Costing Notes Oriental DM
-
Upload
rajratan-singh -
Category
Documents
-
view
220 -
download
0
Transcript of Costing Notes Oriental DM
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 1/21
ORIENTAL Cost & Management
Accounting
COST: MEANING AND ITS ELEMENTS
The term „cost. means the amount of expenses [actual or notional] incurred on or attributable
to specified thing or activity. As per Institute of cost and work accounts (ICWA) India, Cost
is „measurement in monetary terms of the amount of resources used for the purpose of production of goods or rendering services.
Elements of cost
Cost of production/manufacturing consists of various expenses incurred on
production/manufacturing of goods or services. These are the elements of cost, which can be
divided into three groups: Material, Labour and Expenses.
COST SHEET: MEANING AND ITS IMPORTANCE
Cost sheet is a statement, which shows various components of total cost of a product. It
classifies and analyses the components of cost of a product.
Previous periods data is given in the cost sheet for comparative study. It is a statement, which
shows per unit cost in addition to Total Cost. Selling price is ascertained with the help of cost
sheet. The details of total cost presented in the form of a statement are termed as Cost sheet.
Cost sheet is prepared on the basis of:
1. Historical Cost
2. Estimated Cost
Historical Cost
Historical Cost sheet is prepared on the basis of actual cost incurred. A statement of cost
prepared after incurring the actual cost is called Historical Cost Sheet.
Estimated Cost
Estimated cost sheet is prepared on the basis of estimated cost. The statement prepared before
the commencement of production is called estimated cost sheet. Such cost sheet is useful in
quoting the tender price of a job or a contract.
Importance of Cost Sheet
The importance of cost sheet is as follows:
Cost ascertainment
The main objective of the cost sheet is to ascertain the cost of a product.
Cost sheet helps in ascertainment of cost for the purpose of determining cost after they are
incurred. It also helps to ascertain the actual cost or estimated cost of a Job.
BY Dinesh Makani For Private Circulation Only Page 1
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 2/21
ORIENTAL Cost & Management
Accounting
Fixation of selling price
To fix the selling price of a product or service, it is essential to prepare the cost sheet. It helps
in fixing selling price of a product or service by providing detailed information of the cost.
Help in cost control
For controlling the cost of a product it is necessary for every manufacturing unit to prepare a
cost sheet. Estimated cost sheet helps in the control of material cost, labour cost and
overheads cost at every point of production.
Facilitates managerial decisions
It helps in taking important decisions by the management such as:
whether to produce or buy a component, what prices of goods are to be quoted in the tender,
whether to retain or replace an existing machine etc.
COMPONENTS OF TOTAL COST
The Components of cost are shown in the classified and analytical form in the cost sheet.
Components of total cost are as follows:
Prime Cost
It consists of direct material, direct wages and direct expenses. In other words “Prime cost
represents the aggregate of cost of material consumed, productive wages, and direct
expenses”. It is also known as basic, first, flat or direct cost of a product.
Prime Cost = Direct material + Direct Wages + Direct expenses
Direct material means cost of raw material used or consumed in production.
It is not necessary that all the material purchased in a particular period is used in production.
There is some stock of raw material in balance at opening and closing of the period. Hence, it
is necessary that the cost of opening and closing stock of material is adjusted in the material
purchased.
Opening stock of material is added and closing stock of raw material is deducted in the
material purchased and we get material consumed or used in production of a product. It is
calculated as:
Material Consumed = Material purchased + Opening stock of material -Closing stock of material.
Factory Cost
In addition to prime cost it includes works or factory overheads. Factory overheads consist of
cost of indirect material, indirect wages, and indirect expenses incurred in the factory. Factory
cost is also known as works cost, production or manufacturing cost.
Factory Cost = Prime cost + Factory overheads
BY Dinesh Makani For Private Circulation Only Page 2
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 3/21
ORIENTAL Cost & Management
Accounting
TOTAL COST AND COST SHEET
If office and administrative overheads are added to factory or works cost, total cost of
production is arrived at. Hence the total cost of production is calculated as:Total Cost of production = Factory Cost + office and administration overheads
Cost of goods sold
It is not necessary, that all the goods produced in a period are sold in the same period. There
is stock of finished goods in the opening and at the end of the period. The cost of opening
stock of finished goods is added in the total cost of production in the current period and cost
of closing stock of finished goods is deducted. The cost of goods sold is calculated as:
Cost of goods sold = Total cost of production + Opening stock of Finished goods – Closing stock of finished goods
Total Cost i.e., Cost of Sales
If selling and distribution overheads are added to the total cost of production, total cost is
arrived at. This cost is also termed as cost of Sales. Hence the total cost is calculated as:
Total Cost = Cost of Goods sold + Selling and distribution overheads
Sales
If the profit margin is added to the total cost, sales are arrived at. Excess of sales over total
cost is termed as profit. When total cost exceeds sales, it is termed as Loss.
Sales = Total Cost + Profit
Sometimes profit is calculated on the basis of given information in percentage of cost or sales.
In such a situation, the amount is assumed 100 in which the percentage is calculated. Then the
Profit is calculated in the following ways:
Case 1
If Cost is Rs.10,000 and profit on cost 10%. Assume the cost is Rs.100 and
profit on cost is Rs.10. Hence Profit on cost of Rs.10,000 is
10,000 × 10/100 = Rs.1,000
Thus the sales value is Rs 11000 (10,000 + 1000)
Case 2
If Cost is Rs.10,800 and profit on sales price is 10%. Assume sales price is
Rs.100. cost price is Rs.90 [i.e. Rs.100 – Rs.10]. When profit on cost of Rs.90 is
Rs.10. Hence profit on cost of Rs.10,800 is
10,800 × 10/90 = Rs.1,200
10,800 + 1200 = 12,000 sales value
Case 3
If sales price is Rs.12,100 and profit on cost is 10%. Assume Cost price is
Rs.100. Sales price is Rs.110 [i.e.100 + 10]. If sales price is Rs.110, profit isRs.10. Profit on sales price of Rs.12,100 is 12,100 × 10/110 = Rs.1,100 profit
BY Dinesh Makani For Private Circulation Only Page 3
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 4/21
ORIENTAL Cost & Management
Accounting
There is no prescribed format of a Cost sheet. It may change from industry to industry. A
specimen format of a Cost Sheet is given as under:
Particulars Total (Rs.)
A. Materials Consumed:
Purchases
Add: Opening Stock of Raw material
Expenses on Purchases
Less: Closing Stock of Raw Material
Direct Material consumed
B. Direct Labour (Wages)
C. Direct Expenses
D. Prime Cost (A + B + C)
E. Factory/Works Overheads
Add: Opening Stock of Work-in-Progress
Less: Closing Stock of Work-in-Progress
F. Works/Factory Cost (D + E)
G. Office and administration overheads
H. Total Cost of Production (F + G)
Add: Opening Stock of finished Goods
Cost of Goods available for sale
Less: Closing Stock of finished Goods
I. Cost of production of goods Sold or cost of good sold
J. Selling and Distribution Overheads
K. Total Cost (I + J) = Cost of Sales
L. Profit
M. Sales (K + L)
BY Dinesh Makani For Private Circulation Only Page 4
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 5/21
ORIENTAL Cost & Management
Accounting
Components of Total Cost
Prime Cost = Direct material + Direct Wages + Direct expenses works/ factory cost;
Factory Cost = Prime cost + Factory overheads
Cost of production/office cost = Factory Cost + office and administration overheads Cost of production of goods sold = Cost of Production + Opening stock of Finished. Goods –
closing stock of finished goods
Total Cost = Cost of Production of goods sold + Selling and distribution overheads
Sales = Total Cost + Profit
CONTRACT COSTING
Contract costing is A form of specific order costing; attribution of costs to individual
contracts. A contract cost is Aggregated costs of a single contract; usually applies to major
long term contracts rather than short term jobs.
Features of long term contracts
- By contract costing situations, we tend to mean long term and large contracts: such as civil
engineering contracts for building houses, roads, bridges and so on. We could also includecontracts for building ships, and for providing goods and services under a long term
contractual agreement.
- With contract costing, every contract and each development will be accounted for
separately; and does, in many respects, contain the features of a job costing situation.
- Work is frequently site based.
Features of a Contract
- The end product
- The period of the contract
- The specification
- The location of the work
- The price
- Completion by a stipulated date
- The performance of the product
Collection of Costs
Desirable to open up one or more internal job accounts for the collection of costs. If the
contract not obtained, preliminary costs be written off as abortive contract costs in P&L In
some cases a series of job accounts for the contract will be necessary:
BY Dinesh Makani For Private Circulation Only Page 5
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 6/21
ORIENTAL Cost & Management
Accounting
-To collect the cost of different aspects
-To identify different stages in the contract
Special features
- Materials delivered direct to site.
- Direct expenses
- Stores transactions.
- Use of plant on site
Two possible accounting methods:
1. Where a plant is purchased for a particular contract & has little further value to the
business at the end of the contract
2. Where a plant is bought for or used on a contract, but on completion of the contract it
has further useful life to the business
Alternatively the plant may be capitalized with Maintenance and running costs charged to the
contract.”
PROCESS COSTING
PROCESS COSTING IMPORTANCE: -
In process costing, particular attention is given to (a) cost relating to the process, i.e., both
direct and indirect cost, (b) period for which cost for the process is collected, © complete
units in the process at the end of the period and (e) determining unit cost of the process for the
period.
USE OF PROCESS COSTING: -
Process coasting is useful for industries with following characteristics:
(a) Continuous and mass production
(b) Loss of identity of production against a particular order.(C) Homogeneous products
(d) Production involves different process and output of one process forms input of another
process.
(e) Other uses: bottling companies, canning plants, packing, breweries and industries involved
in processing milk products.
Process Costing under different inventory costing methods.
The effect of using FIFO method, LIFO method and average method will be differentiates on
cost per unit of the process.
BY Dinesh Makani For Private Circulation Only Page 6
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 7/21
ORIENTAL Cost & Management
Accounting
FIFO METHOD: -
It is also referred to as first in first –out method of inventory costing. Under FIFO method it
is presumed that units are completed in the order of introduction to the process. Units at the
beginning are completed first. Then, newly introduced units are completed. Only after this,
work is done on closing inventory. According to this method, it is assumed that cost incurred
is used –
(a) First to complete the units already in process,
(b) Then to complete the newly introduced units,
© For the work done to bring closing inventory to given stage of completion.
If units completed are more than units representing opening inventory, it is presumed under
FIFO method that all unfinished units in opening inventory have been completed. When FIFO
method of inventory costing is followed, units completed during the period are divided in two
categories for the purpose of statement of equivalent production:
(a) Work done for completing opening work – in – process,
(b) Newly introduced units completed during the process,
LIFO METHOD: -
It is also referred to as “Last-in-First-out” method of inventory costing. It is presumed under
LIFO method that cost incurred is used:
(a) First to complete newly introduced units.
(b) Then to complete units already in process.
If there is closing work in process, it is supposed in LIFO method that units which represent
opening inventory, remain in closing work – in – process at the end of the period, because
units representing opening inventory are attended to in the last. If units under closing
inventory are more than units under opening inventory, it will be presumed that all units,
which represented opening work in process, remain in closing work – in – process at the end
of period.
Under FIFO method work completed is divided into two categories i.e. (i) units lying under
opening work in process but completed during the period and, (ii) newly introduced units
completed during the period.
When LIFO method is followed closing inventory is divided into two categories i.e.,
(i) Units, which represent opening work in process, but are lying under closing work in
process at the end of the period.
(ii) Newly introduced units lyibg in closing stock.
Difference between Job Order Costing & Process
JOB ORDER COSTING / CONTRACT COSTING
PROCESS COSTING 1 It is used in industries where production is carried on according to specific job order.
Process Costing is used in continuous and mass production industries producing like units of
standard specification.
BY Dinesh Makani For Private Circulation Only Page 7
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 8/21
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 9/21
ORIENTAL Cost & Management
Accounting
MARGINAL COSTING
Marginal costing is formally defined as:
The accounting system in which variable costs are charged to cost units and the fixed costs of
the period are written-off in full against the aggregate contribution. Its special value is in
decision-making.. (Terminology.)
The term „contribution. mentioned in the formal definition is the term given to the difference
between Sales and Marginal cost. Thus
MARGINAL COST = VARIABLE COST DIRECT LABOUR
+ DIRECT MATERIAL +DIRECT EXPENSE+ VARIABLE OVERHEADS
Marginal cost means the cost of the marginal or last unit produced. It is also defined as the
cost of one more or one less unit produced besides existing level of production. In this
connection, a unit may mean a single commodity, a dozen, a gross or any other measure of goods.
The marginal cost varies directly with the volume of production and marginal cost per unit
remains the same. It consists of prime cost, i.e. cost of direct materials, direct labor and all
variable overheads. It does not contain any element of fixed cost, which is kept separate under
marginal cost technique.
Contribution may be defined as the profit before the recovery of fixed costs. Thus,
contribution goes toward the recovery of fixed cost and profit, and is equal to fixed cost plus
profit (C = F + P).
In case a firm neither makes profit nor suffers loss, contribution will be just equal to fixedcost (C = F). This is known as break-even point.
The concept of contribution is very useful in marginal costing. It has a fixed relation with
sales. The proportion of contribution to sales is known as P/V ratio, which remains the same
under given conditions of production and sales.
The principles of marginal costing
The principles of marginal costing are as follows.
a. For any given period of time, fixed costs will be the same, for any volume of sales and production (provided that the level of activity is within the „relevant range.). Therefore, by
selling an extra item of product or service the following will happen.
. Revenue will increase by the sales value of the item sold.
. Costs will increase by the variable cost per unit.
. Profit will increase by the amount of contribution earned from the extra item.
b. Similarly, if the volume of sales falls by one item, the profit will fall by the amount of
contribution earned from the item. c. Profit measurement should therefore be based on an
analysis of total contribution. Since fixed costs relate to a period of time, and do not change
with increases or decreases in sales volume, it is misleading to charge units of sale with a
share of fixed costs. d. When a unit of product is made, the extra costs incurred in its
BY Dinesh Makani For Private Circulation Only Page 9
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 10/21
ORIENTAL Cost & Management
Accounting
manufacture are the variable production costs. Fixed costs are unaffected, and no extra fixed
costs are incurred when output is increased.
Features of Marginal Costing
The main features of marginal costing are as follows:
1. Cost Classification
The marginal costing technique makes a sharp distinction between variable costs and fixed
costs. It is the variable cost on the basis of which production and sales policies are designed
by a firm following the marginal costing technique.
2. Stock/Inventory Valuation
Under marginal costing, inventory/stock for profit measurement is valued at marginal cost. It
is in sharp contrast to the total unit cost under absorption costing method.Marginal Contribution
Marginal costing technique makes use of marginal contribution for marking various
decisions. Marginal contribution is the difference between sales and marginal cost. It forms
the basis for judging the profitability of different products or departments.
Advantages and Disadvantages of Marginal Costing Technique
BY Dinesh Makani For Private Circulation Only Page 10
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 11/21
ORIENTAL Cost & Management
Accounting
Advantages
1. Marginal costing is simple to understand.
BY Dinesh Makani For Private Circulation Only Page 11
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 12/21
ORIENTAL Cost & Management
Accounting
2. By not charging fixed overhead to cost of production, the effect of varying charges per unit
is avoided.
3. It prevents the illogical carry forward in stock valuation of some proportion of current
year.s fixed overhead.
4. The effects of alternative sales or production policies can be more readily available and
assessed, and decisions taken would yield the maximum return to business.
5. It eliminates large balances left in overhead control accounts which indicate the difficulty
of ascertaining an accurate overhead recovery rate.
6. Practical cost control is greatly facilitated. By avoiding arbitrary allocation of fixed
overhead, efforts can be concentrated on maintaining a uniform and consistent marginal
cost. It is useful to various levels of management.
7. It helps in short-term profit planning by breakeven and profitability analysis, both in terms
of quantity and graphs. Comparative profitability and performance between two or
more products and divisions can easily be assessed and brought to the notice of
management for decision making.
Disadvantages
1. The separation of costs into fixed and variable is difficult and sometimes gives misleading
results.
2. Normal costing systems also apply overhead under normal operating volume and this
shows that no advantage is gained by marginal costing.
3. Under marginal costing, stocks and work in progress are understated. The exclusion of
fixed costs from inventories affect profit, and true and fair view of financial affairs of
an organization may not be clearly transparent.
4. Volume variance in standard costing also discloses the effect of fluctuating output on fixed
overhead. Marginal cost data becomes unrealistic in case of highly fluctuating levels of
production, e.g., in case of seasonal factories.
5. Application of fixed overhead depends on estimates and not on the actuals and as such
there may be under or over absorption of the same.
6. Control affected by means of budgetary control is also accepted by many. In order to know
the net profit, we should not be satisfied with contribution and hence, fixed overhead is
also a valuable item.
A system, which ignores fixed costs, is less effective since a major portion of fixed cost is not
taken care of under marginal costing. 7. In practice, sales price, fixed cost and variable
cost per unit may vary. Thus, the assumptions underlying the theory of marginal costing
sometimes becomes unrealistic. For long term profit planning, absorption costing is the
only answer.
MARGINAL COSTING PRO-FORMA
BY Dinesh Makani For Private Circulation Only Page 12
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 13/21
ORIENTAL Cost & Management
Accounting
Rs Rs
Sales Revenue xxxxx
Less Marginal Cost of Sales
Opening Stock (Valued @ marginal cost) xxxx
Add Production Cost (Valued @ marginal cost) xxxx
Total Production Cost xxxx
Less Closing Stock (Valued @ marginal cost) (xxx)
Marginal Cost of Production xxxx
Add Selling, Admin & Distribution Cost xxxx
Marginal Cost of Sales (xxxx)
Contribution xxxxx
Less Fixed Cost (xxxx)
Marginal Costing Profit xxxxx
OBSERVATION
Sales – Marginal cost = Contribution ......(1)
Fixed cost + Profit = Contribution ......(2)
By combining these two equations, we get the fundamental marginal cost equation as follows:
Sales – Marginal cost = Fixed cost + Profit ......(3)
This fundamental marginal cost equation plays a vital role in profit projection and has a wider
application in managerial decision-making problems.
The sales and marginal costs vary directly with the number of units sold or produced. So, the
difference between sales and marginal cost, i.e. contribution, will bear a relation to sales andthe ratio of contribution to sales remains constant at all levels. This is profit volume or P/V
ratio. Thus,
P/V Ratio (or C/S Ratio) = Contribution © ......(4)
Sales (s)
It is expressed in terms of percentage, i.e. P/V ratio is equal to (C/S) x 100.
Or, Contribution = Sales x P/V ratio ......(5) Or, Sales =
Contribution ......(6)
P/V ratio
BY Dinesh Makani For Private Circulation Only Page 13
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 14/21
ORIENTAL Cost & Management
Accounting
1. Contribution
Contribution is the difference between sales and marginal or variable costs. It contributes
toward fixed cost and profit. The concept of contribution helps in deciding breakeven point,
profitability of products, departments etc. to perform the following activities:
Selecting product mix or sales mix for profit maximization
1.Fixing selling prices under different circumstances such as trade depression, export sales,
price discrimination etc.
2. Profit Volume Ratio (P/V Ratio), its Improvement and Application
The ratio of contribution to sales is P/V ratio or C/S ratio. It is the contribution per rupee of
sales and since the fixed cost remains constant in short term period, P/V ratio will also
measure the rate of change of profit due to change in volume of sales. The P/V ratio may be
expressed as follows:
P/V ratio = Sales – Marginal cost of sales = Contribution=Changes in contribution =Change in profit Sales
Sales
Changes in sales
Change in sales
A fundamental property of marginal costing system is that P/V ratio remains constant at
different levels of activity.
A change in fixed cost does not affect P/V ratio. The concept of P/V ratio helps in
determining the following:
Breakeven point
Profit at any volume of sales
Sales volume required to earn a desired quantum of profit
Profitability of products
Processes or departments
The contribution can be increased by increasing the sales price or by reduction of variable
costs. Thus, P/V ratio can be improved by the following:
Increasing selling price
. Reducing marginal costs by effectively utilizing men, machines, materials and other services
. Selling more profitable products, thereby increasing the overall P/V ratio
. Breakeven Point Breakeven point is the volume of sales or production where there is neither
profit nor loss. Thus, we can say that:
BY Dinesh Makani For Private Circulation Only Page 14
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 15/21
ORIENTAL Cost & Management
Accounting
Contribution = Fixed cost
Now, breakeven point can be easily calculated with the help of fundamental marginal cost
equation, P/V ratio or contribution per unit.
a. Using Marginal Costing EquationS (sales) – V (variable cost) = F (fixed cost) + P (profit) At BEP P = 0, BEP S –
V = F
By multiplying both the sides by S and rearranging them, one gets the following equation:
S BEP = F.S/S-V
b. Using P/V Ratio
Sales S BEP =
Contribution at BEP = Fixed cost P/ V ratio
P/ V ratio
4. Margin of Safety (MOS)
Every enterprise tries to know how much above they are from the breakeven point. This is
technically called margin of safety. It is calculated as the difference between sales or
production units at the selected activity and the breakeven sales or production.
Margin of safety is the difference between the total sales (actual or projected) and the
breakeven sales. It may be expressed in monetary terms (value) or as a number of units
(volume). It can be expressed as profit / P/V ratio. A large margin of safety indicates the
soundness and financial strength of business.
Margin of safety can be improved by lowering fixed and variable costs, increasing volume of
sales or selling price and changing product mix, so as to improve contribution and overall P/V
ratio.
Margin of safety = Sales at selected activity – Sales at BEP = Profit at selected activity
P/V ratio Margin of safety is also presented in ratio or percentage as follows:
Margin of safety (sales) x 100 %
Sales at selected activity
The size of margin of safety is an extremely valuable guide to the strength of a business. If itis large, there can be substantial falling of sales and yet a profit can be made. On the other
hand, if margin is small, any loss of sales may be a serious matter. If margin of safety is
unsatisfactory, possible steps to rectify the causes of mismanagement of commercial activities
as listed below can be undertaken.
a. Increasing the selling price—It may be possible for a company to have higher margin of
safety in order to strengthen the financial health of the business. It should be able to influence
price, provided the demand is elastic. Otherwise, the same quantity will not be sold.
b. Reducing fixed costs
c. Reducing variable costs
d. Substitution of existing product(s) by more profitable lines e.
Increase in the volume of output
BY Dinesh Makani For Private Circulation Only Page 15
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 16/21
ORIENTAL Cost & Management
Accounting
e. Modernization of production facilities and the introduction of the
most cost effective technology
BUDGET & BUDGETORY CONTROL
A budget is a plan expressed in quantitative, usually monetary term, covering a specific
period of time, usually one year. In other words a budget is a systematic plan for the
utilization of manpower and material resources.
In a business organization, a budget represents an estimate of future costs and revenues.
Budgets may be divided into two basic classes: Capital Budgets and Operating Budgets.
Capital budgets are directed towards proposed expenditures for new projects and often require
special financing. The operating budgets are directed towards achieving short-term
operational goals of the organization, for instance, production or profit goals in a businessfirm. Operating budgets may be sub-divided into various departmental of functional budgets.
The main characteristics of a budget are:
1. It is prepared in advance and is derived from the long-term strategy of the organization.
2. It relates to future period for which objectives or goals have already been laid down.
It is expressed in quantitative form, physical or monetary units, or both.
Different types of budgets are prepared for different purposed e.g. Sales Budget, Production
Budget, Administrative Expense Budget, Raw-material Budget etc. All these sectional
budgets are afterwards integrated into a master budget, which represents an overall plan of the
organization.
ADVANTAGES OF BUDGETS A budget helps us in the following ways:
1. It brings about efficiency and improvement in the working of the organization.
2. It is a way of communicating the plans to various units of the organization. By establishing
the divisional, departmental, sectional budgets, exact responsibilities are assigned. It thus
minimizes the possibilities of buck passing if the budget figures are not met.
3. It is a way or motivating managers to achieve the goals set for the units.4. It serves as a benchmark for controlling on-going operations.
5. It helps in developing a team spirit where participation in budgeting is encouraged.
6. It helps in reducing wastage and losses by revealing them in time for corrective action.
7. It serves as a basis for evaluating the performance of managers.
8. It serves as a means of educating the managers.
BUDGETARY CONTROL No system of planning can be successful without having an effective and efficient system of
control. Budgeting is closely connected with control. The exercise of control in the
BY Dinesh Makani For Private Circulation Only Page 16
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 17/21
ORIENTAL Cost & Management
Accounting
organization with the help of budgets is known as budgetary control. The process of
budgetary control includes:
1. Preparation of various budgets.
2. Continuous comparison of actual performance with budgetary performance.
3. Revision of budgets in the light of changed circumstances.
A system of budgetary control should not become rigid. There should be enough scope of
flexibility to provide for individual initiative and drive. Budgetary control is an important
device for making the organization. More efficient on all fronts. It is an important tool for
controlling costs and achieving the overall objectives.
Budget Controller Although the chief executive is finally responsible for the budget programme, it is better if a
large part of the supervisory responsibility is delegated to an official designated as Budget
Controller or Budget Director. Such a person should have knowledge of the technical details
of the business and should report directly to the president or the Chief Executive of the
organization.
Fixation of the budget period Budget period mean the period for which a budget is prepared and employed. The budget
period depends upon the nature of the business and the control techniques. For example, a
seasonal industry will budget for each season while an industry requiring long periods to
complete work will budget for four, five or even larger number of year. However, it is
necessary of control purposes to prepare budgets both for long as well as short periods.
Budget Procedures Having established the budget organization and fixed the budget period, the actual work or
budgetary control can be taken upon the following pattern:
STEPS IN BUDGETARY CONTROL
1. Organization for budgeting
2. Budget manual + Theory
"A document which sets out, inter alias, the responsibilities of the persons engaged in, the
routine of and forms and records required for budgetary control."
The budget manual is a written document or booklet that specifies the objectives of budgeting
organization and procedures. Following are some of the important matters covered in a
budget manual:
3. A statement regarding the objectives of the organization and how they can be achieved
through budgetary control.
4. A statement regarding the functions and responsibilities of each Executive by designation
both regarding preparation and execution of budgets.
5. Procedures to be followed for obtaining the necessary approval of budgets.
6. The authority of granting approval should be stated in explicit terms.7. Whether one, two or more signatures are to be required on each document
BY Dinesh Makani For Private Circulation Only Page 17
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 18/21
ORIENTAL Cost & Management
Accounting
8. Should also be clearly stated.
9. Timetable for all stages of budgeting.
10. Reports, statements, forms and other records to be maintained.
11. The accounts classification to be employed. It is necessary that the framework within
which the costs, revenues and other financial amount are classified must be identical both inaccounts and the budget departments.
There are many advantages attached to the use of budget manual. It is a formal record
defining the functions and responsibilities of each executive.
The methods and procedures of budgetary control are standardized.
There is synchronization of the efforts of all which result in maximization of the profits of the
organization.
Making a forecast Consideration of alternative combination of forecasts: Alternative combinations of forecasts
are considered with a view to contain the most efficient overall plan so as to maximize profits.
When the optimum -profit combination of forecasts is selected, the forecasts should be
regarded as being finalized.
Sales budget Past sales figures and trend. The record of previous experience forms the most reliable guide
as to future sales as the past performance is related to actual business conditions. However the
other factors such as seasonal fluctuations, growth of market, trade cycles etc., should not be
lost sight of salesmen's estimates. Salesmen are in a position to estimate the potential demand
of the customers more accurately because they come in direct contact with the customers.
However, proper discount should be made for over-optimistic or too conservative estimates of
the salesmen depending upon their temperament.
Plant Capacity. It should be the endeavor of the business to ensure proper utilization of plant
facilities and that the sale budget provides an economic and balanced production on the
factory.
General trade prospects. The general trade prospects considerable affect the sales. Valuable
information can be gathered in this connection from trade papers and magazines.Orders on hand. In case of industries where production is quite a lengthy process, orders on
hand also have a considerable influence in the amount of sales.
Proposed expansion of discontinuance of products. It is affects sales and therefore, it should
also be considered.
Seasonal fluctuations. Past experience will be the best guide in this respect. However, efforts
should be made to minimize the effects of seasonal fluctuations by giving special concessions
or off-season discounts thus increasing the volume of sales.
Potential market. Market research should be carried out for ascertaining the potential market,
for the company's products. Such an estimate on the basis of expected population growth,
purchasing power of consumers and buying habits of the people.
BY Dinesh Makani For Private Circulation Only Page 18
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 19/21
ORIENTAL Cost & Management
Accounting
Availability of material and supply. Adequate supply of raw materials and other supplies must
be ensured before drafting the sales programme.
Financial aspect. Expansion of sales usually require increase in capital outlay also, therefore,
sales budget must be kept within the bounds of financial capacity.
Production budget
Inventory policies. Inventory standards should be predetermined as that neither there is a
shortage nor over-stocking of goods.
Sales requirements. The quantity of goods to be sold would decide to a great extent how much
is to be produced. Therefore, this budget depends upon the sales budget.
Production stability. For reduction of costs, stability in employment and better utilization of
plant facilities, the production should be evenly distributed throughout the year. In case of
seasonal industries, since it is not possible to have stable levels of production or inventory, an
effort should be made to have the optimum balance between the two.
Plant capacity. How much can be produced depends upon the available plant capacity. Theremust be sufficent capacity to procede the annual requirements and also to meet seasonal high
demands.
Availability of material and labour. Adequate and timely supply of raw material and labour
should have an important effect on the planning of production. 6. Time taken in production
process. The production should commence
well in time deeping in view how much time it would take in the factory to translate the raw
materials into finished goods.
Capital Expenditure Budget
The budget provides a guidance as to the amount of capital that may be
Needed for procurement of capital assets during the budget period. The budget is prepared
after taking into account the available productive capacitates, probable reallocation of existing
assets and possible improvement in production techniques. If necessary separte budgets may
be prepared for edach item o assets, such a building budget, a plnat and equipment budget etc.
Cash budget The cash budget can be prepared by any of the following methods; 1. Receipts and payments
method 2. The adjusted profit and loss method 3. The balance sheet method.
1. Receipts and payments method : In case of this method the cash receipts from various
sources and the cash payments to various agencies are estimated. In the opening balance of
cash , estimated cash receipts are added and From the total, the total of estimated cash
payments are deduted to find out the closing balance.
2. The adjusted profit and loss method : In case of this method the cash budget is prepared on
the basis of opening cash and bank balances, projected profit and loss account and the
balances of the various assests and liabilities.
3. The balance sheet methos : With the helop of budget balances at the
end except cash and bank balances, a budgeted balance sheet can be prepared and the
balancing figure would be the estimated closing cash/ bank balance.
Thus under this method, closing balances other than cash/bank will have to be found out first
to be put in the budgeted balance sheet. This can be done by adjusting the anticipated.Research and Development Budget
BY Dinesh Makani For Private Circulation Only Page 19
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 20/21
ORIENTAL Cost & Management
Accounting
Research and development costs are to be incurred so that the products or the methods of the
concern do not become out of date. The research and development budget is a forecast of all
such expenses.
Zero-Based Budgeting – ZBB A method of budgeting in which all expenses must be justified for each new period. Zero-
based budgeting starts from a “zero base” and every function within an organization are
analyzed for its needs and costs. Budgets are then built around what is needed for the
upcoming period, regardless of whether the budget is higher or lower than the previous one.
ZBB allows top-level strategic goals to be implemented into the budgeting process by tying
them to specific functional areas of the organization, where costs can be first grouped, then
measured against previous results and current expectations.
Advantages of zero-based budgeting
1. Efficient allocation of resources, as it is based on needs and benefits.
2. Drives managers to find cost effective ways to improve operations.
3. Detects inflated budgets.
4. Useful for service departments where the output is difficult to identify.
5. Increases staff motivation by providing greater initiative and responsibility in decision-
making.6. Increases communication and coordination within the organization.
7. Identifies and eliminates wasteful and obsolete operations.
8. Identifies opportunities for outsourcing.
9. Forces cost centers to identify their mission and their relationship to overall goals.
Disadvantages of zero-based budgeting 1. Difficult to define decision units and decision packages, as it is time-consuming and
exhaustive.
2. Forced to justify every detail related to expenditure. The R&D department is threatened
whereas the production department benefits.
3. Necessary to train managers. Zero-based budgeting must be clearly understood by
managers at various levels to be successfully implemented. Difficult to administer and
communicate the budgeting because more managers are involved in the process.
4. In a large organization, the volume of forms may be so large that no one person could read
it all. Compressing the information down to a usable size might remove critically important
details.
5. Honesty of the managers must be reliable and uniform. Any manager that exaggerates
skews the results.
BY Dinesh Makani For Private Circulation Only Page 20
7/31/2019 Costing Notes Oriental DM
http://slidepdf.com/reader/full/costing-notes-oriental-dm 21/21
ORIENTAL Cost & Management
Accounting
DECISION MAKING
Cost accounting has long been used to help managers understand the costs of running a
business. Modern cost accounting originated during the industrial revolution, when thecomplexities of running a large scale business led to the development of systems for
recording and tracking costs to help business owners and managers make decisions.
In the early industrial age, most of the costs incurred by a business were what modern
accountants call "variable costs" because they varied directly with the amount of production.
Money was spent on labor, raw materials, power to run a factory, etc. in direct proportion to
production. Managers could simply total the variable costs for a product and use this as a
rough guide for decision-making processes.
Some costs tend to remain the same even during busy periods, unlike variable costs, which
rise and fall with volume of work. Over time, the importance of these "fixed costs" has
become more important to managers. Examples of fixed costs include the depreciation of
plant and equipment, and the cost of departments such as maintenance, tooling, production
control, purchasing, quality control, storage and handling, plant supervision and engineering.
In the early twentieth century, these costs were of little importance to mostbusinesses. However, in the twenty-first century, these costs are often more important than
the variable cost of a product, and allocating them to a broad range of products can lead to
bad decision making. Managers must understand fixed costs in order to make decisions about
products and pricing.
Thank You
BY Dinesh Makani For Private Circulation Only Page 21