is 800 units. Lubricants and supplies of service departments are charged to production departments as a percentage of direct materials whereas the supervisory labour is charged as a percentage to direct labour.

You are required to calculate: (1) the total costs taking products X’ and Y’ as separate cost centres and (2) responsibility costs taking each department as a responsibility centre.

 

[I.C.W.A – Adapted and Modified]

Solution

NOTE:

1. Total costs for each product will have to be prepared. But this does not show the responsibility of the manager.
2. Hence, one more statement of cost has to be prepared to identify the amount of costs that each of the four departmental managers is responsible for.
3. Lubricants and supplies for products X’ and Y’ have to be calculated as follows:

1. Direct material used in both departments A and B = Rs. 15,000 + Rs. 5,000 = Rs. 20,000.
2. Lubricants and supplies used in both service departments C and D = Rs. 300 + 200 = Rs. 500.
3. Percentage of lubricants and supplies to direct materials
   =
4. (a) Lubricants and supplies for Product X’:

(i) Direct:	=	Rs. 600
(ii) From service departments:	=	Rs. 375
	=	Rs. 975.
(b) Lubricants and supplies for product Y′:
(i) Direct:	=	Rs. 500
(ii) From service departments:	=	Rs. 125
	=	Rs. 625.

Supervisory labour:

1. Direct labour in departments A and B (Rs. 6,000 + 4,000): Rs. 10,000.
2. Supervisory labour in service departments: (Rs. 2,000 + Rs. 3000): Rs. 5,000.
3. Percentage of supervisory labour to direct-labour costs = 50%.

4. (a) Supervisory labour for Product X’:
   (i) Direct	=	Rs. 1,500
   (ii) From service departments = 50% of Rs. 6,000	=	Rs. 3,000
   		Rs. 4,500.
   (b) Supervisory labour for Product Y’:
   (i) Direct		Rs. 2,000
   (ii) From service departments = 50% of Rs. 4,000	=	Rs. 2,000
   		Rs. 4,000.

 

ZERO-BASED BUDGETING^*

• Zero-based budgeting is an analytical approach to budgeting. It is a method of budgeting in which all activities are re-evaluated each time a budget is formulated.
• Each functional budget starts with the assumption that the function does not exist and is at zero cost.
• Zero-based budgeting starts the budgeting exercise from scratch.
• Previous year’s actual results are not given any due consideration.
• The steps involved in zero-based budgeting are:
  1. Determination of objectives.
  2. Consideration of alternate ways of doing each activity.
  3. Evaluation of all alternate ways in terms of costs and benefits at different levels.
  4. Fixing criteria for evaluation of work load and performance.
  5. Ranking of all the activities in order of preference.
• The process involved in zero-based budgeting are as follows:
  1. Definition of decision units: Decision units are the lowest levels of an organization. A separate budget is to be prepared for each decision unit.
  2. Preparation of set of decision packages for each decision unit: Decision packages contain: (i) specification of objectives; (ii) outcome of non-performing activities; (iii) alternate ways available to achieve objectives; and (iv) implications in financial terms.
  3. Ranking of decision packages: The decision packages are to be ranked in the order of preference.
  4. Forwarding of decision packages: After ranking, decision packages have to be sent to the immediate higher level of management.
  5. Decision making: The budget committee has to take a decision whether to accept or reject the decision packages.
  6. Resources to be appropriated: For approved decision packages, resources must be appropriated by the budget committee.

Illustration 14.21

Model 20: Zero-based budgeting

X Ltd intends to introduce the system of zero-based budgeting. The company has only Rs. 25,00,000 available for different items of expenses for the current year. From the following separate estimates of expenses for maintaining (a) the minimum viability and (b) the quality and image of the company, you are required to rank the different proposals and prepare a budget with zero base as follows:

Proposal	Cost
	At a Minimum Viable Level Rs.	At Quality-image Level Rs.
(a) Purchase of 5,00,000 paper backs	12,00,000	12,00,000
(b) Postage for dispatch of goods to customers
(i) I-class mail	–	3,00,000
(ii) II-class mail	2,00,000	–
(c) Collecting orders on Telephone & online
(i) 5 hours a day	40,000	–
(ii) 8 hours a day	–	1,20,000
(d) Package of goods:
(i) Polymer bags	–	4,00,000
(ii) Paper bags	1,50,000
(e) Accounting:
(i) Manual	50,000
(ii) Computerized		1,50,000
(f) Display of goods:
(i) In showroom only	1,50,000
(ii) In showroom, railway junctions, airports & brochure distribution		3,00,000
(g) Customer-collection service
(i) Nil	–	–
(ii) Full	–	1,00,000
(h) Painting and modernization of premises:
(i) Nil	–	–
(ii) Regular basis	–	2,00,000
Total	17,90,000	27,70,000

The company can afford to spend more than that required for the minimum viable level for some items but not for all. However, it hopes to make a profit if Rs. 25,00,000 is spent.

 

Based on the analysis, the company would have to adopt either of the following two options:

1. To accept the decision package from rank 1 to 8 – the total cumulative costs of Rs. 23,10,000 up to this and the balance left out is Rs. 1,90,000 (Rs. 25,000 – Rs. 23,10,000)—simultaneously rejecting the remaining decision packages from rank 8 to 13.
2. To allocate this Rs. 1,90,000 judiciously for the next ranking decision package, that is, 9 & 10, namely, expansion of window. Display and distribution of brochures and despatch through I-class mail. Ratio of allocation may be 50:50.

In case the company opts for allocating as per (2) above, the revised zero-based budgeting ranking will be as follows:

Advantages of zero-based budgeting:

1. It ensures an active participation of managers in the budgeting process.
2. Resources are allocated on the basis of needs and benefits.
3. Inefficient operations are identified and dropped at once.
4. Objectives of each decision unit are reviewed on a continuous basis.
5. Priories among activities are highlighted in a better way.
6. It results in an operational efficiency of organizations.

Disadvantages of zero-based budgeting:

1. Efficient managerial training is vital to implement this.
2. It results in an increase of work load as there is an instant updation.
3. It is costly.
4. It is time consuming.

Budget is a plan for specified future period, expressed in monetary terms.

Budgeting is the process of preparation, implementation and operation of budgets.

Budgetary control is a system of planning and controlling costs.

The following are the steps involved in Budgetary Control: (i) Establishment of budgets (ii) Measuring actual performance (iii) Comparison of actual performance with budgeted performance (iv) Analysis of causes of variance (v) Reporting to take right action at the right time and (vi) Revision of budgets objectives of budgetary control. (i) Planning (ii) coordination (iii) control (iv) Maximum profitability (v) Optimum use of resources and (vi) execution.

Advantages of budgetary control: (i) Planning (ii) Control (iii) Coordination (iv) Delegation of authority (v) Management by exception and (vi) motivation.

Limitations of Budgetary Control: (i) Based on estimates, (ii) Conflict of goals, (iii) Ambitious targets (iv) Rigidity and (v) costly.

Steps in installing an effective budgetary control system: (i) Preparation of organisational chart (ii) Setting up of a budget centre (iii) Preparation of budget manual (iv) Budget controller to coordinate various budget centres (v) Formation of a budget committee (vi) Fixing budget period (vii) Identification of principal budget factors (viii) Preparation of budget reports.

Budgets are mainly classified on the basis of (i) Coverage (ii) Capacity (iii) The periods and (iv) Condition.

Various categories of budgets, special features and objectives of each such budget and preparation of each category of budget—refer the text and Illustrations from 14.1 to 14.16.

Controls ratios: To assess deviations from budgeted figures, managements employ ratio analysis technique. Activity ratio capacity ratio and Efficiency ratio are some important ratios used by them. Their formulae, method of computation are shown in Illustrations 14.17, 14.18 and 14.19.

Responsibility Accounting: It is a system of accounting by delegating and locating the responsibility for costs. It fixes responsibility on individuals. Authority and responsibility of each executive is defined with precision. The performance of each executive is evaluated continuously and constantly.

Cost centre vs. Responsibility centre—The major point of difference is that cost centre is associated with cost accounting whereas responsibility centre is associated with Responsibility Accounting. Computation of total costs for cost centres and Responsibility costs is shown in Illustration No. 14.20.

Zero Base Budgeting: This is an analytical approach to budgeting. Each functional budget starts with the assumption that the function is at ZERO COST.

Steps involved in zero base budgeting are: (i) Determination of objectives (ii) Considering alternate ways (iii) Evaluation of alternative ways (iv) Fixing criteria of evaluation of work load and performance and (v) Ranking in order of preference. This is explained by way of Illustration No. 14.21.

Budget: A plan quantified in monetary terms to be achieved in a defined period of time.

Budgeting: The process of preparation, implementation and the operation of budgets, expressed in numerical terms.

Budgetary Control: A system which uses budgets as a means of planning and controlling all aspects of production and sales of all goods or services.

Operating Budgets: Plans in respect of operations of a firm.

Financial Budgets: Plans relating to financial decisions of a firm.

Budget Manual: A written document that specifies the objectives of the budgeting organization and procedures.

Key Factor: The factor which constrains the functions of business also known as “limiting factor”.

Fixed Budget: A budget which remains unchanged irrespective of the volume of output.

Flexible Budget: A budget which is designed to determine the budgeted costs for any level of activity.

Responsibility Centres: Cost centres in an organization, entrusted with personnel who are accountable for any adverse variance in the cost factors.

Responsibility Accounting: A system of evaluating the performance of managers who are entrusted responsibility with accountability for cost centres.

Performance Budgeting: A system in which targets are set both in terms of money value as well as physical units.

Zero-Based Budgeting: An analytical approach in which the budgeting exercise commences from the zero base.

QUESTION BANK

 

I. State whether the following statements are true or false:

1. In simpler terms, a budget is only a financial plan.
2. A budget is prepared for an indefinite period of time.
3. Budgetary control is a system of management control and accounting in which all operations are forecasted.
4. Budget and forecast – both the terms are synonymous.
5. The end result of the budgetary process is a master budget.
6. The master budget consists of two parts: (1) operating budgets and (2) financial budgets.
7. The objective of budgetary control is the preparation of financial budgets and, therefore, operating budgets are ignored.
8. The cash budget is a tool of financial planning.
9. Direct material-purchase budget is the basis on which all other budgets will have to be prepared.
10. In the manufacturing concerns, fixed budgets are preferable to flexible budgets.
11. Activity ration indicates whether and to what extent the budgeted hours of activity are actually utilized.
12. Capacity ratio is a measure of the level of activity of a concern.
13. Efficiency ratio denotes the degree of efficiency attained in production.
14. Responsibility accounting puts much emphasis on cost ascertainment than on cost control.
15. Responsibility accounting cannot act without responsibility centres.
16. Responsibility centres and cost centres are both the same.
17. Performance budgeting cannot function without responsibility accounting.
18. Zero-based budgeting is an extension of the cost-benefit analysis method.
19. Budget centres differ from cost centres.
20. A budget manual is a magazine – which exclusively exposes various corporate activities periodically.

Answers:

 

1. True	2. False	3. True	4. False
5. True	6. True	7. False	8. True
9. False	10. False	11. False	12. False
13. True	14. False	15. True	16. False
17. True	18. True	19. True	20. False

 

II. Fill in the blanks with apt word(s):

1. A budget is a plan and blue print for ______ period.
2. A budget is an effective tool for a ______ term planning.
3. A budget comprising the summary of all operating and financial budgets is known as ______ .
4. The process of preparation, implementation, and the operation of budgets is termed as ______ .
5. ______ is a system that uses budgets as a means of planning and controlling all aspects of production and sale.
6. The figures in the budget are expressed in terms of ______.
7. A forecast can be made for ______ period.
8. A forecast may or may not be expressed in ______ .
9. Budgeting facilitates the principle: management by ______.
10. The master budget consists of two parts: (1) operating budgets and (2) ______ .
11. The preparation of budget is both an accounting exercise as well as a ______ .
12. ______ factor imposes a constraint or establishes a limit to the level of activity.
13. ______ is the starting point of the sales budget.
14. A sales forecast is only an ______.
15. The ____ budget should be integrated with the sales budget.
16. The direct-labour budget assists the preparation of ______ budget and the cost of sales budget.
17. The direct material-purchase budget is used for the preparation of ______ .
18. The ______ should lay down the various levels of authority for capital expenditure.
19. The ______ budget is a tool for financial planning.
20. A budget which is designed to remain unchanged irrespective of the volume of output is known as ______.
21. A ______ budget recognizes the difference between variable, semi-variable and fixed expenses.
22. The range of possible output and sales is termed as ______.
23. A system of accounting which is tailored to an organization where costs are collected and reported by levels of responsibility is referred to as ______ .
24. A budget of income and/or expenditure applicable to particular function is known as ______ .
25. Zero-based budgeting proceeds on the assumption that the function does not exit and its cost is ______ .

Answers:

1. future
2. short
3. master budget
4. budgeting
5. budget control
6. money
7. any time
8. monetary terms
9. exception
10. financial budgets
11. management
12. key factor (or) limiting process factor
13. sales forecast
14. estimate
15. production
16. cash
17. cash budget
18. budget manual
19. cash
20. fixed budget
21. flexible budget
22. relevant range
23. responsibility
24. functional budget accounting
25. zero

III. Multiple choice Questions Choose the correct answer:

1. A budget is a
   1. technique of analysing historical records.
   2. projection of past experience.
   3. plan and blue print for the future management action.
   4. None of the above.
2. A budget is an effective tool for
   1. short-term planning.
   2. long-term planning.
   3. making estimates whenever need arises.
   4. none of these.
3. Key factor
   1. is the factor whose influence must be assessed before preparing the budgets.
   2. is the basis factor for cash receipts.
   3. is the prime factor for cash payments.
   4. none of the above.
4. The cash budget is prepared by a
   1. cashier
   2. sales manager
   3. production manager
   4. chief accountant
5. A budget giving the summary of all operating and financial budgets is called
   1. fixed budget
   2. master budget
   3. flexible budget
   4. sales budget
6. A budget prepared to project the budgeted cost for any level of activity is called
   1. fixed budget
   2. flexible budget
   3. budgetary control
   4. none of these
7. A budget prepared on the basis of a standard level of activity is known as:
   1. standard budget
   2. fixed budget
   3. cash budget
   4. capital budget
8. Which one is not a feature of budgetary control:
   1. A tool for management control.
   2. An instrument of delegation and accountability.
   3. An instrument for evaluating the overall performance.
   4. A statement of budget and forecast.
9. Control ratios are expressed in terms of
   1. percentages
   2. monetary value
   3. quantity or grade
   4. price and quantity
10. In responsibility accounting, the thrust is on
    1. cost ascertainment
    2. making a forecast for future action
    3. cost control
    4. none of these

Answers:

 

1. (c)	2. (a)	3. (a)	4. (d)
5. (b)	6. (b)	7. (b)	8. (d)
9. (a)	10. (c)

 

1. Define “budget”.
2. What is meant by “budgeting”?
3. What is “budgetary control”?
4. Mention any four important features of budgetary control.
5. What do you understand by “production budget”?
6. What is sales budget?
7. Write short notes on “cash budget”?
8. Explain the difference between overhead absorption and budgeted overhead allowance?
9. Mention the important steps involved in the preparation of a production budget.
10. Is the sales budget a base for the preparation of other budgets? Give reasons for your answer.
11. Explain the term: key factor.
12. Distinguish between flexible budget and fixed budget.
13. Explain the term: master budget.
14. What do you understand by “performance budgeting”.
15. What is plant-utilization budget?
16. Distinguish between a forecast and a budget.
17. What is meant by “budget manual”?
18. What is responsibility centre? Mention some important responsibility centres in an organization.
19. Explain the term: responsibility accounting.
20. Write short notes on “zero-based budgeting”.

1. Define budget and budgetary control. State the salient features of budgetary control.
2. What are the advantages of budgetary control in an organization? What are its limitations?
3. Explain the main steps involved in budgetary control.
4. Discuss the pre-requisites required for adoption of budgetary control system in an organization.
5. What is a budget manual? Explain its contents.
6. How can a production budget be prepared?
7. Explain the steps involved in the preparation of a sales budget.
8. What is a cash budget? How is it prepared? What are its advantages?
9. Elucidate the main factors that are essential for the preparation of a master budget.
10. Define a “flexible budget”. Mention the special features of flexible budget. Explain its importance as a budgeting technique and as a tool of control.
11. What is performance budgeting? Explain its salient features.
12. What is responsibility accounting? How can responsibility centres be established? How does it differ from “profit centre”?
13. Define “zero-based budgeting”. Distinguish it from traditional budgeting. Enumerate the advantages of zero-based budgeting.

 

[Model 21: Sales budget]

1. A manufacturing company submits the following figures of product A for the first quarter of 2009:

Sales in units:

 

January	75,000
February	60,000
March	90,000

 

Selling price per unit = Rs. 100.

Target for the I quarter of 2010:

    Sales units increase by 20%.

    Selling price increases by 10%.

Prepare the sales budgets.

 

[Madras University]

[Ans: Total units: 2,70,000 units; Rs.2,97,00,000]

2. Raj Bros. sells two products A and B, which are manufactured in one plant. During the year 2009, it plans to sell the following quantities of each product:

 

The company plans to sell product A throughout the year at a price of Rs.10 per unit and product B at a price of Rs.16 per unit. A study of the past experience reveals that the company has lost 3% of its billed revenue each year because of return (constituting 2% of loss of revenue) allowances and bad debts (1% loss). You are required to prepare a sales budget incorporating the above information.

 

[Madras – modified]

[Ans: I Quarter II Quarter III Quarter IV Quarter (Rs.) 5,52,900; 13,48,300; 19,10,900; 10,96,100 A (Rs.) 2,42,500; 7,27,500; 12,12,500; 4,36,500 B (Rs.) 3,10,400; 6,20,800; 6,98,400; 6,59,600]

3. Renu & Co. Ltd produces two products X and Y. There are two sales divisions North and South. Budgeted sales for the year that ended on 31 December 2009 were as follows:

Actual sales for the said period were:

On the basis of assessment of the salesmen, the following are the observations of sales divisions for the year ending 31 December 2010.

 

North:	X – Budgeted increase of 40% on 2009 budget.
	Y –Budgeted increase of 10% on 2009 budget.
South:	X – Budgeted increase of 12% on 2009 budget.
	Y – Budgeted increase of 15% on 2009 budget.

 

It was further decided that because of the increased sales campaign in North, an additional sales of 2,500 units of the product will result.

You are required to prepare a sales budget for 2009 and 2010 and the actuals for 2009.

 

[Bharathidasan University – modified]

[Ans: Budget for 2009: units 47,000; value Rs.7,15,000;
Budget for 2010: units 58,940; value Rs.9,14,425;
Actual for 2009: units 52,000; value Rs.7,85,000.]

[Model 22: Production budget]

4. Prepare a production budget for three months ending 31 March 2010 for a manufacturing unit producing four products, on the basis of the following information:

[Madras – modified]

[Ans: Estimated production (units): P – 25,000; Q – 27,000; R – 20,000; S – 25,000]

5. Rojer Ltd plans to sell 1,00,000 units of a certain product line in the first fiscal period; 1,15,000 units in the second period; 1,25,000 units in the third period;1,40,000 units in the fourth period; and 1,30,000 units in the fifth and last period of the fiscal year. At the beginning of the first fiscal period of the current year, there were 10,000 units of the product in stock. At the end of each period, the company plans to have an inventory equal to th of the sales for the next period of the said fiscal period. How many units must be manufactured in each period of the current year?

 

[Madras – modified]

[Ans: Period I: 1,13,000; II- 17,000; III- 1,28,000; IV: 1,38,000.]

6. Prepare a production budget from the following data:

Product	1 January 2009 units	31 December 2009 units
P	12,000	16,000
Q	8,000	6,000
	16,000	18,00

Estimated sales during the year 2009:

 

P	1,20,000 units.
Q	1,00,000 units.
R	80,000 units.

 

Normal loss in production:

 

P	4%
Q	3%
R	6%

 

[Ans: P: 1,29,166; Q: 1,01,030; R: 87,234]

[Model 23: Production-cost budget]

7. The sales forecast in units for the first six months of 2009 is given as follows:

Finished goods equal to half the sales for the next month will be in stock at the end of each month (including for previous December). Budgeted production and production cost for the whole year are as follows:

 

Production units	25,000.
Material cost per unit	Rs.13.
Wages per unit	Rs. 5.50.

Factory overhead for the year Rs. 75,000.

Prepare the production budget and the summarized production cost budget for 5 months ending 31 May 2009.

 

[Madras University]

[Ans: Estimated production (units):

        Jan   Feb   Mar   Apr   May

        1,600   1,900   2,300   2,700   2,900

        Total production (units) = 11,400.

        Total production cost (Rs.) = Rs. 2,45,100].

8. From the following particulars, prepare the production-cost budget for the month of December 2009:

Budgeted sales for the month: 35,000 units.

Raw materials required to produce one unit: A – 2 kg at Rs. 8 per kg; B – 1 kg at Rs.25 per kg

 

[Madras – modified]

[Ans:	Estimated production units – 37,000 units.
	Material purchased A: 1,47,000 kg; B: 79,500 kg.
	Purchase cost A: Rs. 11,76,000; B: 19,87,500.
	Production cost A: Rs. 11,84,000; B: 18,50,000.]

[Model 24: Purchase budget (material consumption)]

9. Shekar Co.requires a material-purchase budget for 2009 from the following figures:

Materials:

	M	N
Estimated stock on January 1(units):	1,800	1,200
Estimated stock on December 31(units):	3,400	2,400
Estimated consumption (units):	10,400	8,800

Prepare a material-purchase budget for 2009.

 

[Bharathidasan and Madras – modified]

[Ans: M – 12,000 units; N – 10,000 units]

10. The sales director of a manufacturing company reports that next year he expects to sell 40,000 units of a particular product. The production department gives the following particulars:

Two kinds of raw materials A and B are required for manufacturing the product. Each product requires 3 units of material A and 2 units of material B.

The estimated opening balances for the next year will be:

 

Finished product:	10,000 units.
Material A:	12,000 units.
Material B:	15,000 units.

 

The desirable closing balances at the end of the year are:

 

Finished product–	16,000 units.
Material A–	14,000 units.
Material B–	15,000 units.

 

Draw a material-purchase budget.

 

[Madras University]

[Ans: Production – 46,000 units; Purchases – A: 1,40,000; B: 92,000]

[Model 25: Material-purchase cost budget]

11. From the following figures, prepare a raw material-purchase cost budget:

[Madras – Modified]

[Ans: X = 1,00,000 units @ 0.25 = Rs. 25,000.
      Y = 1,50,000 units @ 0.50 = Rs. 75,000.
      Z = 2,00,000 units @ 0.60 = Rs. 1,20,000.]

[Model 26: Manufacturing-overhead budget]

12. From the following average figures of previous quarters, prepare a manufacturing-overhead budget for the quarter ending on 31 March 2010:

The budgeted output for March 2010 is 6,000 units.

 

	Rs.
Fixed overheads:	Rs.30,000.
Variable overheads:	Rs.15,000 (varying at Rs.5 per unit).
Semi-variable overheads –	Rs.15,000 (40% fixed and 60% variable at Rs.3 per unit)

 

[Ans: Rs. 84,000]

 

[Madurai – modified]

[Model 27: Selling-overhead budget]

13. You are required to construct a selling-overhead budget from the following details:

 

		Rs.
Establishment expenses of the sales department	Rs.	30,000.
Other expenses of the sales department	Rs.	12,000.
Advertisement	Rs.	9,000.
Salaries to counter-salesmen	Rs.	30,000.

 

Commission to counter-salesmen at 2% on their sales.

   Commission to travelling salesmen at 5% on their sales and out-of-pocket expenses at 3% on their sales.

The following are the likely sales range for a year.

 

Sales as counter	Sales by travelling salesmen
Rs.	Rs.
Rs. 3,00,000	Rs. 30,000
Rs. 4,00,000	Rs. 40,000
Rs. 5,00,000	Rs. 50,000

 

[Madras – modified]

 

[Ans: Selling overhead:	Rs. 89,400
	Rs. 92,200
	Rs. 95,000]

[Model 28: Cash budget]

14. From the following particulars, prepare a cash budget for the period October to December 2009, indicating the extent of the bank facilities the company will require at the end of each month:

Additional information:

1. 50% of credit sales are realized in the month following the sales and the remaining 50% in the second month following.
2. Creditors are paid in the month following the month of purchase.
3. Cash as bank on 1 October 2009 (estimated) Rs.12,500.

[Ans: Closing balance:

1. Rs. 22,500;
2. 25,000;
3. Rs. 87,500.]

15. From the following information (forecasts) of income and expenditure, prepare a cash budget for the months from January to April 2010:

Additional information:

1. The customers are allowed a credit period of 2 months.
2. A dividend of Rs. 10,000 is payable in April.
3. Capital expenditure to be incurred:

   Plant purchased on 15th January for Rs. 5,000, a building has been purchased on 1st March and the payments are to be made in monthly instalments of Rs. 2,000 each.

4. The creditors are allowing a credit of 2 months.
5. Wages are paid on the first of next month.
6. Lag in payment of other expenses is one month.
7. Balances of cash in hand on 1st January 2010 is Rs. 5000.

[Bharathidasan University and Andhra University – Modified]

[Ans: Closing cash balance: Rs. 8,985; Rs. 18,795; Rs. 20,975; Rs. 13,685]

16. Draw up a cash budget for the months January to March 2010, from the following information:

1. Cash and bank balance on 1 January 2010 – Rs. 3,00,000
2. Actual and budgeted sales:

    

   Actual: 2009:	September	Rs. 5,00,000
   	October	Rs. 7,50,000
   	November	Rs. 8,00,000
   	December	Rs. 8,50,000
   Budgeted: 2010:	January	Rs. 9,00,000
   	February	Rs. 9,20,000
   	March	Rs. 9,90,000

    

3. Purchases: Actual and Budgeted:

    

   Actual: 2009:	November	5,50,000
   Budgeted: 2010:	January	5,80,000
   	February	5,00,000
   	March	6,00,000

    

4. Wages and expenses: Actual and budgeted:

    

   Actual: 2009:	November	Rs. 2,50,000 & Rs. 1,50,000
   	December	Rs. 2,50,000 & Rs. 1,60,000
   Budgeted 2010:	January	Rs. 2,80,000 & Rs. 1,60,000
   	February	Rs. 2,80,000 & Rs. 1,80,000
   March		Rs. 3,00,000 & Rs. 1,80,000

    

5. Special items:
   1. Advance payment of tax in March 2010 is Rs. 50,000.
   2. Plan to be acquired and paid in January 2010 is Rs. 1,00,000.
6. Assume 10% purchases and sales are on cash basis.
7. Lag in the payment of wages: 1/2 month; expenses: 1/4 month.
8. Period allowed by debtors: 2 months.
9. Period allowed by creditors: 1 month.

[Madras – modified]

[Ans: Closing balance: Rs. 32,000; Rs. 1,38,000; Rs. 2,59,000]

[Model 29: Fixed budget]

17. A firm has a contract to supply 15,000 units of its only product during 2009. The following were budgeted expenses and revenues:

 

Material	Rs. 15 per unit
Wages	Rs. 12 per unit
Work expenses (fixed)	Rs. 75,000
Work expenses (variable)	Rs. 9 per unit
General expenses (all)	Rs. 1,12,500

 

Profit is 20% on the sale price. Prepare the budget for 2009 showing the cost and profit.

 

[Madras – Modified]

[Ans: Profit: Rs. 1,81,875; Sales: Rs. 9,09,375]

[Model 30: Flexible budget]

18. The following particulars are taken from the books of a factory working at 60% of its capacity:

 

	Rs.
Variable expenses	3,00,000
Semi-variable expenses (50% fixed)	1,25,000
Fixed expenses	2,50,000

 

Prepare a budget for 75% of its capacity.

[Ans: Total at 75% capacity = Rs. 7,65,625.]

19. The expenses for the budgeted production of 5,000 units in a factory are furnished as follows:

	Rs. Per Unit
Materials	35.00
Labour	12.50
Variable overheads	10.00
Fixed overheads (Rs. 50,000)	5.00
Variable expenses (direct)	2.50
Selling expenses (10% fixed)	6.50
Distribution expenses (20% fixed)	3.50
Administration expenses (25,000) (fixed for all levels)	2.50
Total cost	77.50

Prepare a flexible budget for the production of (a) 3,000 units and (b) 4,000 units.

 

[Madras – Modified]

[Ans: (a) 3,000 units: Rs. 2,50,200

        (b) 4,000 units: Rs. 3,18,850

        (c) 5,000 units: Rs. 3,87,500]

[Model 31: Master budget]

20. A company requires to calculate and present the budget for the next year from the following data:

 

	Rs.
Sales	21,00,000.
Direct-material cost	40% of sales.
Direct wages of 10 workers at	Rs. 600 per month.
Factory overheads:
Indirect labour:
Works manager	Rs. 2,100 p.m.
Foreman	Rs. 600 p.m.
Stores & Spares	3% on sales.
Depreciation on machinery	Rs. 30,000.
Light & Power	Rs. 6,000.
Other sundries	10% on direct wages.
Administration, selling and	Rs. 42,000 per year. distribution
Repairs & Maintenance	Rs. 21,000.

[Modified – Madras]

[Ans: Sales: Rs. 21,00,000; Prime cost: Rs. 9,12,000;Works cost: Rs. 10,71,600; Gross profit: Rs. 10,28,400; Net profit – Rs. 9,86,400]

[Model 32: Control ratios]

21. From the following data, calculate:

(a) capacity ratio; (b) activity ratio; (c) efficiency ratio; and (d) calendar ratio.

 

Budgeted hours	– 200
Actual hour worked	– 250
Standard hours for actual production	– 240
Scheduled working days for the month	– 25
Actual number of days worked	– 23

 

[Ans: (a) 125%; (b) 120%; (c) 96%; (d) 92%]

 

[Model 33: Production budget and Labour budget]

22. Century India Ltd. is manufacturing three products – A, C and E in two production departments F and G. The following details in respect of the products are given as follows:

Standard labour time per unit and wage rate/hour

Department ‘F’   10   0–25   0–20   0–20

Department ‘G’   12   0–25   0–20   0–25

You are required to prepare:

1. The production budget for 2009–2010.
2. The direct-labour budget for 2009–2010; product-wise and department-wise.

[Modified – I.C.W.A. – Inter]

[Ans: (a) Units to be produced: A: 150; B: 190; C: 400.

(b) Product A: Department F – Rs. 3,75,000;

        Department G – Rs. 4,50,000.

        Product C: Department F – Rs. 3,80,000;

        Department G – Rs. 4,56,000.

        Product E: Department F – Rs. 8,00,000;

        Department G – Rs. 12,00,000.

[Model 34: Production budget, budgeted selling price and break-even point]

23. Ahead Ltd produces and sells a single product. Sales budget for the calendar year ended 31 December by quarters is as follows:

Quarter I	No. of Units to be Sold
I	12,000
II	15,000
III	16,500
IV	18,000

The year is expected to open with an inventory of 4,000 units of finished products and close with an inventory of 6,500 units. Production is customarily scheduled to provide for two-thirds of the current quarter’s sales demand plus one-third of the following quarter’s demand. Thus, the production anticipates a sales volume by about one month. The standard cost details for unit of the product is as follows:

Direct materials – 10 kg at 0.50 p per kg.

Direct labour for 1 hour – 30 minutes at Rs. 4 per hour.

Variable overheads for 1 hr – 30 minutes at Re 1 per hour.

Fixed overheads for 1 hr – 30 minutes at Rs. 2 per hour based on a budgeted production volume of 90,000 direct labour hours for the year.

1. Prepare a production budget for the year by quarters showing the number of units to be produced and the total costs of direct material, direct-labour-variable overhead and fixed overheads.
2. If the budgeted selling price per unit is Rs. 17, what would be the budgeted profit for the year as a whole?
3. In which quarter of the year is the company expected to break even?

[Modified – C.S. – Inter]

[Ans: Quarters

[Model 35: Production budget and Purchases budget]

24. The following are the estimated sales of a company for eight months that ended on 30 November 2009:

Months	Estimated sales (units)
April	12,000
May	13,000
June	9,000
July	8,000
August	10,000
September	12,000
October	14,000
November	12,000

As a matter of policy, the company maintains the closing balance of finished goods and raw materials as follows:

Stock item – Closing balance of a month.

Finished goods – 50% of estimated sales for the next month.

Raw materials – Estimated consumption for the next month.

Every unit of production requires 2 kg of raw materials costing Rs. 5 per kg. Prepare a production budget (in units) and raw material-purchase budget (in units and cost) of the company for the half year that ended on 30 September 2009.

 

[Modified – I.C.W.A. – Inter]

[Model 36: Production budget, raw material used and purchased and FIFO method storing ledger A/c]

25. A single product company estimated its sales for the next quarter as follows:

Quarter	Sales Units
I	30,000
II	37,500
III	41,250
IV	45,000

The opening stock of finished goods is 10,000 units and the company expects to maintain the closing stock of finished goods at 16,250 units at the end of the year. The production pattern in each quarter is based on 80% of the sales of the current quarter and 20% of the sales of the next quarter.

The opening stock of raw materials in the beginning of the year is 10,000 kg and the closing stock at the end of the year is required to be maintained at 5,000 kg. Each unit of the finished output requires 2 kg of raw materials.

The company proposes to purchase the entire annual requirements of raw materials in the first three quarters in the proportion and at the prices given as follows:

Quarter	Purchase of raw materials in % to total annual requirement in quantity	Price per kg Rs.
I	30%	2
II	50%	3
III	20%	4

The value of the opening stock of raw materials in the beginning of the year is Rs. 20,000.

You are required to present the following for the next year, quarter-wise:

1. Production budget in units.
2. Raw-material-consumption budget.
3. Raw-material-purchase budget in quantity and value.
4. Priced-stores ledger card of the raw material using FIFO method.

[C.A. – Inter]

[Ans:

1. Qr: I: Rs. 31,500; II: 38,250; III: 42,000; and IV: 48,250. Total: 1,60,000 units.
2. Raw-material consumption: I: 63,000; II: 76,500; III: 84,000; IV: 96,500. Total: 3,20,000 kg.
3. Raw-material purchase: Rs. 9,13,500.
4. Stores-ledger closing balance:
   1. 41,500 at Rs. 83,000;
   2. 1,22,500 at Rs. 3,67,500;
   3. 1,01,500 at Rs. 3,67,500;
   4. 5,000 at Rs. 20,000]

[Model 37: Production-overhead budget]

26. The monthly-production overhead budget for a factory of 100% capacity (1,00,000 hours) was as follows:

	Rs.	Category
Salaries	40,000	C
Indirect wages	8,000	B
Repairs & Maintenance	5,000	B
Consumable stores	4,000	A
Miscellaneous	5,000	B
Spoilage	2,000	A
Fuel and Power	15,000	A
	79,000

The behaviour of various categories of expenses was as follows:

There were three products and in a month, the total production was expected to be:

 

x	10,000 units.
y	15,000 units.
z	5,000 units.

 

The standard hours per unit of three products were agreed to be 5 for x, 4 for y and 6 for z.

Prepare the production-overhead budget for the concerned month.

 

[I.C.W.A. – Final]

[Ans: Total production-overhead budget: Rs. 85,630. Hint: Capacity level = 140%. Multiplier at 140% capacity is to be applied.]

[Model 38: Sales budget]

27. Vniak Ltd, a company engaged in the manufacture of electrical appliances, has set the following budget for 2009.

 

When the budget was placed before the budget committee, the marketing manager put up a proposal to increase the sales by 20,000 additional units for which the capacity existed. The additional 20,000 units could be one product or any combination of products. The proposal was accepted by the committee.

The committee also decided that the production capacity for the next year, namely, 2010 could be set in such a way that there would be a further increase in the output by 50,000 units over and above the increase of 20,000 units that were envisaged for 2009. The additional production of 50,000 units would be of table lamps only for which a new plant would be acquired. The additional fixed expenses of the new plant were estimated at Rs. 70,000 per annum. During 2010, the raw material and labour costs were expected to increase by 10% but the other costs and selling expenses would remain the same.

Required:

1. Set a budget for 2009, in such a way that the additional capacity of 20,000 units is utilized to maximize the profits.
2. Set a budget for 2010.
3. Assuming that the increased output may not fully materialize.
4. Calculate the no. of units of table lamps required to be sold in 2010 at the given price in order to ensure that the profitability level is maintained at least in 2009.

[Modified –I.C.W.A. – Final]

[Ans:

1. Net profit for 2009 – Rs. 5,60,000.
2. Net profit for 2010 – Rs. 7,76,500.
3. 44,700 units.]

[Model 39: Cash budget – Adjusted P&L method]

28. Your Board of Directors has the following proposals for the next financial year:

1. Capital-expenditure proposals Rs. 28 lakhs.
2. Borrowings Rs. 25 lakhs.
3. Investments worth Rs. 4.50 lakhs to be sold for Rs. 7.20 lakhs.

(b) Credit terms are as follows:

Sales/debtors – 10% sales are on cash, 50% of the credit sales are collected next month and the balance in the following months:

 

Creditors: Materials	– 2 months.
Wages	– 1/4; month.
Overheads	– 1/2; month.

 

(c) Cash and bank balance on 1 April 2010 is expected to be 6000.

(d) Other relevant information are as follows:

1. Plant and machinery will be installed in February 2010 at a cost of Rs. 96,000. The monthly instalment of Rs. 2000 is payable from April onward.
2. Dividend@ 5% on the preference-share capital of Rs. 2,00,000 will be paid on 1 June.
3. Advance to be received for sale of vehicles@ Rs. 9,000 in June.
4. Dividends from investments amounting to Rs. 1,000 are expected to be received in June.
5. Income tax (advance) to be paid in June is Rs. 2,000.

[I.C.W.A. – Inter – modified]

[Ans: Deficit – April: Rs. 2,050; May: Rs. 950; June: Rs. 2,700; Closing balance – April: Rs. 3,950; May: Rs. 3,000; June: Rs. 300.]

[Model 40: Flexible budgets]

29. The following data are available in a manufacturing company for a half-yearly period:

Fixed expenses:

	Rs. (lakhs)	Rs. (lakhs)
Wages & salaries	8.4
Rent, rates & taxes	5.6
Depreciation	7.0
Sundry administration expenses	8.9	29.9

Semi-variable expenses:

(at 50% of capacity)

1. Equipment of original value of Rs. 1.63 lakhs with accumulated depreciation of 0.84 lakhs to be sold.
2. The increase in working capital is as follows:
   1. Inventory Rs. 5.2 lakhs
   2. Debtors Rs. 2.8 lakhs
3. Dividends of Rs. 15 lakhs to be paid.
4. Term-loan instalment due during the year – Rs. 3 lakhs.
5. Following is the budgeted P&L A/c for the next year

	(Rs. in lakhs)
Sales	155.44
Less: Cost of sales (includes depreciation of Rs. 10.37 lakhs)	101.24
Less: Administration & selling costs	30.68
Less: Interest	1.25
Add: Gain on sale of:
Equipments	0.11
Investments	2.70
Gross income	25.08
Tax	12.19
Net income	12.89

 

Prepare a cash budget from the above and assess the surplus or deficit.

 

[Modified – CIMA – London]

[Ans: Deficit: Rs. 0.45 lakhs]

[Model 41: Cash budget]

30. Prepare a cash budget for the three months ending on 30 June 2010 from the following information:

Maintenance & Repairs	2.5
Indirect labour	9.9
Sales department & salaries	2.9
Sundry administrative expenses	2.6
Total	17.9
Variable expenses: (at 50% of capacity)
Materials	24.0
Labour	25.6
Other expenses	3.8
Total	53.4

 

Assume that the fixed expenses remain constant for all levels of production; semi-variable expenses remain constant between 45% and 65% of capacity increasing by 10% between 65% and 80% capacity, and by 20% between 80% and 100% capacity.

Sales at the various levels are:

 

	Rs. (lakhs)
60% capacity	100.00
70% capacity	125
90% capacity	150
100% capacity	170

 

Prepare a flexible budget for the half year and forecast the profits at 60%; 75%; 90% and 100% of capacity.

[C.S. – Inter]

[Ans:	60% – Loss Rs. 11,88,000
	75% – Loss Rs. 9,69,000
	90% – Profit Rs. 2,50,000
	100% – Profit Rs. 11,82,000]

[Model 42: Control ratios]

31. In a manufacturing shop, product X required 2.5 man hours and product Y requires 6 man hours. In a month of 25 working days of 8 hours a day 2,000 units of X and 1,000 units of Y were produced. The company employed 50 workers in the shop and the budgeted man hours are 1,08,000 for the year.

You are required to workout the capacity ratio, activity ratio and efficiency ratio.

 

[I.C.W.A. – Inter]

[Ans: Capacity ratio: 111.11%; Activity ratio: 122.22%; Efficiency ratio: 110%]

32. State what do you understand by:

1. Efficiency ratio
2. Activity ratio
3. Capacity ratio

Illustrate your answer with a formula and example of each calculated from the following figures:

 

Budgeted production	880 units
Standard hours per unit	10
Actual production	750 units
Actual working hours	6,000

 

[C.A. – Inter]

[Ans: (a) 125%; (b) 85.23%; and (c) 68.18%]

33. If the activity ratio and capacity ratio of a company is 104% and 96%, respectively. Find out its efficiency ratio?

 

[C.A – Inter]

[Ans: 108.33%]

34. Narang Ltd produces two commodities, Good and Better, in one of its departments. Each unit takes 5 hrs and 10 hrs as production time, respectively. 1,000 units of Good and 600 units of Better were produced during the month March. The actual man hours spent in this production were 10,000. Yearly budgeted hours are 96,000.

 

[C.S. Final]

[Ans: Capacity ratio: 125%; Efficiency ratio: 110%; Activity ratio: 137.5%]

[Model 43: Master budget]

35. A manufacturing company requires you to calculate and present the master budget for the next year 2011 from the following information:

 

Sales	– Rs. 16,00,000.
Direct-material cost	– 60% of sales.
Direct wages	– 20 workers @ Rs. 300 p.m.

 

Factory overheads:

 

Indirect labour: Works Manager	– Rs. 1,000 p.m.
Foreman	– Rs. 800 p.m.
Stores & Spares	– 2½; % on sales.
Depreciation on machinery	– Rs. 25,200.
Light & Power	– Rs. 10,000.
Other sundries	– 10% on direct wages.
Administration & Selling	– Rs. 28,000 per year.
Repairs & Maintenance	– Rs. 16,000.

 

[Ans: Prime cost: Rs. 10,32,000; Works cost: Rs. 11,52,000; Gross profit: Rs. 4,48,000; Net profit: Rs. 4,20,000.]

[Model 44: Principal budget factor and forecasts]

36. In its budget for the period ahead X Limited is considering two possible sales forecasts for its three products as follows:

Variable costs per unit are expected to be the same at different levels of possible sales. The variable costs per unit are as follows:

Fixed overheads are expected to total Rs. 1,00,000. These are expected to be unaffected by the possible changes in activity which are being considered. Due to recent high-labour turnover problems, direct labour will be restricted to a maximum of Rs. 1,30,000 in the period. It can be assumed that all labour is of the same grade and is freely transferable between products. Other resources are expected to be generally available.

 

Required:

Taking each of the possible sales forecast in turn:

1. Say what the principal budget factor is for each of the forecasts.
2. For each forecast, calculate the sales budget that you would recommend to maximize profits.
3. What profit would you expect from each sales budget?

Assume that the products will be sold according to the selling price estimated as per the forecast and no interchange of the forecast is allowed.

 

[C.A. – Inter]

[Ans:

1. Principal budget factor for Forecast I is Sales and for Forecast II is Labour.
2. Sales budget for Forecast I: Product A – 22,000 units at Rs. 10 per unit; Product B – 40,000 units @ Rs. 6 per unit; and Product C – 6,000 units @ Rs. 7.50 per unit.

   Sales budget for Forecast II: Product A – 30,000 units at Rs. 9 per unit; Product B – 42,000 units at Rs. 5.50/unit; and Product C – 7,000 units @ Rs. 7.50 per unit.

3. Profit: Forecast I – Rs. 77,000.
   Forecast II – Rs. 63,500.]

[Model 45: Responsibility accounting]

37. The following is a control report prepared by a cost accountant of Department X in a factory.

Overhead directly assigned to Department X:

	Rs.	Rs.
Indirect materials (based onactual requisitions)	30,000
Indirect labour ( job tickets)	27,000
Overtime charges	3,000
Depreciation on equipment	15,000	75,000
Allocated factory overhead (38% of factory space)		1,29,000
Allocated overhead of repair shop (62% of repairs in) repair shop done for Department X		36,000
Allocated office and administration overhead (on agreed basis)		1,50,000
Total department expenses		3,90,000

You are required to revise the report treating Department X as a responsibility centre.

 

[Modified – C,A. – Final]

[Ans:	Fully controllable costs − Rs. 60,000;
	Partially controllable costs − Rs. 36,000;
	Non-controllable costs: Depreciation − Rs. 15,000;
	Allocated and factory overhead − Rs. 1,29,000;
	Allocated administration overhead − Rs. 1,50,000.
	As such, they are to be excluded from the revised control report.]