BUDGET

BUDGET
 A budget is a financial plan for the future concerning the
revenues and costs of a business
 Their primary functions are to
› provide management with a projection of the
activities necessary to reach established goals,
› and to serve as a control device.
 Benefits of budgets

1. Forces managers to do planning.

2. Realistic performance targets.
3. Basis for controlling what happens within the
organisation.
4. Helps coordinate the activities of the various centres
that make up the business.
5. Communication – managers exchange information on
ideas, etc.
6. Motivating tool – if the process involves staff.

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 Limitations of budgets

 Only estimates, not statements of facts.

 No substitute for sound management practices.
 Need to be amended if circumstances change.
 Preparation does not guarantee success.
 Aspects of people’s behavior may undermine the value
of the process.

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TYPES OF BUDGET
Types of Budget
Cash Budget
Financial Budget
Capital Expenditure Budget

Sales Budget

Production Budget
Budget Operating Budget
Direct Materials Purchases Budget

Selling and Administrative Expenses

Budget

Cost of Goods Sold Budget

Factory Overhead Cost Budget

Master Budget Direct Labor Cost Budget

 Cash Budget
 The cash budget is for cash planning and control.
 It presents expected cash inflow and outflow for a designated
time period.
 The cash budget helps management keep cash balances in
reasonable relationship to its needs and aids in avoiding idle
cash and possible cash shortages.
 This budget is used to ascertain whether company operations
and other activities will provide a sufficient amount of cash
to meet projected cash requirements. If not, management
must find additional funding sources.
 The cash budget is comprised of two main areas, which are
A. Sources of Cash and
B. Uses of Cash.
A. The Sources of Cash section contains
• the beginning cash balance,
• cash receipts from cash sales,
• accounts receivable collections, and
• the sale of assets.
B. The Uses of Cash section contains
• all planned cash expenditures, which comes from the direct materials budget,
• direct labor budget,
• manufacturing overhead budget, and
• selling and administrative expense budget.
• It may also contain line items for fixed asset purchases and dividends to
shareholders.
•The Institute of Cost & Management Accountants defines
variance as the difference between a standard cost and the
comparable actual cost incurred during a period

•Variance Analysis can be defined as the process of computing the

amount of and isolating the cause of variances between actual
costs and standard costs.

•It involves two phases:

•Computation of individual variances
•Determination of the cause(s) of each variance
Care to be taken while comparing actual and standard cost

1.Conditions might have changed, thus rendering the standard costs unrealistic – for
instance the quality of available materials may be low.

2.Standards fixed upon on too idealistic a basis will remain unattainable.

3.The service rendered by a service departments may not be upto the mark so that, for
example time is lost due to a machine working slow.

4.In certain activities, fixation of standard is either not possible or not desirable. Goods
requiring artistic work of high quality cannot be and should not be subject to
quantitative standards. In certain cases work cannot be properly measured. Standards in
these cases will be useless.
Material Variances

Labour Variances

Variable Overhead Variances

Fixed Overhead Variances

Variances

Variances

Material
Direct
Cost Overheads
Labour
Variance

Quantity or Time or
Price Rate Idle Time Fixed OH Variable OH
Usage Efficiency
Variance Variance Variance Variance Variance
Variance Variance

Yield or
Mix Mix or Gang Yield Expenditure Volume
Sub-usage
Variance Variance Variance Variance Variance
Variance

Efficiency Capacity Calendar

Variance Variance Variance
• The reasons for the overall variances can be easily
find out for taking remedial action.
• The sub-division of variance analysis discloses the
relationship prevailing between different
variances.
• It is highly useful for fixing responsibility of an
individual or department or section for each
variance separately.
• It highlights all inefficient performances and the
extent of inefficiency.
• It is used for cost control.
 CONTD.
• The top management can follow the principle of
management by exception. Only unfavorable variances
are reporting to management.
• Sometimes, the variances can be classified as
controllable and uncontrollable variances. In this case,
controllable variances are taken into consideration for
further action.
• Profit planning work can be properly carried on by the
top management.
• The results of managerial action can be a cost reduction.
• It creates cost consciousness in the minds of the every
employee of business organization.
• Non-Standardized Production
• Service Organizations
• Assigning Responsibilities
• Reporting Delay
• Behavioral issues
 Break-Even Point Analysis

A decision-making aid that enables

a manager to determine whether a
particular volume of sales will result in
losses or profits
 Cost Terms
The term “cost” appears in many contexts and carries a
number of meanings.

Different categories of cost terms are merely different

ways to look at costs or to slice and dice cost information.
They are not necessarily complementary to or mutually
exclusive of other cost categories.
 Cost Classification
Variable costs: costs that
increase or decrease (in total)
relative to increases or decreases
in the level of business activity.
Fixed costs: costs that do not
change (in total) relative to
changes in business activity.
Period costs : Its usually
associated with the selling
function of the business or its
general administration.
Opportunity cost : These are the
values of potential benefits
foregone when a decision is
made.
Direct costs: costs that are
directly traceable to some object
such as a product, activity or
department.
Indirect costs: costs that are
NOT directly traceable to a
product, activity or department.
 What it can be used for?
• Monthly expenses- use it to see if your
income is more then your expenses
• Determine minimum price product can be
sold for
• Determine optimum price product can be
sold for
• Calculate effects of marketing programs on
price

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 Cost Analysis
 Cost: The amount expended in order to obtain benefit from
goods or services (such as purchase of materials) that will help
an organization achieve its objectives.

 Classification depends on the nature of the organization

concerned.

 The manufacturing costs of a product are made up of three

basic elements—materials, labor and production overhead
(expense).

 The selling costs are all the costs necessary to obtain customer
orders and to supply the finished product to the customer.

 The administrative costs are all the costs incurred in operating

the business affairs of a firm.
NATURE AND CLASSIFICATION OF COSTS

• Direct cost
 Direct cost is a cost that can be obviously and
physically traced to the particular cost object under
consideration of the line would be direct costs.
• Indirect cost
 Indirect cost is a cost that must be allocated to the
particular cost object under consideration.
 This is because it is not directly traceable to any
particular product line but is incurred as a
consequence of general, overall operating activities.
 Indirect costs are also known as common costs.
NATURE AND CLASSIFICATION OF COSTS
› Product (inventoriable) costs
 Costs involved in the purchase or manufacture of
goods.
 Product costs are viewed as 'attaching' to units of
product at the time the goods are purchased or
manufactured, and they remain attached until sale
takes place.
 At the point of sale, the costs are released from
stock as expenses and matched against sales
revenue.
NATURE AND CLASSIFICATION OF COSTS
› Period (non-inventoriable) costs
 Costs that are treated as an expense in the period
incurred and matched against revenue on a time
basis.

 This treatment reflects the difficulty in establishing

a link between the cost and revenue earned.

 It also reflects the fact that even though the

expenditure is made, it will not eliminate the need
for future outlays of the same nature.
NATURE AND CLASSIFICATION OF COSTS
 For example, advertising costs of
products cannot be directly linked to
current or future sales but will certainly influence
the level of sales achieved.
• Variable costs
 Variable costs are costs that vary, in total, in direct
proportion to changes in the level of activity.
 Example : cost of direct materials.
 The cost of direct materials used during a period
will vary, in total, in direct proportion to the number
of units that are produced.
 NATURE AND CLASSIFICATION OF
COSTS
 To illustrate this idea, assume that a company
produces motor vehicles and that each car produced
requires one battery costing $10:
NATURE AND CLASSIFICATION OF COSTS
› Fixed costs
 Fixed costs are costs that remain constant in total,
regardless of changes in the level of activity from
period to period.

 No matter how much activity levels rise or fall, fixed

costs remain constant in total amount unless
influenced by some outside force, such as price
changes.
 NATURE AND CLASSIFICATION OF
COSTS
 Rent is a good example of a fixed cost.
 This idea is illustrated below, assuming a monthly
rental cost of $5000 for a machine that is capable of
producing up to 1000 units of
product each
month.
 The Break-Even Point (BEP) Formula

P(X) = F + V(X)
Revenue
Where: Total Costs

› F = fixed costs
› V = variable costs per unit
› X = volume of output (in units)
› P = price per unit

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 ADVANTAGES OF BEP
ANALYSIS
• Break-even analysis enables a business
organization to:
› Measure profit and losses at different levels of
production and sales.
› Predict the effect of changes in sales prices.
› Analyze the relationship between fixed and variable
costs.
› Predict the effect of cost and efficiency changes on
profitability.
 Limitations of BEP Analysis
• Assumes that sales prices are constant at all
levels of output.
• Assumes production and sales are the same.
• Break even charts may be time consuming to
prepare.
• It can only apply to a single product or single mix
of products.

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