Management Accounting Unit 4 Budgeting for Profit Planning and Control

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Management Accounting Unit 4 Budgeting for Profit Planning and Control

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Budgeting for Profit Planning and Control

MANAGEMENT ACCOUNTING

1. Fill in the blanks:

(a) A budget is a blueprint of a plan expressed in ___________ terms.

Ans: Quantitative.

(b) Performance budgeting may be described as the budgeting system in which input costs are related to ___________.

Ans: Performance.

(c) Zero based budgeting focussed on ___________ analysis.

Ans: Cost-benefit.

(d) A ___________ is that part of the organisation for which the budget is prepared.

Ans: Budget centre.

(e) When the operating budget of a firm is constructed in terms of responsibility areas it is called the _____________.

Ans: Responsibility budget.

(f) The ___________ budget is an analysis of flow of cash in a business over a future, short or long period of time.

Ans: Cash.

(g) Master budget incorporates all ___________ budgets.

Ans: Functional.

(h) Zero-base budgeting was first used in America in ___________.

 Ans: 1962.

(i) A _________ is an estimate of expected sales during a budget period.

Ans: Sales budget.

(j) A ___________ is a document which spells out the duties and also the responsibilities of the various executives concerned with the budgets.

Ans: Budget manual.

(k) Budgetary control helps management to plan and ____________ .

Ans: Control.

(l) __________ is a budget designed to finish budgeted cost for any level of activity actually allowed.

Ans: Flexible budget.

(m) A budget which consolidates the organisation’s overall plan is called __________.

Ans: Master budget.

(n) Cash budget is a ___________ budget.

Ans: Short term budget.

(o) Budgetary control ___________ key managerial functions.

Ans: Integrates.

2. State ‘True’ or ‘False’ against each of the following statements:

(a) A good system of accounting is essential to make the budgeting successful.

Ans: True.

(b) Budgeting is done for every segment of the business. 

Ans: True.

(c) Budgeting provides the logical basis for forecasting.

Ans: False.

(d) In fixed budgets costs are classified according to their nature.

Ans: False.

(e) Programme budgeting is a system of budgeting which provides for appraisal of performance as well as follow up measures.

Ans: False.

(f) Performance budgeting is relevant to the problems of top level management.

Ans: False.

(g) The preparation of zero-base budgeting is based upon the selection of a decision package in view of cost-benefit analysis.

Ans: True.

(h) Flexible budgets clearly show the impact of expenses on operations and it helps in making accurate forecasts.

Ans: True.

(i) There is no difference between a budget and a for cost.

Ans: False.

(j) A fixed budget is concerned with budgeting of fixed assets.

Ans: False.

(k) A flexible budget is necessary for a business enterprise whose demand for goods is stable.

Ans: False.

(l) Sales budget is a functional budget.

Ans: True.

(m) The budget that is prepared first of all is master budget.

Ans: False.

SHORT TYPE QUESTIONS & ANSWERS

1. What do you mean by a budget manual?

Ans: A budget manual is a document which spells out the duties and also the responsibilities of the various executives concerned with the budget. It specifies the relations among various functionaries. In other words a budget manual lays down the details of the organisational setup, the routine, procedures and programmes to be followed for developing budgets of various items and the duties and responsibilities of the executives regarding the operation of the budgetary control system.

2. What is rolling budget?

Ans: This is a budget which is updated continuously by adding a further period and deducting a corresponding earlier period. It will enable to evolve a precise plan of action and control of variance functions by a board plan for the future.

3. Define ‘Activity Based Budgeting’.

Ans: In the traditional method of making budgets the previous year’s figure are taken as the base and to it certain averages are added for increase in costs for the next period. This method is followed particularly for indirect cost because it is very difficult to establish exact relationship between the level of activities and the indirect cost.

4. What do you mean by ‘principal budget factor’?

Ans: Principal budget factor is such an important factor that would affect all the functional budgets to a large extent. The extent of its influence must be assessed first in order to ensure that functional budgets are reasonably capable of fulfillment. This is the factor in the activities of an undertaking which at a particular point in time or over a period will limit the volume of output.

5. Compare budget, budgeting and budgetary control.

Ans: Budgets are the individual objectives of a 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 an overall management tool for the business planning and control. Thus a budget is a blue print of a plan expressed in quantitative term, budgeting is a technique for formulating budget and budgetary control refers to the principles, procedures and practices of achieving given objectives through budget.

6. Distinguish between budget and forecast?

Ans: Differences between budget and forecast are as follows:

7. Distinguish between ‘Traditional Budgeting’ and ‘zero-based Budgeting’.

Ans: Difference between Traditional budgeting and zero-based budgeting are follows:

8. Explain the importance of a flexible budget. 

Ans: Importance of flexible budget are as follows:

(i) Flexible budget provides a logical comparison of budgeted allowances with the actual cost.

(ii) Flexible budget recognizes concept of variability and provides logical comparison of expenditure with actual expenditure as a mean of control.

(iii) With flexible budget, it is possible to establish budgeted cost for any range of activity.

(iv) A flexible budget is very useful for purposes of budgetary control because it corresponds with changes in the level of activity.

(v) Cost ascertainment at different levels of activity is possible because a flexible budget is prepared for various levels of activity.

(vi) It is helpful in price fixation and sending quotations.

9. What are the advantages of cash budget?

Ans: The following are the main advantages of preparing cash budget:

(i) It provides an opportunity to review the cash flow for future periods as realistically as possible and make sure that cash is available for revenue and capital expenditure.

(ii) If large surplus of cash is likely to result during certain periods then it will be possible to plan most profitable investment of these fund.

(iii) Preparation of a cash budget by a company will help to plan its cash position in such a way that maximum seasonal discounts can be availed of.

(iv) Even for obtaining funds from financial institution, the system of preparing cash budget helps to convince the bank. 

(v) The importance of cash budget may be more in some trades than in other e.g. in trades where there are wide season fluctuations.

10. Describe the essential steps for of a successful budgetary control. 

Ans: For making a budgetary control system successful, following requisites are required: 

(i) Clarifying objectives: The objectives must be clearly spelt out so that budgets are properly prepared. In the absence of clear goals, the budgets will also be unrealistic.

(ii) Proper Delegation of Authority and Responsibility: Budget preparation and control is done at every level of management. Even though budgets are finalised at top level but the involvement of persons from lower level of management is also essential.

(iii) Proper communication system: An effective system of communication is required for a successful budgetary control. The flow of information regarding budget should be quick.

(iv) Participation of All Employees: It will also require the active participation and involvement of all employees.

(v) Flexibility: Flexibility in budgets is required to make them suitable under changed circumstances. Budgets are prepared for the future, which is always uncertain even though budgets are prepared by considering the future possibilities but still some occurences later on may necessitate certain adjustment.

(vi) Motivation: Budgets are to be implemented by human beings. Their successful implementation will depend upon the interest shown by the employees. All persons should be motivated to improve their working so that budgeting is successful.

11. X co. wishes to arrange overdraft facilities with banker during the period April to June of 2010. Prepare a cash budget for the above period.

Additional information :

(i) 50% of credit sales are realised in next month and the remaining following.

(ii) Creditors are paid in the next month

(iii) Cash balance on 1st April Rs.25000

Ans: Cash Budget: for the months from April of June

12. Draw up a flexible budget at 80% capacity from the following information.

Additional information:

(i) Administrative overhead will 10% increase.

(ii) There is a reduction in selling price by 5% at 80% capacity.

(iii) Economy in purchase of material will equal to 21/2% 

(iv) The research & development expenditure is Rs.250000 at this level.

Solution:

Flexible budget:

Working note:

(i) Material at 60% = Rs.1200000

Material at 80% = Rs.160000

(-) 21/2% = Rs.40000

= Rs.1560000

(ii) Variable fixed portion of expenses.

(iii) At 80% capacity:

LONG TYPE QUESTIONS & ANSWERS

1. Write the meaning of the following:

Ans: The meaning of the following are:

(a) Budget: A budget is the monetary or/and quantitative expression of business plans and policies to be pursued in the future period of time. According to CIMA, “A budget is a financial and/or quantitative statement prepared prior to a defined period of time, of the policy to be pursued during the period for the purpose of attained a given objective.”

(b) Budgetary control: Budgetary control is the process of determining various budgeted figures for the enterprises for the future period and then comparing the budgeted figures with the actual performance for calculating variances, if any.

According to Brown and Howard “Budgetary control is a system of controlling costs which includes the preparation of budgets, co-ordinating the department and establishing responsibilities, comparing actual performance with the budgeted and acting upon results to achieve maximum profitability.”

(c) Budget centre: A budget centre is that part of the organisation for which the budget is prepared. A budget centre may be a department, section of a department or any other part of the department. The establishment of budget centres is essential for covering all parts of the organisation.

(d) Programme budget: Programme budget consists of expected revenues and costs of various products or projects that are termed as the major programmes of the firm. Such a budget can be prepared for each product line or project showing revenues, costs and the relative profitability of various programmes.

(e) Responsibility budget: When the operating budget of a firm is constructed in term of responsibility areas, it is called the responsibility budget. Such a budget shows the plan in terms of persons responsible for achieving them. It is used by the management as a control device to evaluate the performance of executives who are in charge of various cost centres.

(f) Master budget: Master budget is prepared by the ultimate integration of separate functional budgets. According to ICWA, “The Master budget is the summary budget incorporating its functional budgets”.

(g) Fixed budget: According to ICWA London, “Fixed budget is a budget which is designed to remain unchanged irrespective of the level of activity actually attained: Fixed budgets are suitable under static conditions. If sales, expenses and costs can be enforced with greater accuracy then this budget can be advantageously used.

(h) Flexible budget: A flexible budget consists of a series of budgets for different level of activity. It therefore, varies with the level of activity attained. It is thus defined as a budget which by recognising the difference between fixed, semi-fixed and variable costs is designed to change in relation to the level of activity.

(i) Cash budget: A cash budget is an estimate of cash receipts and disbursements during a future period of time. It is an analysis of flow of cash in a business over a future, short or long period of time. It is a forecast of expected cash intake and outlay. 

(j) Performance budgeting: Performance budgeting has been defined as a “Budget based on functions, activities and projects”. It may be described as the budgeting system in which input costs are related to the performance, i.e, end results. It is a system of budgeting which provides for appraisal of performance as well as follow up measures.

(k) Responsibility accounting: Responsibility accounting is a system of control where responsibility is assigned for the control of costs. The persons are made responsible for the control of costs. Proper authority is given to the persons so that they are able to keep up their performance. In case the performance is not according to the predetermined standards then the persons who are assigned this duty will be personally responsible for it. In responsibility accounting the emphasis is on men rather than on system.

(l) Zero-base budgeting (ZBB): Zero base budgeting is the latest technique of budgeting and it has an increased use as a managerial tool. This technique was first used in America in 1962. The former president of America, Jimmy Carter used this technique when he was in Gorgia for controlling state expenditure.

As the name suggests, it starts from a scratch. The normal technique of budgeting is to use previous years’s cost level as a base for preparing this years’ budget. This method carries previous years’ in efficiencies to the present year because we take last year as a guide and decide “what is to be done this year, when this much was the performance of the last year”.

(m) Key factor: Key factor is a factor which governs the quantity that is to be manufactured or sold at a particular time or over a period. It is the governing factor which is considered as a major constraint to all operational activities. This factor is to be considered whether budgets are capable of attainment or not. So, this factor is to be located before a budget is prepared. It influences almost all budgets.

ICMA defined the key factor as “A factor which at anytime or over a period may limit the activity of an entity, often one where there is a shortage or difficulty of supply”. This factor is not static. 

2. Answer the following in brief: 

(i)  Define Budgetary control? Write some advantages of budgetary control.

Ans: Budgetary control is the process of determining various budgeted figures for the enterprises for the future period and then comparing the budgeted figures with the actual performance for calculating variances, if any.

According to Brown and Howard “Budgetary control is a system of controlling costs which includes the preparation of budgets, co-ordinating the department and establishing responsibilities, comparing actual performance with the budgeted and acting upon results to achieve maximum profitability.”

Some of the advantages of budgetary control are:

(a) Maximisation of profit: The budgetary control aims at the maximisation of profit of the enterprise. The achieve this aim, a proper planning and co-ordination of different functions is undertaken. The resources are also put to the best possible use.

(b) Co-ordination: The working of different departments and sectors is properly co-ordinated. The budgets of different departments having a bearing on one another. The co-ordination of various executives and subordinates is necessary for achieving budgeted targets.

(c) Specific aims: The plans, policies and goals are decided by the top management. All efforts are put together to reach the common goal of the organisation.

(d) Economy: The planning of expenditure will be systematic and there will be economy in spending. The finances will be put to optimum use. The benefits derived for the concern will ultimately extend to industry and then to national economy.

(e) Consciousness: It creates budget consciousness among the employees. By fixing targets for the employees, they are made conscious of their responsibilities.

(ii) Write the limitations of budgetary control.

Ans: Some of the limitations of budgetary control are as follows:

(a) Uncertain future: The budgets are prepared for the future period. Despite best estimates made for the future, the prediction may not always come true. The future is always uncertain and the situation which is presented to prevail in future may change.

(b) Budgetary revisions required: Budgets are prepared on the assumptions that certain conditions will prevail. Because of future uncertainties, assumed conditions may not prevail necessitating the revision of budgetary targets.

(c) Discourages efficient persons: Under budgetary control system, targets are given to every in the organisation. The common tendency of people is to achieve the targets only. There may be some efficient persons who can exceed the targets but they will also feel contended by reaching their the targets. So, budgets serve as constraints on managerial initiatives.

(d) Conflicts among different department: Budgetary control may lead to conflicts among functional departments. Every departmental head worried for his departmental goals without thinking of business goals. Every department tries to get maximum allocations of funds and this raises a conflict among different departments. 

(e) Depends upon support of top management: Budgetary control system depends upon the support of top management. The management should be enthusiastic for the success of this system and should give full support for it. If at any time there is a lack of support from top management then this system will collapse.

(iii) State the objectives or functions of Budgetary Control.

Ans: The following are the objectives of budgetary control:

(a) Planning: Budgetary control involves the preparation of a detailed operational plan to achieve the expected results of a business. Budgets will force the management at all levels to plan in time all the activities they will perform during a future period.

(b) Co-ordination: Budgetary control co-ordinates the efforts of the various sections of the business to achieve the business goals of a given period. It forces the executives to think in terms of a group and gives a direction to the business as a whole. Thus, it brings about matching efforts of the concerned department in the implementation of a well thought out plan of action and is termed as an important toll for the materialisation of a firms’ business policy.

(c) Communication: Budgetary control involves communication of the goal, programmes and policies to be pursued by the management. This communication is made to the management of all levels for the proper implementation of the plans & programmes within the prescribed time.

(d) Motivation: Budgetary control motivates managers for the achievement of the business goals as laid down in the budget. As the budgetary control system contains the incentive schemes for efficiencies and penal action for inefficiencies, it motivates the employees to improve their performance.

(e) Control: Control consists of the action necessary to ensure that the performance of the organisation conforms to the plans and objectives. Control of performance is possible when the actuals are compared with the pre-determined standards laid down in the budget. It is a technique of determining the efficiencies or inefficiencies of the functional managers.

(f) Evaluation: Comparison of the actual performance with the budgeted standards would reveal the deviations from the standards. Such deviations are analysed and causes are determined. The corrective actions are taken up where necessary. It acts as a guidance for revision where necessary in the preparation of future budgets.

(iv) Explain and illustrate the process of cash budgeting and its relevance in short term integrated fund planning.

Ans: Cash Budget is a forecast of cash position for a period. It is a detailed budget of cash receipts and cash expenditure incorporating both revenue and capital items. “It is an analysis of flow of cash in a business over a future, short or long period of time. It is a forecast of expected cash intake and outlay. Thus, it is an estimate of anticipated receipts and payments of cash during a budget period. However, cash adjustments and accruals are not shown in the cash budget.

Process Of Preparing A Cash Budget:

Cash budget can be prepared in three ways:

(a) Receipts and Payments method. 

(b) Adjusted Profit and loss method. and

(c) Balance Sheet method.

Procedure of preparing cash budget: It is started with opening cash balance adjustments are made with:

(a) Receipts:

(i) Cash from cash sale.

(ii) Cash received from debtors.

(iii) Cash received from other sources.

(iv) Dividend and rent received.

(v) Issue of shares and debentures.

(vi) Sale of investments.

(b) Payments:

(i) Cash requirements for material, labour and overheads.

(ii) Payment to creditors.

(iii) Cash requirement for capital expenditure such as purchase of fixed assets etc.

(iv) Repayment of loans and debentures.

(v) Cash requirements for other purposes such as payment of dividend, income tax, fines, penalties, etc.

Balance is the balance of cash in hand or deficit.

Relevance in integrated fund planning: It provides an opportunity of cash for revenue and capital expenditure. It helps the management to know in advance when cash available is inadequate and management can take timely action. When it shows a large surplus, during a period, the management can use this surplus fruitfully. It helps the management to avail the maximum seasonal discount by planning its cash position accordingly.

The management can convince the financial institutions through cash budget, for granting loans and advances. It will help the management in meeting its contractual obligations in time.

In short, the profitability of the business as shown in the functional budgets can be achieved only through proper cash management because the success of all budgets depends on the availability of adequate cash. Thus, profit planning of an organisation and its implementation is largely influenced by the availability of cash in time. Like blood in a human body, it shows the state of health of a firm and trend of solvency.

3. Explain the meaning of sales budget and production budget. Distinguish between sales budget and production budget.    

Ans: A sales budget isn’t the same as sales forecasting, which is the process of estimating future sales revenue. But a solid sales budget may be used to inform a sales forecast. A sales budget is also different from a sales expense budget, which focuses on company expenses over a certain period of time.The sales budget is a planning tool that allows companies to manage resources and profits based on expected sales. It takes into account previous sales patterns and budgets for similar time periods so that each department can have a big-picture idea of where they stand financially. This helps companies be more efficient in reaching their goals and maximising their profit.

A production budget is a calculation of how many units of a specific product a company can make within a budgetary time period. The production or manufacturing manner usually prepares this budget by collaborating with other team members, like data analysts and other managers, to obtain information and properly implement the information gained from the budget.

4. State the principles and significance of responsibility accounting.

Ans: Responsibility accounting is based on the following principles: 

(a) Fixing targets: Targets should be fixed on budgets or standards according to the responsibility.

(b) Evaluation of performance: Actual results should be compared with the budgets or standards for ascertaining the variances.

(c) Reporting: After analysing the variances, reports should be submitted to the top management.

(d) Corrective Action: Next step is taking corrective actions and communicating these to the persons concerned.

(e) Setting up of various responsibility centres: Responsibility centres like cost centre or expenses centre, revenue centre, profit centre, investment centre, contribution centre, etc., can be established.

(f) Motivating employees: The objective of responsibility accounting should be motivating employees.

Significance or advantages of responsibility accounting:

(a) Responsibility Accounting helps in the process of introduction of an impressive cost control system.

(b) Budgeting helps in the process of comparison of actual performances against the budgets set.

(c) This system helps the management to make an effective delegation of authority and responsibility.

(d) It saves time of management by preparing reports relating to departmental work on the principle of exception.

(e) This system motivates managerial executives by increasing their interests since they are asked to explain the reasons of deviation of actuals from the budgeted figures.

5. Define Fixed budget? Write the Features of Fixed budget.

Ans: According to ICWA London, “Fixed budget is a budget which is designed to remain unchanged irrespective of the level of activity actually attained: Fixed budgets are suitable under static conditions. If sales, expenses and costs can be enforced with greater accuracy then this budget can be advantageously used.

The following are the features of fixed budget:

(a) Fixed budget is rarely prepared and used. The reason is that the actual output is differing from the budgeted output. Hence, the management cannot exercise cost control.

(b) The performance report does not contain useful information and misleading one.

(c) If units are overlooked in the cost-to-cost comparison, accurate result is not available.

(d) The performance report gives merely whether the actual cost are higher or lower than budgeted costs.

(e) Fixed budget is limited by the costs and expenses which are affected by fluctuations in volume. This is a well known accepted fact. 

(f) There is no meaning of comparing one activity level with some other activity level. A fixed budget can be usefully employed when budgeted output is close to the actual output.

6. What are the Advantages or benefits of the fixed budget? 

Ans: (i) Needless to make changes to the budget every month: You do not have to make changes to the budget every month. Mostly, fixed budget planning is established keeping in mind the long-term goals. Doing so will help organizations deal with tough situations or emergencies. 

(ii) Helps in planning ahead: Typically, most agencies and companies plan their proposals way ahead. To plan a budget proposal in advance, financial managers need some data like how many employees need insurance, how much is the annual rent of the office, what are the taxes to be paid to the government, etc. So managers can set the fixed budget considering the previous year’s data. It also helps in planning your budget as per your company goals and needs. Thus, you can make smart decisions while spending (or) during a crisis.

(iii) Easy tracking: A fixed budget will help you keep track of your budget as your budget remains the same.

(iv) Easy implementation: A static budget is easy to implement as you do not have to update changes in your account books or software. It also allows the company to compare its expenses and revenues and implement the necessary strategies in the future.

(v) Keeping Costs Down: The fixed budget inevitably keeps costs down so long as the business abides by the strict financial limits placed upon the entire business. This forces the business to make savvier spending decisions as opposed to more expensive and possibly riskier investments if no cap on expenditures exists. It forces financial discipline at almost every level in the business.

(vi) Measure Profits: A fixed budget allows a business to measure both short-term and long-term budgets. The fixed budget allocates a set amount of money towards essentials such as overhead costs. Any money left over at the end of the month (or any other period you review your budget) is your profit. This may seem simple and straightforward but bears mentioning, since you cannot accurately measure profits without a budget. Further, the fixed budget makes profit measurement easier, since you allocate the same amount of money towards necessities on a regular basis. Profit measurement becomes more difficult if the budget constantly fluctuates.

(vii) Measure Performance: Since a fixed budget allots the same amount of money each month on necessities, you can compare each monthly budget to measure success. You can also measure yearly budgets to measure long-term success. This comparison gives you immediate insight into which months have better cash flow and the reason for that. One month’s increased expenditure in one area and decrease in another may have produced a stronger financial result than expected. The regular, fixed budgeting allows small business owners to keep track of such changes and change the business model accordingly to take advantage of positive financial changes.

7. What are various types of budget? Explain them.  

Ans: Here are the various type of budget control:

(i)  Incremental budgeting: Incremental budgeting takes last year’s actual figures and adds or subtracts a percentage to obtain the current year’s budget. It is the most common type of budget because it is simple and easy to understand.  Incremental budgeting is appropriate to use if the primary cost drives do not change from year to year. 

(ii) Activity-based budgeting: Activity-based budgeting is a top – down type of budget that determines the amount of inputs required to support the targets or outputs set by the company.  For example, a company sets an output target of $100 million in revenues.  The company will need to first determine the activities that need to be undertaken to meet the sales target, and then find out the costs of carrying out these activities. 

(iii) Value proposition budgeting: Value proposition budgeting is really a mindset about making sure that everything that is included in the budget delivers value for the business. Value proposition budgeting aims to avoid unnecessary expenditures – although it is not as precisely aimed at that goal as our final budgeting option, zero-based budgeting.

(iv) Zero-based budgeting: As one of the most commonly used budgeting methods, it starts with the assumption that all department budgets are zero and must be rebuilt from scratch.  Managers must be able to justify every single expense. No expenditures are automatically “okayed”. Zero-based budgeting is very tight, aiming to avoid any and all expenditures that are not considered absolutely essential to the company’s successful (profitable) operation.

8. What are the drawbacks of Fixed budget?

Ans: Following are the drawbacks of using such a budget:

(i) Estimates are not accurate as it is very hard to correctly predict the demand and industry trend.

(ii) It doesn’t help when there is a need to allocate additional resources to keep up with the rise in demand.

(iii) This budget is based on past budgets. So, it gets very hard for a new firm to prepare such a budget.

(iv) Since estimates are not accurate, it gets extremely difficult to evaluate the performance of the departments.

(v) Such a budget is not handy when evaluating the cost centers. For instance, if a cost center gets a massive budget, but spends well below it. 

(vi) The company cannot allocate funds when it feels that a certain department is underperforming and it can negatively impact the performance of an entity.

(vii) As said earlier, a fixed budget is based on previous data so new business may face problems while implementing and fixing the budget.

(viii) The level of activity tends to change with the shortage of raw material, sheer competition, and other internal & external factors.

(ix) Because of limitations, a fixed budget is considered as an ineffective tool for cost control.

(x) It lacks when it comes to allocating additional resources, when needed the most, to keep up with the increasing sales volume.

9. How to Overcome the Drawbacks of Fixed budget?

Ans: There are a few ways that can help a company overcome the shortcomings of a fixed budget. These ways are:

(i) Continuous Budgeting: We can combine a fixed budget with continuous budgeting. In this, a company adds a new budget period as soon as the last budget period gets over. This way, the budget gets the latest projections along with the full-year budget,

(ii) Reduce the Period: Reducing the period of a budget can also help in making the budget more accurate. For instance, a budget for a period of three months will have less time to diverge from the estimates, than a budget for six months or a year.

(iii) Flexible Budget: A flexible budget is a very good alternative to a fixed budget. It addresses all the drawbacks of a fixed budget so as to make budgeting more accurate. In a flexible budget, we can adjust the budget numbers to reflect the changes in the business activity. Moreover, management can easily alter a flexible budget as per the needs of a business. Along with the past data, the flexible budget also includes the estimates of future realistic situations.

However, it is more complex in comparison to the fixed one. Also, it takes comparatively more time to prepare. Despite these drawbacks, a flexible budget suits all kinds of businesses, be it a big, medium or small, or micro-enterprise.

10. What Does Flexible Budget Mean?

Ans: Flexible budgets can also be used after an accounting period to evaluate the successful areas and unsuccessful areas of the last period performance. Management carefully compares the budgeted numbers with the actual performance statistics to see where the company improved and where the company needs more improvement.

11. What are the essentials for effective budgeting? 

Ans: Essentials of Effective Budgeting System:

(i) Support of Top Management: The whole system should enjoy the support and co-operation of top management.

(ii) Efficient Organization: There should be well-planned organizational set-up with responsibility and authority clearly demarcated.

(iii) Accurate Accounting System: There should be a good accounting system which provides accurate and timely information.

(iv) Well defined Policies: The business policies of the firm should be well conceived, explained and implemented.

(v) Constant Vigilance: Variations should be reported promptly and clearly to the appropriate levels of management

(vi) Motivation: Staff should be strongly and properly motivated towards the system.

12. How to create a flexible budget?

Ans: The following are steps you can take to create a flexible budget for your business:

(i) Identify which costs are variable and which costs are fixed: Fixed costs typically include expenses such as rent and monthly marketing costs. Once you have determined which costs are fixed and which are variable, separate them on your budget sheet.

(ii) Divide the budget: Divide the budget you plan on spending on variable costs by your estimated production. This will provide a starting budget for cost per unit.

(iii) Create your budget with set fixed costs: Create your budget with set fixed costs that will not change and variable costs depicted as percentages that can be adjusted based on actual revenue.

(iv) Update the budget: Once an accounting period is over, update your budget with the actual revenue and/or activity measurements. This will adjust the variable costs based on accurate data from the accounting period.

(v) Input and compare: Input the final flexible budget from an accounting period into your accounting software to compare it to the expenses you initially anticipated.

13. What are the Types of flexible budgets? Explain.

Ans: A company can produce several variations of a flexible budget that range from basic to sophisticated depending on the company’s needs.

The following are the three types of flexible budgets most commonly used:

(i) Basic flexible budget: This type of budget flexes with a company’s expenses that change directly in relation to its revenue. A basic budget may build in a percentage that varies based on revenue. This type of budget is typically used to denote cost per unit or percentage of sales.

(ii) Intermediate flexible budget: An intermediate flexible budget takes into account expenses that go beyond a company’s revenue. Typically, this budget includes costs that are related to activity in addition to or rather than revenue. For example, a business’s insurance policy costs may vary based on how many employees the company has and may increase if the company hires new employees.

(iii) Advanced flexible budget: This type of budget takes into account the variation and ranges of expenses based on each category of a company’s budget. An advanced flexible budget will also change based on the actual expenses for each category.

14. Write the characteristics of flexible budget.

Ans: The important characteristics of flexible budget can be pointed as follows:

(a) Wide Range: Flexible budget covers a range of activities because it is prepared to show the expected cost and revenue for different levels of activities.

(b) Flexibility: Flexibility is another notable characteristic of flexible budget as it is easy to change according to variations of production and sales levels.

(c) Performance Evaluation: Flexible budget facilitates performance measurement and evaluation. It helps the management to evaluate the actual performance and efficiency with predetermined estimates.

(d) Changes: It takes into account the changes in the volume of activity.

(e) Replace Of Static Budget: Flexible budget helps to overcome the limitations of static budget by replacing it.

15. What does Flexible Budget Mean? Write some disadvantage of flexible budget.

Ans: Flexible budgets can also be used after an accounting period to evaluate the successful areas and unsuccessful areas of the last period performance. Management carefully compares the budgeted numbers with the actual performance statistics to see where the company improved and where the company needs more improvement.

Disadvantages of Flexible Budgeting are:

(a) Confusing: Budgets are simple because they provide one figure within which someone must remain. Flexible budgets require more planning in order to track expenses and adjust for any differences between periods. A range that changes over time can make the budgeting processing overly confusing for some users and therefore reduce the odds that they will successfully follow it.

(b) Enables Cheating: The rules of a traditional budget are straightforward: don’t spend more than the limit. Flexible budgets complicate things by include more rules that can easily be bent or broken by someone who is struggling to stay within the boundaries.

(c) Less Discipline: The whole point of a flexible budget is to make it easier to adhere to, however, by not following the same rigid program every month, such systems are unlikely to foster the same discipline or long term habits as more traditional alternatives.

(d) This budget requires skilled workers to work on it. The availability of skilled workers becomes a challenge for the industry. Therefore, many Industries and companies can’t use this budget despite its enormous advantages.

(e) It depends upon the proper accounting disclosures. The result cannot come out to be correct if there are any mistakes in the Books of Accounts provided. A flexible budget depends very much upon a forecast of the past business performance. So the historical information used needs to be accurate.

 (f) It is an expensive affair. Skilled workers are to be appointed, and they should be paid for their services. It’s quite a laborious task too. Thus many companies and industries can’t afford to have this budget.

(g) It also depends upon the factors of the production, which are not in the hands of the management. Therefore the predictions can be inaccurate due to these conditions.

(h) Variance Analysis provides useful information as each cost is analyzed according to its nature. Thus it becomes difficult for the experts to prepare Flexible budgets.

16. In which Situation Flexible budgeting used?

Ans: Situations to use Flexible Budgeting:

(i) In the case of a typical business, if it is newly started, it becomes tough to predict the demand for the product/services accurately. But this can be dealt with by putting a Flexible budget in place.

In the case where the business totally depends upon Mother Nature, i.e., rain, dry and cold, the flexible budget helps the business to estimate there output considering the good or adverse weather conditions. For example, agricultural activities, wool-based industries, etc.

In case of a business which carries their entire work with the help of laborers. The laborers’ availability is a critical factor for these types of companies. Therefore it helps the management to accurately know about their productivity and output, for example, jute factories, handloom industries, etc.

17. What is a fixed and flexible budget? Distinguish between them. 

Ans: A fixed budget is one that stays the same and doesn’t change based on variable costs. A flexible budget, on the other hand, is a more dynamic model. Flexible budgets change based on fluctuations with variable costs and have the ability to expand or contract in real time.

Flexible budgeting is an adaptable budgeting method that enables businesses to modify expense constraints in real-time according to changes in costs, production, sales, or other factors. Flexible budgeting is a hybrid approach to strategic planning, as it begins with a static framework, based on costs that aren’t likely to change, and layers a flexible budgeting system on top that allows other costs to fluctuate.

18. Explain the Types of Functional Budget.

Ans: Functional budgets provide an opportunity for companies to scrutinize individual aspects of the organization. Below we will examine three key functional budgets; sales, production and cash budgets to consider how they can improve planning and control within a business.

(i) Sales Budget: The sales budget is very important because it can help you plan your production patterns and is often linked to key targets within an organization. The sales budget will look different in every organization due to the range of products being sold, size of the company and the company’s organizational structure. The way sales are reported will be determined by the purpose of the budget. If the budget is related to sales targets, then the sales are normally recorded as they are invoiced because the budget can be analyzed against these targets. If the sales budget is used to feed directly into the cash budget, the sales may be recorded when the sales transactions convert into cash received.

(ii) Production Budget: The production budget, or operating budget as it will be known in a service-sector organization, considers the ‘units’ of production rather than the cost. Therefore, the budget value is normally units not currency. This budget is linked to your inventory accounts and your sales account. It will also include any normal loss that is anticipated during the production and include contingency policies. This budget is useful in two ways: to manage the production rate and to help maintain the company policy on stock levels. If a company uses philosophies such as just in time (JIT) then they will want to maintain very low stock levels, and this will mean their control on the production budget will be essential, ensuring correct items are purchased at precisely the right time.

(iii) Cash Budget: Cash is the heart of every organization. Regardless of the millions of pounds presented on the Income Statement and the Statement of Financial Position, if they cannot pay their debts they will go bankrupt. The management of cash is fundamental in any business or public organization; it is in terms of spending too much money and not spending enough. Managerial accounting uses cash budgets as a technique to manage this process.

Budgets can be incredibly useful in providing detail which can be used for planning purposes. Whether it is a sales budgets or a carbon budget, it provides the users with a target.

(iv) Material Budget: A Material Budget shows the estimated quantity as well as the cost of each type of direct material and component required for producing goods as per production budget. There are two stages of preparing material budget. At the first stage, the quantifies of different types of direct material are estimated.

(v) Purchase Budget: Purchase Budget gives the details of the purchases which must be made during the budget period. It includes all items of purchase, such as, raw materials, indirect material and other equipment.

(vi) Labour Budget: This budget contains the estimates relating to number of employees and types of employees required for the budgeted output. Once the classification of labour into its different grades has carried out, the labour requirements for each type of product can be estimated.

The standard labour hours required for each type of product are then set with the help of time and motion study. From the total man-hours required for production, labour requirements are determined and, from the estimated rate per hour, labour cost per unit is determined.

(vii) Factory Overhead Budget: Factory overhead budget gives estimates of all fixed, variable and semi-variable items of factory overhead to be incurred during the budget period to achieve the production budget.

(viii) Plant Utilisation Budget: This budget indicates plant and machinery facility required to meet the budgeted production during the budget period. Plant capacities/facilities will be expressed in the budget in terms of convenient units such as working hours or weight or the number of products etc. While preparing this budget allowance must be made for the time lost in repairs and maintenance, setting-up time etc.

(ix) Selling and Distribution Cost Budget: This budget is a forecast of the expenses connected with the selling and distributing the product of a concern during the budget period. This budget is closely connected with the sales budget. While preparing this budget, a classification is made according to the variability of cost. This budget is prepared by the sales managers.

(x) Administration Cost Budget: This budget represents the estimated cost of formulating policy, directing the organisation and controlling the business operations. Since most of the administration cost is fixed in nature, the preparation of this budgets does not present much difficulty. The main budget is divided into separate budget covering separate administrative activities such as legal, finance, accounting, management information services, internal audit and taxation.

19. What are the Types of Control Ratios? 

Ans: The types of control ratios are as follows:

(i) Capacity Ratio: The capacity ratio is also known as the actual usage of budgeted capacity ratio. It shows the relationship between the actual number of working hours and the budgeted number of working hours. This ratio indicates the extent to which available facilities have actually been utilized during the budget period.

Formula:

Capacity ratio = (Actual hours / Budgeted hours) × 100

(ii) Activity Ratio: The activity ratio is the number of standard hours equivalent to the work produced expressed as a percentage of the budgeted standard hours. This ratio measures the level of activity at which a business is operating.

Formula 

Activity ratio = (Actual production in standard hours/Budgeted production in standard hours) x 100

(iii) Efficiency Ratio: The efficiency ratio is the number of standard hours equivalent to the work produced expressed as a percentage of the actual hours spent in production. This ratio measures the efficiency of a firm’s operations.

Formula:

Efficiency ratio = (Actual production in standard hours / Actual hours worked) × 100

20. What is zero-based budgeting? 

Ans: As the name says “Zero-based budgeting” is an approach to plan and prepare the budget from the scratch. Zero-based budgeting starts from zero, rather than a traditional budget that is based on previous budgets. With this budgeting approach, you need to justify each and every expense before adding it to the actual budget. The primary objective of zero-based budgeting is the reduction of unnecessary cost by looking at where costs can be cut.

To create a zero base budget involvement of the employees is required. You can ask your employees what kind of expenses the business will have to bear and figure out where you can control such expenses. If a particular expense fails to benefit the business, the same should be axed from the budget.

21. Differences between Traditional Budgeting and Zero Base Budgeting.

Ans: (i) In traditional Budgeting, the previous year’s budget is taken as a base for the preparation of a budget. Whereas, each time the budget under zero-based budgeting is created, the activities are re-evaluated and thus started from scratch.

(ii) The emphasis of the traditional budgeting is on the previous expenditure level. On the contrary, zero-based budgeting focuses on forming a new economic proposal, whenever the budget is set.

(iii) Traditional Budgeting works on cost accounting principle, thereby, it is more accounting oriented. Whereas the zero-based budgeting is decision oriented.

(iv) In the traditional budgeting, justification of the line items and expenses are not at all required. On the other hand, in zero-based budgeting, proper justification is required, taking into account the cost and benefit.

(v) In traditional budgeting, the top management take decisions regarding any amount that will be spent on a particular product. In contrast, in zero-based budgeting, the decision regarding the spending a specific sum on a particular product is on the managers.

(vi) Zero-based budgeting is better than traditional budgeting when it comes to clarity and responsiveness.

(vii) Traditional budgeting follows a monotonous approach. On the contrary, zero-based budgeting follows a straightforward approach.

22. What is zero-based budgeting? Explain the advantages and disadvantages of Zero Based Budgeting.

Ans:  As the name says “Zero-based budgeting” is an approach to plan and prepare the budget from the scratch. Zero-based budgeting starts from zero, rather than a traditional budget that is based on previous budgets. With this budgeting approach, you need to justify each and every expense before adding it to the actual budget. The primary objective of zero-based budgeting is the reduction of unnecessary cost by looking at where costs can be cut.

To create a zero base budget involvement of the employees is required. You can ask your employees what kind of expenses the business will have to bear and figure out where you can control such expenses. If a particular expense fails to benefit the business, the same should be axed from the budget.

Advantages of Zero Based Budgeting:

Efficiency: Zero-based Budgeting helps a business in the allocation of resources efficiently (department-wise) as it does not look at the previous budget numbers, instead looks at the actual numbers.

Accuracy: Against the traditional budgeting method that involves mere some arbitrary changes to the earlier budget, this budgeting approach makes all departments relook every item of the cash flow and compute their operation costs. This methodology helps in cost reduction to a certain extent as it gives a true picture of costs against the desired performance.

Budget inflation: As mentioned above every expense is to be justified. Zero-based budget compensates the weakness of incremental budgeting budgeting of budget inflation.

Cordination and Communication: Zero-based budgeting provides  better cordination and communication within the department and motivation to employees by involving them in decision-making.

Reduction in redundant activities: This approach leads to identify optimum opportunities and more cost-efficient ways of doing things by eliminating all the redundant or unproductive activities Although this concept is a lucrative method of budgeting.

it is also important to know the disadvantages as listed below:

Disadvantages of Zero Based Budgeting:

High Manpower Turnover: The foundation of zero-based budgeting itself is a zero. Budget under this concept is planned and prepared from the scratch and require the involvement of a large number of employees. Many departments may not have adequate human resource and time for the same.

Time-Consuming: This Zero-based budgeting approach is a highly time- intensive for a company to do annually as against incremental budgeting approach, which is a far easier method.

Lack of Expertise: Providing an explanation for every line item and every cost is a problematic task and requires training for the managers.

23. Give the Zero-based budgeting process.

Ans: Businesses can develop or modify their own unique approaches to ZBB, and the following five steps can provide a baseline for implementation.

(i) Start: Begin at ground zero. Create a new annual budget from scratch without using last year’s actuals as a baseline.

(ii) Evaluate: Evaluate every cost area. Eliminate and reduce unnecessary activities or services.

(iii) Justify: Account for all components of the budget. Identify cost- effective, relevant, and cost-saving areas.

(iv) Streamline: Determine what activities should be performed and how. Automate and standardise processes where possible.

(v) Execute: Roll out comprehensive planning and execution processes. Communicate clear plans, roles, and responsibilities.

24. When to use zero-based budgeting?

Ans: Businesses that are struggling to effectively manage their costs can make use of zero-based budgeting. ZBB is a more thorоugh and strict form of budgeting that requires time to implement. Businesses that have a cost reduction target of 10 per cent or less can make use of this type of budgeting. It is also suitable for businesses that are willing to take on the challenges posed by zero-based budgeting. Zero-based budgeting requires training as it requires the creation of a cost-saving culture among employees. Businesses that are willing to put in the effort can consider using zero-based budgeting as it is most likely to bear fruit in the long term. 

Zero-based budgeting can be used by businesses of all sizes and all types as it can lead to big savings over time. Business owners often wrongly believe that ZBB is only for businesses that are unable to grow. Businesses can implement zero-based budgeting for growth as it can act as a growth booster. It does this by allocating the unproductive costs to productive endeavors. Small businesses and growing businesses can effectively use zero-based budgeting for better growth in the short term. It can also be used by businesses that are using traditional cost-cutting methods but want a more cost reduction.

25. Selling and Distribution Overheads Budget.

Ans: The budget gives an estimate of selling and distribution expenses to be incurred in the budget period. For example, Salesmen’s salary, commission, advertisement, transportation costs etc. It is prepared by the sales executive. It is closely linked with sales budget.

Control of Selling and Distribution Overhead, It is very difficult to control the selling and distribution overhead as most of them are fixed in nature. Only variable portion may be controlled.

However, the following techniques may be taken into consideration:

(a) Budgetary control.

(b) Standard costing.

(c) Comparison with past results.

26. What are the Five zero-based budgeting best practices?

Ans: Five zero-based budgeting best practices:

(i) Adopt a positive approach: ZBB is more than just slashing costs. It’s a necessary step for freeing the resources and funds needed for business renewal and growth initiatives. Working with the business leaders, you can use internal and external benchmarking to illustrate profitability gaps needing to be closed and explain exactly what will happen to the savings.

(ii) Identify the quick wins: Initially focus your ZBB initiative either on the larger and more stable business units struggling with profitability, or selected areas of overhead (such as sales, general, and administrative expenses) where there are large indirect costs not clearly understood. Not only will such choices reinforce the rationale for undertaking ZBB, but they will also deliver the largest cost savings with minimal disruption to the rest of the organization.

(iii) Don’t do it alone: Assemble a cross-functional project team with members from finance, IT, and other relevant business units, and preferably chaired by a C-level executive. The core of ZBB is the challenge and review process-scrutinizing every activity a department undertakes to see if it can be stopped or done more cheaply. It may be worthwhile to pay an experienced and objective third party to help negotiate the inevitable compromises.

(iv) Select the right planning platform: The success of ZBB depends on having detailed insight into the operational drivers of costs such as activity volumes, productivity ratios, and input costs-none of which are contained in traditional planning and budgeting software. These older systems only contain highly aggregated financial data, and as a consequence, need to be supplemented with considerable amounts of data from elsewhere such as spreadsheets. Manipulating this data in ancillary spreadsheets increases both the complexity and workload involved in any ZBB initiative. A better alternative is to hold all the detailed operational and financial data on a single financial planning and analysis platform such as Anaplan. See how one CPG company did just this. Such a platform makes it easy to model the causal relationship between activity volumes and the resulting resource requirements. In addition, Anaplan’s proprietary in-memory calculation engine provides the necessary power to process the large volumes of data involved.

(v) Plan for sustainability: Once you implement a successful ZBB project, keep your skills fresh by moving on to other business units or expense categories and revisiting previous projects to ensure the savings stick. Don’t mothball your ZBB model either. Because it contains the causal relationships between various activities, the resulting resource needs, and the expenses of those needs, the ZBB model can easily be developed into a driver-based planning and budgeting model that could beneficially supplement or replace existing FP&A processes. Successful ZBB projects should result in a heightened awareness of cost control. Keep in mind awareness won’t happen if the organization returns to the traditional incremental approach for annual planning and budgeting once the implementation is over.

27. Write the meaning of responsibility accounting. Explain the features of it.

Ans: Responsibility accounting refers to a system that undertakes the identification of responsibility centres, subsequently determine its objectives. It also helps in the development of processes related to performance measurement as well as the preparation and analysis of performance reports of the identified responsibility centres. 

Features of responsibility accounting are: 

(i) Inputs and Outputs: Responsibility accounting system can be implemented only on the basis of due information of input and output. The monetary term of inputs is costs, and outputs are correspondingly called revenues. Hence, cost and revenue information is crucial for responsibility accounting.

(ii) Use of Budgeting: Apart from the data of cost and revenue, planned and actual financial data is also required. It is only with effective budgeting that the accounting plan implementation can be communicated to the concerned levels of management.

(iii) Relationship between responsibility accounting system and organisation structure: Clear lines of authority and effective organisation structure is an absolute necessity for the success of a responsibility accounting system. The accounting system is appropriately designed to be consistent with the existing organisational structure.

(iv) Identification of responsibility centres: Only after responsibility centres are identified, the responsibility accounting system can be implemented. The centres go on to represent the decision points within the organisation.

(v) Performance reporting: As responsibility account primarily relates to control, any deviation or disruption in the plan has to be noted and reported at the earliest. On the report of such an issue, corrective measures have to be taken. Such information is the basis on which ‘responsibility’ or performance reports are prepared.

28. Write the Objectives of Responsibility Accounting. Explain the types of responsibility centres.

Ans: See below for the major objectives or principles of responsibility accounting:

(i) Each responsibility centre is given a target, which is communicated to the relevant management level.

(ii) At the end of the time period, there is a comparison between the target and the actual performance.

(iii) The variations that are detected in the budgeted plan are examined for fixing responsibility to the centre.

(iv) Due measures are taken by the top management which is communicated to the responsible personnel.

(v) The responsibility for costs does not include the policy costs and various other apportioned costs.

Let us take a look at the four types of responsibility centres.

(i) Profit centre: It contributes to both revenue and expenses, resulting in profit and loss, respectively. For example – Product line is a profit centre, and the responsible person is the product manager.

(ii) Cost centre: The centre only contributes to specific costs that have incurred. For example – Housekeeping department will only incur cost.

(iii) Revenue centre: The revenue centre only leads to the generation of sales. For example – Sales department of an organisation.

(iv) Investment centre: The centre is responsible for profits and returns on investment. The latter includes the fund which is invested in the organisation’s operations. For example – A subsidiary entity of a company is an investment centre. The responsible person in that instance would be the president of the subsidiary.

29. Write the advantages and disadvantages of Responsibility Accounting.

Ans: Advantages of Responsibility Accounting:

(i) Responsibility accounting establishes a robust mechanism for cost control.

(ii) To achieve the objectives of cost control, the organisational structure is re-assessed by the management to consider attribution of responsibility as well as engaging in power delegation.

(iii) Budgeting is put in place which helps in the comparison of actual achievement on the ground.

(iv) The awareness among designated personnel is enhanced, which is likely to lead greater productivity. They will also be held accountable for their actions, and any deviation will necessarily call for an explanation.

(v) Reporting structure and timings are facilitated because such items are excluded which is beyond the purview of individual responsibility of the designated personnel.

Disadvantages of Responsibility Accounting:

(i) There could be instances of individual interest and organisational interest to be at loggerheads. Such conflict is likely to create problems for policy implementation.

(ii) Organisational chart may not be possible to be established in such a manner where the grant of authority and the responsibility lines are clearly demarcated.

(iii) The policy implementation process is likely to experience the reactions from the designated person as well, which may eventually cause passive resistance. Such actions may negatively impact the organisational objectives.

(iv) The tool can only be effective if an outstanding reporting system is put in place.

(v) In the absence of a sound structure of organisation, the responsibility centres cannot be clearly identified

(vi) Fresh analysis of the conventional methods of the classification of expenses may be cumbersome.

30. Explain the Components of Responsibility Accounting.

Ans: Below are the Components of Responsibility Accounting:

(i) Inputs and Outputs: The implementation of responsibility accounting based upon information relating to inputs and outputs. The resource utilized in an organization like qty.. of raw material consumed, Labor hours consumed are termed as Inputs, and finished product generated is termed as outputs.

(ii) Identification of Responsibility Center: The whole concept of responsibility accounting depends upon identification of responsibility center. The responsibility center defines the decision point in the organization. In small organizations generally, one person who is probably owners of the firm can manage the entire organization. 

(iii) Target and Actual Information: Responsibility accounting requires target or budget data and Actual data for performance evaluation of the responsible manager of each responsibility center.

(iv) Responsibility between Organization Structure and Responsibility Center: An organization structure with clear authority and responsibility is required for a successful responsibility accounting system. Similarly, the responsibility accounting system must be designed as per the organization structure.

(v) Assigning Cost and Revenue to an Individual: After defining the authority – responsibility relationship, cost, and revenue which are controllable should be assigned to individuals for evaluating their performance.

31. What is the Performance Budget? Explain its characteristics. 

Ans: Performance budget is a budget which refers to programs, functions, and performance which reflects the estimated expenses and revenues of the companies, Government or Statutory bodies. It is a budget that provides the objective and purpose for which funds are being raised and proposed activities and programs to be accomplished. It is aimed to improve the efficiency of the people involved in performing the budgeted task as per the budgets.

Characteristics of Performance Budgets:

(a) Improved Management: It helps in improving management skills and implementing the management processes more efficiently. It helps in identifying the organizational objectives, evaluate the program performances, understand the problems with the operations and structure of the program.

(b) Higher Transparency & Accountability: The resources are categorized according to the programs and also provide the performance indicators. It finds solution-based accountability management, which is responsible for the objectives they have to achieve.

(c) Enhanced Communications: It helps in enhancing the communications as there are personal responsibilities in performing their work, which will result in clear and improved communication to avoid any delay in achieving the objective of the program and also helps in the individual performances of the management. 

(d) Better Decision Making: It helps in making a decision, with the help of a better understanding of the processes. With the help of proper information, the management can implement techniques for improvement and can take appropriate actions to resolve the issues involved.

32. Explain the steps in Performance Budget Process. Write the Advantages and disadvantages of Performance Budget.

Ans: Below is the step by step process which takes place:

Step 1: Formulation of Objectives: It is the initial step to formulate the objective as to what to achieve. It is essential to set the objectives, and then only the designated tasks can be allocated to the teams based on their abilities.

Step 2: Identifying various process and plans: It is the second stage to identify the process and plan, which will help in achieving the objectives-various processes and strategy which can be introduced to the program to achieve the objective.

Step 3: Evaluation & Selection of the processes and plans: After identification, various processes and plans, the most profitable and easy to communicate and implement plan and processes should be evaluated and selected to achieve the objectives.

Step 4: Development of Performance Criteria: It is another step to develop the criteria on which the processes and plans will be rolled out. It is also essential to develop a basis to measure the performances of the persons involved in the processes.

Step 5: Financial Planning: After developing the processes, identifying the steps involved, it is required to plan for the financial requirement and prepare a financial budget for the processes planned.

Step 6: Assessing Performance: After rolling out the processes, it is vital to measure the performance given by the persons involved in the process to initiate the actions accordingly. It is crucial to see whose performance was up to the mark and what changes are required to be made.

Step 7: Correcting Deviations: It is the final step that corrects the deviations in the process and performances. Also, to make the required changes in both the process and performance to remove all those deviations.

These are the following advantages:

(i) Clear Purpose: It provides a clear purpose of budgeting and provides a clear understanding of the performance of the persons involved. It becomes easier to access the deviations and the performances and correct them.

(ii) Improvement in Performance: It helps in improving the performance, as there will be a continuous check on the deviations and performances to remove the errors and correct the deviations, and therefore this will help in improving the performances.

(iii) Sets Accountability: Since this budget provides a clear understanding of the roles to be performed and tasks to be completed by the persons, it provides accountability on every person for their roles and tasks, and they will be held accountable for there part of work.

(iv) Transparency: It succeeds in making transparency in the budgeted task and their performances, as it is clear to all their roles and responsibility, and they are accountable for their jobs, which will help in providing clear transparency in the processes.

Disadvantages:

Following are the disadvantages:

(i) Subjective: Since the performance budget is subjective in nature, it creates disagreement amongst the management. Also, social projects are with a long-term vision. It is difficult to quantify in money terms. The costs may differ from one government body to another government body. Therefore, The more use of result-based approach helps in the improvement of the budgetary process, accountability, and administration of the organization.

(ii) Strong System of Evaluation: The performance budget requires a strong system of accounting. Therefore, the reporting system has to be strong for its successful implementation. 

(iii) Manipulation of Data: Staff may manipulate the data. Further, the calculation of the financial information is not reliable because of the errors in preparation. Therefore, a proper internal control system helps in maintaining the accuracy of the data.

(iv) Difficult for Long-term: It is difficult for the long-term processes as there is a continuous update in the processes; The time period between the allocation of resources in the project and the achievement of the result might be more than a year. Undoubtedly, it makes it difficult to measure the results of the projects in long term. 

Therefore, Dividing the project into small parts may help in simplifying the evaluation process. Without a doubt, over a period of time Performance Budget became popular overall in the industry.

(v) There can be the possibility of manipulation of data.

(vi) There is a requirement of a robust system of accounting.

(vii) These budgets are subjective in nature.

33. Differences between Budgetary Control and Standard Costing.

Ans: 

PRACTICAL PROBLEMS

1. The expenses budget for the production of 10,000 units in factory are furnished below:

Prepare a budget for the production of (i) 8,000 units and (ii) 6,000 units. Assume that administrative expenses are rigid for all levels of production.

Solution: 

Flexible Budget  

                                                                            (Rs.)

2. The following are the budgeted expenses for 10,000 units of a product.

Prepare budget for the production of 6,000,7000 and 8,000 units showing distinctly marginal cost and total cost.

Solution:

Flexible Budget

3. Prepare a flexible budget for overheads on the basis of the following data. Ascertain the overhead rates at 50%, 60% and 70% capacity.

Solution:

Flexible Budget

Fixed overhead:

(i) Indirect Materials:

For 60% capacity, indirect material – Rs.6,000

For 50% capacity, indirect material – 6,000/60×50 = 5,000

For, 70% capacity indirect material = 5,000/50×70 = 70,000

Indirect Labour at 50% capacity and 60% is calculated in the way indirect material is calculated.

(ii) At 60% capacity, electricity is Rs. 30,000 out of this Rs. 30,000 of this Rs. 12,000 (40% of Rs.30,000) is fixed and Rs. 18,000 (60% Rs. 30,000) is variable. Rs. 12,000 fixed electricity will remain the same at all while variable part will vary with production and is calculated as follows for 60% capacity, variable electricity = 18,000

For 50% capacity, variable electricity = 18,000/60×50 = 15,000

For 70% capacity, variable electricity = 15,000/50×70=21,000

So total electricity = Fixed + Variable

At 50% capacity = Rs. 12,000 + Rs. 15,000 = Rs. 27,000

At 70% capacity = Rs. 12,000 + Rs. 21,000 = Rs. 33,000

(iii) At 60% capacity, repairs and maintenance is Rs. 3,000

out of this Rs. 2,400 (80/ of Rs. 3,000) is fixed and Rs. 600 

(20% of Rs. 3,000) is variable. The fixed repairs Rs. 2,400 will remain the same at all levels while the variable part will vary and is calculated as followed:

For 60% capacity, variable repairs = Rs. 600

Rs: 50% capacity, variable repairs = 600/60×50=500

For 70% capacity, variable repairs = 500/50×70=700

So total repairs and maintenances.

At 50% capacity = Rs. 2,400+Rs. 500 = Rs. 2,900 

At 70% capacity = Rs. 2,400+Rs. 700 = Rs. 3,100

4. Prepare flexible budget from the following date:

Capacity – 50%

Volume – 10,000 units

Selling Price per unit – Rs.200

Material per unit – 100

Labour per unit – Rs.30

Factory overhead per unit – Rs.30 (Rs.12 fixed)

Administrative overhead per unit – Rs.20 (Rs.10 fixed)

At 60% working, material cost per unit increase by 2% and selling price per unit falls by 2%.

At 80% working, material cost per unit increase by 5% and selling price fall by 5%.

Estimate profit at 60% and 80% working.

Soln:

Flexible budget

Factory overhead:

Fixed portion is Rs.12 and variable portion is Rs.18

(30-12). Therefore, total fixed factory overhead is Rs. 12×10,000 

= Rs.1,20,000 which remains same at all levels of activities.

Similarly-fixed administrative overhead is Rs. 10×10,000 =1,00,000

5. The production cost of a factory is given as follows:

Direct wages – Rs.90,000 

Direct Material – Rs.1,20,000

Production overhead.

Fixed – 40,000

Variable – 60,000

During the forthcoming year it is anticipated that:

(a) Overage rate of direct labour will fall from Re. 0.90 per hour to Re 0.75 per hour.

(b) Production efficiency will reduce by 5%.

(c) Price per unit of direct material and of other material and services which comprise overheads will remain unchanged.

(d) Direct labour hours will increase by 33 ⅓ % draw up a budget.

Solution:

I. Working:

II. Labour:

No of labour hour = 90,000

= Rs.0.90

= 1,00,000 hrs

Wages for 100,000 hrs + 33 ⅓ of 100,000 hrs.

= 133,333 ⅓ hrs×Re 0.75

= Rs.100,000

III. Variable overhead:

6. Production costs of a Co. are as follows:

A proposal to increase production to 90% level of activity is under the consideration of management. The proposal is not accepted to involve any increase in fixed factory overhead.

Prepare a statement showing the Prime Cost total marginal cost amt total factory cost at 90% level of activity.

Solution: 

Working: Statement of cost per unit at different levels

A study of unit cost at different levels shows that direct materials and direct labour is to be constant per unit and therefore these are variable cost. Factory overhead may vary per unit and are partly fixed and partly variable.

Calculation of factory variable overhead per unit.

The difference in overhead represents variable overheads, hence, variable overhead of 200 units is Rs.800.

Per unit variable overhead = 800/200 = Rs.4.00

Fixed factory overhead = Total factory overhead _ Variable factory overhead.

At 80% level, fixed overheads = 14,400 – (1,600×4) = Rs.8,000

At 70% level, fixed overheads = 13,600 – (14,400×4) = Rs.8000

[Calculation may be made by taking the overheads at 70% and 60% level as well]

Statement of cost at 90% activity level

7. From the following information, prepare a cash budget for the months January to April, 1998.

Additional Information:

(i) Customers are allowed a credit of 2 months.

(ii) A dividend of Rs.10,000 is payable in April.

(iii) Capital expenditure to be made –

Plant purchased on 15th of January for Rs.5000 a building has been purchased on 1st March and the payments are to be made in monthly instalment of Rs.2000 each.

(iv) The creditors are allowing a credit of 2 months.

(v) Wages are paid in the 1st of next month.

(vi) Lag in payment of other expenses is 1 month.

(vii) Balance of cash on 1.1.98 is Rs. 15,000.

Ans:

Cash Budget for the period of four month from April to June 1998

8. From the following information you are required to prepare a Cash Budget for the period from 1st January 1993 to 31st March 93, indicating the overdraft facilities required by the firm at the end of each month.

(b) 50% of the credit sales are realised in the month following the sales and the remaining 50% in the next month.

(c) Creditors are paid in the month following the month of purchase.

(d) Cash at bank on 1.1.93 – 25000

(e) Wages are paid on 1st of the following month.

Solution:

Cash budget for the period of three months, Jan-Mar 93

Working Note:

9. From the following, prepare a cash budget for the month of January to April.

Wages to be paid to workers Rs.5,000 each month balance at bank on 1st January.

It has been decided by management that:

(i) In case of deficit of fund within a limit of Rs.10,000, arrangement can be made with the bank.

(ii) In case of deficit of fund within the limit of Rs.42000 of issue of debenture is to be preferred.

(iii) In case of deficit of fund exceeding Rs.42000 issue of shares is preferred.

Solution: 

Cash Budget for the periods four month January to April 

10. From the following information supplied by Bright Ltd, prepare a cash budget for the period from 1st Sep, 03 to 31st Dec, 03.

Additional Information:

(i) Expected cash balance on Sep 1 Rs.10500.

(ii) Period of credit allowed to Debtors – 2 months.

(iii) Period of credit allowed by creditors – 1 month.

(iv) Lag in payment of wages and selling overhead – 1 month.

(v) Selling commission @2% on sales is payable on month after sales.

(vi) Expenditure on machinery worth Rs.50,000 is payable is October.

(vii) Expected cash sale per month Rs.15000. 

no commission payable on cash.

Solution: 

Cash Budget for the period of four months

From Sept to Dev, 2003

11. Prepare a cash budget for the three month ending 30th June from the following information.

(a)

(b) Credit terms are: Sale/Debtors-10% sales are on cash, 50% of the credit sales are collected next month and the balance in the following month.

(c) Creditors – Materials 2 months

Wages – ¼ month

overhead – ½  month

(d) Cash and bank balance on 1st April is expected to be Rs.6000.

(e) Other relevent information is:

(i) Plant & machinery will be installed in February at a cost of 96000. The monthly installments of Rs.2,000 are payable from April onwards.

(ii) Dividend @5% on preference share capital of Rs.2,00,000 will be paid on 1st June.

(iii) Advance to be received for sale of vehicle Rs.90,000 in June.

(iv) Dividend from investment amounting to Rs.1,000 are expected to be received in June.

(v) Income-tax advance to be paid in June is Rs.2000.

Solution:

Cash Budget for the period April to June

Working:

1. Cash sale and collection from Debtors:

2. Payment of wages:

3. Payment of overhead