Budgetary Control

Learning Objectives.............................................................................................................. 2
1. Introduction to Budgeting................................................................................................. 3
2. Budgetary Control............................................................................................................. 5
3. Types of Budgets............................................................................................................... 7
4. Preparation of Budgets..................................................................................................... 8
4.1 Sales Budget................................................................................................................ 8
4.2 Production budget....................................................................................................... 9
4.3 Material Purchase Budget.......................................................................................... 10
4.4 Cash Budget.............................................................................................................. 11
4.5 Other functional budget............................................................................................. 13
4.6 Master Budget........................................................................................................... 13
4.7 Fixed and Flexible budgets........................................................................................ 14
5. Zero Based Budgeting.................................................................................................... 15
6. Solved illustration........................................................................................................... 16
7. Summary........................................................................................................................ 21
8. Exercises......................................................................................................................... 21
8.1 Multiple Choice Questions......................................................................................... 21
8.2 Theory Questions....................................................................................................... 23
8.3 Exercises.................................................................................................................... 23

Learning Objectives
After learning this unit you will be able

To understand the basic concepts of Budgets and Budgetary Control

To prepare various types of budgets

To learn concept of zero Based Budgeting

1. Introduction to Budgeting
A budget is a plan expressed in quantitative, usually monetary terms, covering a
specific period of time, usually one year. In other words, a budget is a systematic
plan for the utilisation of manpower and material resources. In a business
organisation a budget represents an estimate of future costs and revenues. Budget
is prepared either in quantitative details or monetary details or both.
Objectives of Budgeting
An effective budgeting system plays a crucial role in the success of a business
organization. The budgeting system has the following objectives, which are of
paramount importance in the overall efficiency and effectiveness of the business
organization. These objectives are discussed below.
Planning: A well- prepared plan helps the organization to use the scarce
resources in an efficient manner and thus achieving the pre- determined targets
becomes easy. A budget is prepared for future period and it lays down targets
regarding various aspects like purchase, production, sales, manpower planning
etc.
Co-ordination: For achieving the predetermined objectives, apart from planning,
coordinated efforts are required. Budgeting facilitates coordination in the sense
that budgets cannot be developed in isolation. For example, while developing the
production budget, the production manager will have to consult the sales manager
for sales forecast and purchase manager for the availability of the raw material.
Control: Planning is looking ahead while controlling is looking back. Preparation of
budgets involves detailed planning about various activities like purchase, sales,
production, and other functions like marketing, sales promotion, manpower planning.
But planning alone is not sufficient. There should be a proper system of controlling
which will ensure that the work is progressing as per the plan. Budgets provide the
basis for such controlling in the sense that the actual performance can be compared
with the budgeted performance. Any deviation between the two can be found out
and analyzed to ascertain.
Benefits of Budgeting

Budgeting plays an important role in planning and controlling. It helps in directing the
scarce resources to the most productive use and thus ensures overall efficiency in the
organization. The benefits derived by an organization from an effective system of
budgeting can be summarized as given below.
a) Budgeting facilitates planning of various activities and ensures that the working of
the organization is systematic and smooth.
b) Budgeting is a coordinated exercise and hence combines the ideas of different levels
of management in preparation of the same.
c) Any budget cannot be prepared in isolation and therefore coordination among various
departments is facilitated automatically.
d) Budgeting helps planning and controlling income and expenditure so as to achieve
higher profitability and also act as a guide for various management decisions.
e) It is extremely necessary to evaluate the actual performance with predetermined
parameters. Budgeting ensures that there are well-defined parameters and thus the
performance is evaluated against these parameters.
f) As the resources are directed to the most productive use, budgeting helps in reducing
the wastages and losses.

2. Budgetary Control
A budgetary control is extremely useful for planning and controlling, however, for getting
these benefits, sufficient preparation should be made. For complete success, a solid
foundation should be laid down and in view of this the following aspects are of crucial
importance. Following steps may be taken for installing an effective system of budgetary
control in an organisation.

Organisation for Budgeting

The setting up of a definite plan of organisation is the first step towards installing
budgetary control system in an organisation. A, Budget Manual should be prepared giving
details of the powers, duties, responsibilities and areas of operation of each executive in
the organisation.
Responsibility for Budgeting
The responsibility for preparation and implementation of the budgets may be fixed as
under:
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 of the Chief Executive of the organisation.
Budget Committee
The Budget Controller is assisted in his work by the Budget Committee. The
Committee may consist of Heads of various departments, viz., Production, Sales
Finance, Personnel, Purchase, etc. with the Budget Controller as its Chairman. It is
generally the responsibility of the Budget Committee to submit, discuss and finally
approve the budget figures. Each head of the department should have his own Subcommittee with executives working under him as its members.
Fixation of the Budget Period
`Budget period' means 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 years.
However, it is necessary for control purposes to prepare budgets both for long as well as
short periods.
Budget Procedures
Having established the budget organisation and fixed the budget period, the actual work
or budgetary control can be taken upon the following pattern:
Key Factor
It is also termed as limiting factor. The extent of influence of this factor must first be
assessed in order to ensure that the budget targets are met. It would be desirable to
prepare first the budget relating to this particular factor, and then prepare the other
budgets. We are giving below an illustrative list of key factors in certain industries.
Industry

Key factor

Motor Car

Sales demand

Aluminium

Power

Petroleum Refinery

Supply of crude oil

Electro-optics

Skilled technicians

Making a Forecast
A forecast is an estimate of the future financial conditions or operating results. Any
estimation is based on consideration of probabilities. An estimate differs from a budget in
that the latter embodies an operating plan of an organisation.
A budget envisages a commitment to certain objectives or targets, which the
management seeks to attain on the basis of the forecasts prepared. A forecast on the
other hand is an estimate based on probabilities of an event. A forecast may be prepared
in financial or physical terms for sales, production cost, or other resources required for
business. Instead of just one forecast a number of alternative forecasts may be considered
with a view to obtaining the most realistic, overall plan.

Preparing Budgets
After the forecasts have been finalised the preparation of budgets follows. The budget
activity starts with the preparation of the sales budget. Then production budget is
prepared on the basis of sales budget and the production capacity avail-able. Financial
budget (i.e. cash or working capital budget) will be prepared on the basis of sales forecast
and production budget. All these budgets are combined and coordinated into a master
budget. The budgets may be revised in the course of the financial period if it becomes
necessary to do so, in view of the unexpected developments, which have already taken
place or are likely to take place.

3. Types of Budgets
As budgets serve different purposes, different types of budgets have been
developed. The following are the different classification of budgets developed on
the basis of time, functions, and flexibility or capacity.

Classification
on the basis
of Time

Long-Term Budgets
Short-Term Budgets
Current Budgets

Classification
according to
Functions

Functional or Subsidiary Budgets

Master Budgets

Classification
on the basis
of Capacity

Fixed Budgets
Flexible Budgets

Classification on the basis of Time

1. Long-Term Budgets: Long-term budgets are prepared for a longer period varies between
five to ten years. It is usually developed by the top level management. These budgets
summarise the general plan of operations and its expected consequences. Long-Term
Budgets are prepared for important activities like composition of its capital expenditure,
new product development and research, long-term finance etc.
2. Short-Term Budgets: These budgets are usually prepared for a period of one year.
Sometimes they may be prepared for shorter period as for quarterly or half yearly. The
scope of budgeting activity may vary considerably among different organization.
3. Current Budgets: Current budgets are prepared for the current operations of the
business. The planning period of a budget generally in months or weeks. As per ICMA
London, "Current budget is a budget which is established for use over a short period of
time and related to current conditions."
Classification according to Functions
1. Functional Budget: The functional budget is one which relates to any of the functions of
an organization. The number of functional budgets depends upon the size and nature of
business. The following are the commonly used:
(1) Sales Budget
(2) Purchase Budget

(3) Production Budget

(4) Selling and Distribution Cost Budget
(5) Labour Cost Budget
(6) Cash Budget
(7) Capital Expenditure Budget
2. Master Budget: The Master Budget is a summary budget. This budget encompasses all
the functional activities into one harmonious unit. The ICMA England defines a Master
Budget as the summary budget incorporating its functional budgets, which is finally
approved, adopted and employed.
Classification on the Basis of Capacity
1. Fixed Budget: A fixed budget is designed to remain unchanged irrespective of the level
of activity
actually attained.
2. Flexible Budget: A flexible budget is a budget which is designed to change in
accordance with the
various level of activity actually attained. The flexible budget also called as Variable
Budget or Sliding
Scale Budget, takes both fixed, variable and semi fixed manufacturing costs into account.

4. Preparation of Budgets
4.1 Sales Budget
A Sales Budget shows forecast of expected sales in the future period [the period is welldefined] and expressed in quantity of the product to be sold as well as the monetary value
of the same. A Sales Budget may be prepared product wise, territories/area/country wise,
customer group wise, salesmen wise as well as time wise like quarter wise, month wise,
weekly etc. The following factors are taken into consideration while preparing a sales
budget.

Analysis of past sales

Estimates given by the sales staff
Market Potential Analysis
Dependent Factor

Illustration 1

A company manufactures two products, A and B. Its sales department has three area
divisions, North, East and South. Preliminary sales budgets for the year ending 31st March
2012, based on the assessment of the divisional managers were as follows.
Product A: North 2,00,000 units, South 5,50,000 units and East1,00,000 units
Product B: North 3,00,000 units, South 4,00,000 units and East Nil
Sale price: A Rs.4 and B Rs.3 in all areas.
Arrangements are made for the extensive advertising of Products A and B and it is estimated
that the North division sales will increase by 1,00,000 units. Arrangements are also made to
advertise and distribute product in Eastern area in the second half of the year 2006-07 when
sales are expected to be 5,00,000 units.
Prepare a revised sales budget for the year ended 31 st March after taking into consideration
the above mentioned adjustments.

Solution:
Product A

Product B

Division

Quantity

Price.
Rs.

North

3, 00, 000

12,00,000 North

South

5, 50, 000

East

1, 00, 000

Total

9, 50,
000

Price.

Value

4, 00, 000

12, 00, 000

22,00,000 South

4, 40, 000

13, 20, 000

4,00,000 East

5, 00, 000

15, 00, 000

Value
Rs.

Division Quantity

38,00,00 Total
0

13, 40,
000

40, 20,
000

4.2 Production budget

Production budget is usually prepared on the basis of sales budget. But it also takes into
account the stock levels desired to be maintained. The estimated output of business firm
during a budget period will be forecast in production budget. The production budget
determines the level of activity of the produce business and facilities planning of
production so as to maximum efficiency. While preparing the production budget, the
factors like estimated sales, availability of raw materials, plant capacity, availability of
labour, budgeted stock requirements etc. are carefully considered.
Illustration 2

From the following particular, you are required to prepare production budget of Mrs. V. G. P.
Ltd. a manufacturing organization that has three products X, Y and Z.
Product

X
Y
z

Estimated stock at
the beginning
(units)
5000
4000
6000

Estimated stock at
the end(units)

6400
3850
7800

Estimated sales as
per sales
budget(units)
21600
19200
23100

Solution
Particulars
Expected sales
Add: closing stock

Less: opening
stock
Budgeted
production

21600

19200

23100

6400
28000
5000

3850
23050
4000

7800
30900
6000

23000

19050

24900

4.3 Material Purchase Budget

This budget shows the quantity of materials to be purchased during the coming year. For the
preparation of this budget, production budget is the starting point if it is the key factor. If the
raw material availability is the key factor, it becomes the starting point. The desired closing
inventory of the raw materials is added to the requirement as per the production budget and
the opening inventory is subtracted from the gross requirements. This budget is prepared in
quantity as well as in the monetary terms and helps immensely in planning of the purchases of
raw materials.

Illustration 3
Draw up a material purchase budget from the following information:
Estimated sales of a product is 30,000 units. Two kinds of raw materials A and B are
required for manufacturing the product. Each unit of the product requires 3 units of A and
4 units of B. The estimated opening balance in the beginning of the next year: finished
goods 5,000 units; A, 6,000 units; B, 10,000 units. The desirable closing balance at the
end of the next year: finished product, 8,000 units; A, 10,000 units; B 12,000 units.
Solution
Estimated Production = Expected Sales + Desired Closing Stock of Finished Good Estimated Opening Stock of Finished Goods
= 30,000 + 8,000 - 5,000
= 33,000 units
Material A

Material B

Material Required to meet Production Target

Material A - 33,000 x 3

99000

Material B - 33,000 x 4

Add : Desired closing stock at the end of next year

Less : Expected stock at the commencement of
next year (opening balance)
Quantity of Materials to be purchased

10000
109
000
6
000

132000
12000
14
4000
1
0000

103
000

13
4000

4.4 Cash Budget

This budget represents the anticipated receipts and payment of cash during the budget
period. The cash budget also called as Functional Budget. Cash budget is the most
important of the entire functional budget because; cash is required for the purpose to
meeting its current cash obligations. If at any time, a concern fails to meet its obligations,
it will be technically insolvent. Therefore, this budget is prepared on the basis of detailed
cash receipts and cash payments. The estimated Cash Receipts include:
(1) Cash Sales
(2) Credit Sales
(3) Collection from Sundry Debtors
(4) Bills Receivable
(5) Interest Received
(6) Income from Sale of Investment
(7) Commission Received
(8) Dividend Received
The estimated Cash Payments include the following:
(1) Cash Purchase
(2) Payment to Creditors
(3) Payment of Wages
(4) Payments relate to Production Expenses
(5) Payments relate to Office and Administrative Expenses
(6) Payments relate to Selling and Distribution Expenses
(7) Any other payments relate to Revenue and Capital Expenditure
(8) Income Tax Payable, Dividend Payable etc.

Illustration 4
ABC Co. wished to arrange overdraft facilities with its bankers during the period April 2012
to June 2012 when it will be manufacturing mostly for the stock. Prepare a Cash Budget for
the above period from the following data, indicating the extent of the bank facilities the
company will require at the end of each month.
Particulars

Purchases

Wages

Rs.1, 80,000

Rs.1, 24,800

Rs.12, 000

March

1, 92,000

1, 44,000

14, 000

April

1, 08,000

2, 43,000

11, 000

May

1, 74,000

2, 46,000

10, 000

June

1, 26,000

2, 68,000

15, 000

February 2008

Sales

Additional Information:
1.

50% of the credit sales are realized in the month following the sales and remaining 50%
in the second month following. Creditors are paid in the month following the month of
purchases. There are no cash sales or cash purchases

2.

Cash at bank [overdraft] estimated on 1st April 2012 is Rs.25.

Solution
Cash Budget April June 2012

Particulars
A] Opening Balance
[Overdraft]

April Rs.
25, 000

May Rs.
56, 000

June Rs.
[47, 000]

B] Expected Receipts
Collections from debtors

1, 86,000

1, 50,000

1, 41,000

C] Total Cash Available

[A + B]

2, 11,000

2, 06,000

94,000

1, 44,000

2, 43,000

2, 46,000

11,000

10,000

15,000

1, 55,000

2, 53,000

2, 61,000

56,000

[47,000]

[1, 67,000]

D] Expected Payments
i.
ii.

Payment to creditors
Wages

E] Total Payments
F] Closing Balance
[C E]

Collection from debtors:

+ April:

+ 50% of sales of February Rs.90, 000} Total Rs.1, 86,000

+ 50% of sales of March Rs.96, 000}
+ May
+ 50% of sales of March Rs.96, 000} Total Rs.1, 50,000
+ 50% of sales of April Rs.54, 000}
+ June
+ 50% of sales of April Rs.54, 000} Total Rs.1, 41,000
+ 50% of sales of May Rs.87, 000}

4.5 Other functional budget

Direct Labour Budget: The labour budget estimates the labour required for smooth and
uninterrupted production. The labour budget shows the number of each type or grade of
workers required in each period to achieve the budgeted output, budgeted cost of such
labour, period wise and period of training necessary for different types of labour.
Factory Overhead Budget: This budget is prepared for planning of the factory overheads
to be incurred during the budget period. In this budget the overheads should be shown
department wise so that responsibility can be fixed on proper persons. Classification of
factory overheads into fixed and variable components should also be shown in this budget.
Administrative Overhead Budget: This budget covers the administrative costs for nonmanufacturing business activities. The administrative overheads include expenses like office
expenses, office salaries, directors remuneration, legal expenses, audit fees, rent, interest,
property taxes, postage, telephone, telegraph etc. These expenses should be classified
properly under different headings to determine the responsibilities regarding cost control
and reduction.
Capital Expenditure Budget: Capital expenditure is incurred with a long - term
perspective and with the objective of augmenting the earning capacity of the firm in the
long run. Capital expenditure results in either acquisition of fixed asset or permanent
improvement in the existing fixed assets.
Manpower Planning Budget: This budget shows the requirement of manpower in the
budget period. The categories in which manpower is required are also shown in this budget.
The requirement of manpower depends on the expansion plans of the organization and also
on the expected separations during the budget period.
Research and Development Cost Budget: This budget is one of the important tools for
planning and controlling research and development costs. It helps management in planning
the research and development activities well in advance and also about the fairness of the
expenditure. Research and development is one of the important activities of any firm and
hence proper planning and coordination is required for effectiveness of the same. This
budget also helps to plan the requirement of necessary staff for carrying out research and
development.

4.6 Master Budget

The Master or final budget is a summary budget, which incorporates all functional budgets
in a capsule form. It sets out the plan of operations for all departments in considerable
detail for the budget period. A Master Budget which is also called as Comprehensive
Budget is a consolidation of all the functional budgets. It shows the projected Profit and
Loss Account and Balance Sheet of the business organization.

4.7 Fixed and Flexible budgets

Fixed Budgets: When a budget is prepared by assuming a fixed percentage of capacity
utilization, it is called as a fixed budget. For example, a firm may decide to operate at 90% of its
total capacity and prepare a budget showing the projected profit or loss at that capacity. This
budget is defined by The Institute of Cost and Management Accountants [U.K.] as the budget
which is designed to remain unchanged irrespective of the level of activity actually attained. It
is based on a single level of activity. For preparation of this budget, sales forecast will have to
be prepared along with the cost estimates.
Flexible Budgets: A flexible budget is a budget that is prepared for different levels of
capacity utilization. It can be called as a series of fixed budgets prepared for different levels of
activity. For example, a budget can be prepared for capacity utilization levels of 50%, 60%,
70%, 80%, 90% and 100%. While preparing flexible budget, it is necessary to study the
behavior of costs and divide them in fixed, variable and semi variable. After doing this, the
costs can be estimated for a given level of activity. It is also necessary to plan the range of
activity. A firm may decide to develop flexible budget for activity level starting from 50% to
100% with an interval of 10% in between. It is necessary to estimate the costs and associate
them with the chosen level of activity. Finally the profit or loss at different levels of activity will
be computed by comparing the costs with the revenues.
Illustration 5
A factory engaged in manufacturing plastic toys is working at 40% capacity and produces
10000 toys per month. The present cost break up for one toy is as under.
Material: Rs.10
Labour: Rs.3
Overheads: Rs.5 [60% fixed]
The selling price is Rs.20 per toy. If it is decided to work the factory at 50% capacity, the
selling price falls by 3%. At 90% capacity, the selling price falls by 5% accompanied by a
similar fall in the price of material. You are required to prepare a statement showing the
profits/losses at 40%, 50% and 90% capacity utilizations.

Solution
Flexible Budget
At 40%, 50% and 90% Capacity Utilization
Particulars
Production Units

40% Capacity
Utilization
10, 000

50% Capacity 90% Capacity

Utilization
Utilization
12, 500
22, 500

Selling Price Per Unit

Sales Value [units X selling
price per unit]

Rs.20

Rs.19.40

Rs.19

Rs.2, 00,000

Rs.2, 42, 500

Rs.4, 2
7, 500

Variable Costs:
Material Rs.10 per unit

Rs.1, 00,000

Rs.1, 21, 500 * Rs.2, 13, 750 **

Labor Rs.3 per unit

Rs.30, 000

Rs.37, 500

Rs.67, 500

Overheads Rs.2 per unit

Rs.20, 000

Rs.25, 000

Rs.45, 000

Rs.1, 50, 000

Rs.184000

Rs.3, 26, 250

Rs.30, 000

Rs.30, 000

Rs.30, 000

Total Costs

Rs.1, 80, 000

Rs.214000

Rs. 356, 250

Profit/Loss

Rs.20, 000

Rs.27, 500

Rs.71, 250

Total Variable Costs

Fixed Costs

5. Zero Based Budgeting

Zero Base Budgeting is the latest technique of budgeting. A budget is a representation of
quantification of the firms objectives. An accurate budget can be framed, when a
relationship between the inputs and outputs can be established. In all the activities, such
relationship cannot be established. In such areas, it is difficult to develop standard costs.
Where it is difficult to compare the resources allocation with the output, ZBB is more
appropriate in controlling. Zero based budgeting [also known as priority based budgeting]
actually emerged in the late 1960s as an attempt to overcome the limitations of incremental
budgeting. This approach requires that all activities are justified and prioritized before
decisions are taken relating to the amount of resources allocated to each activity. in Zero
Based Budgeting, the beginning is made from scratch and each activity and function is
reviewed thoroughly before sanctioning the same and all expenditures are analyzed and
sanctioned only if they are justified.
Besides adopting a Zero Based approach, the Zero Based Budgeting also focuses on
programs or activities instead of functional departments based on line items, which is a feature
of traditional budgeting.
Benefits of Zero Based Budgeting

ZBB facilitates review of various activities right from the scratch and a detailed cost
benefit study is conducted for each activity. Thus an activity is continued only if the cost

benefit study is favourable. This ensures that an activity will not be continued merely

because it was conducted in the previous year.

A detailed cost benefit analysis results in efficient allocation of resources and

consequently wastages and obsolescence is eliminated.

A lot of brainstorming is required for evaluating cost and benefits arising from an activity

and this result into generation of new ideas and also a sense of involvement of the staff.
ZBB facilitates improvement in communication and co-ordination amongst the staff.
Awareness amongst the managers about the input costs is created which helps the

organization to become cost conscious.

An exhaustive documentation is necessary for the implementation of this system and it
automatically leads to record building.

Limitations of Zero Based Budgeting: The following are the limitations of Zero Based
Budgeting.

It is a very detailed procedure and naturally if time consuming and lot of paper work is

involved in the same.

Cost involved in preparation and implementation of this system is very high.
Morale of staff may be very low as they might feel threatened if a particular activity

is discontinued.
Ranking of activities and decision-making may become subjective at times.
It may not advisable to apply this method when there are non financial considerations,
such as ethical and social responsibility because this will dictate rejecting a budget claim
on low ranking projects.

6. Solved illustration
Illustration 6
Speciality Auto follows a policy of manufacture of auto spares evenly throughout the year
@ 100000 units per month for utilizing its labour force properly. However, demands in
different months are not uniform. The company follows a policy of maintaining 2 weeks
raw Materials in stock to facilitate smooth production process production process. It pays
to supplier within 1 month of purchase and collects from customers within one month of
sale. Cost estimates of the company are as follows:
Raw Materials Rs. 10 per unit
Wages Rs. 3 per unit
Direct expense Rs. 2 per unit
Factory overhead- Fixed Rs. 200000 per month, Variable Re. 1 per unit of output
Administrative Overhead Fixed Rs. 250000 per month
Selling & Distribution Overhead Fixed Rs. 80000 per month, Variable Rs. 2 per unit sold.

Selling price Rs. 25.8 per unit

Output- Input ratio 90%
Opening Stock of finished Goods at the beginning of Jan 40000 units @ Rs. 15
Sales Forecast:
Dec (A)
95000

Jan
97000

Feb
90000

Sales
(Units)
You may help the company in preparing:

Mar
85000

Apr
90000

May
95000

Jun
100000

(1) Sales Budget (2) Purchase Budget (3) Production Cost Budget (4) Inventory Analysis
(5)Cash Flow Budget (6) Budgeted Profit and Loss Account
The company is currently running on the basis of working capital loan computed applying
operating cycle concept. Bank loan is to the extent of 75% of net working capital set in the
month of January on the basis of average production. What will be the difficultly in the
present method of working capital financing? How should cash budget is expected to
overcome the problem?
Solution
Sales Budget- You can prepare sales budget taking monthly sales forecast multiplied by
selling price.
Sales
(units)
Selling
Price (Rs.)
Selling
Budget
(Rs.)

Dec(A)
95000

Jan
97000

Feb
90000

Mar
85000

Apr
90000

May
95000

Jun
100000

25.8

25.8

25.8

25.8

25.8

25.8

25.8

24510
00

250260
0

23220
00

219300
0

232200
0

245100
0

258000
0

Production Budget- Adjust with sales opening and closing stock to get production
budget. Since Speciality Auto follows a policy of fixed units of production per month, and in
this example closing stock is derived using-

Production + Opening Stock Sales= Closing Stock.

Productio
n budget
Opening
Stock
Sales
Closing
Stock

Jan
100000

Feb
100000

Mar
100000

Apr
100000

May
100000

Jun
100000

40000

43000

53000

68000

78000

83000

97000
43000

90000
53000

85000
68000

90000
78000

95000
83000

100000
83000

Material Requirement Budget

You need to study the companys Raw Material holding policy and output- input Ratio.
Raw Material inventory Policy: the company follows a policy of maintaining 2 weeks raw
Materials in stock to facilitate smooth production process.
Output Input Ratio 90%
So 50% of the material requirement of a month should be the opening Stock and 50% of
next months requirement should be the closing Stock.
Since production per month is fixed, opening and closing stock are the same.
Therefore, material requirement and purchases also remain constant.
Material Requirement Budget
For
productio
n
Opening
Stock
Closing
Stock
Purchase
Purchase
Budget

Jan
111111

Feb
111111

Mar
111111

Apr
111111

May
111111

Jun
111111

55556

55556

55556

55556

55556

55556

55556

55556

55556

55556

55556

55556

111111
1111111

111111
1111111

111111
1111111

111111
1111111

111111
1111111

111111
1111111

Production Cost Budget Various Components of production cost budget are presented
below:

Production Cost Budget

Direct
labour
Direct
labour
Direct
Expense
Prime
cost
Fixed OH
Factory
cost

Jan
1111111

Feb
1111111

Mar
1111111

Apr
1111111

May
1111111

Jun
1111111

300000

300000

300000

300000

300000

300000

200000

200000

200000

200000

200000

200000

1611111

1611111

1611111

1611111

1611111

1611111

300000
1911111

300000
1911111

300000
1911111

300000
1911111

300000
1911111

300000
1911111

Add:
Opening
Cost

Less:
Closing
Stock
COGS
Admin
OH
S&D OH
Cost of
Sales
profit

600000

771270

994169

1291369

1486804

1584421

2511111

2682381

2905280

3202347

3397915

3495532

771270

994169

1291236

1486804

1584421

1585405

1739841
200000

1688212
200001

1614045
200002

1715543
200003

1813494
200004

1910127
200005

274000
2213841

260000
2148413

250000
2064047

260000
2283496

270000
2283498

280000
2390132

288759

173787

128953

146454

167502

189868

Calculation of closing stock

COP
Productio
n
+
opening
stock
units
Weighted
average
cost per
unit (Rs.)

2511111
140000

2682381
143000

2905280
153000

3202347
168000

3397915
178000

3495532
183000

17.94

18.76

18.99

19.06

19.09

19.10

Notes:
i.
ii.
iii.
iv.
v.
vi.
vii.

Direct material = Material requirement* Per unit material cost

Direct labour = Production units* Labour cost unit of production
Direct expense = Production units * Expense per unit of production
Factory overheads = Rs. 200000 Fixed plus Re. 1 * production units
Administrative overhead is fixed Rs. 200000
Selling distribution overhead = Rs. 80000 + Rs. 2 per unit sold
Closing stock of finished goods is valued at weighted average cost.

Financial Budgets: Financial Budgets include

Budgeted profit and loss account;
This has already been presented along with production cost budget.
Budgeted balance sheet;
This is estimated cash flow report against which actual cash flow is compared.
Cash budget;
Cash budget reflects the cash inflows and outflows arising out of operations,
investment and financing activities. We have already learnt the technique of
preparation of historical cash flows. In this paragraph, let us learn the technique of
preparation of budget. Cash budget is projected cash flows. Cash budget is generally

prepared on monthly basis. For the purpose of our example, we shall prepare cash
budget on monthly basis. For the purpose of our example, we shall prepare cash
budget on monthly basis.
Working capital budget

Different components of working capital are- Raw material stock, finished goods stock,
Debtors

CASH BUDGET
Cash
Budget
Payments
to
Suppliers
Direct
labour
Direct
Expense
Fixed OH
Admin
OH
S&D OH
Cash
outflows
Collection
from Drs.
Net cash
flows
Opening
balance
Closing
balance

Jan

Feb

Mar

Apl

May

Jun

1111111

1111111

1111111

1111111

1111111

1111111

300000

300000

300000

300000

300000

300000

200000

200000

200000

200000

200000

200000

300000
200000

300000
200000

300000
200000

300000
200000

300000
200000

300000
200000

274000
2385111

260000
2371111

250000
2361111

260000
2371111

270000
2381111

280000
2391111

2451000
0
65889

2502600

2322000

2193000

2322000

2451000

131489

-39111

-178111

-59111

59889

65889

131489

-39111

-178111

-59111

197378

92378

-217222

-237222

778

WORKING CAPITAL BUDGET

Working
capital
Raw
material
inventor
y
Finished
goods
inventor
y
Debtors

Jan

Feb

Mar

Apr

May

Jun

555556

555556

555556

555556

555556

555556

771270

994169

129123
6

148680
4

158442
1

158540
5

250260

232200

219300

232200

245100

258000

Gross
WC
Less
Crs.
Net WC

0
382942
5
111111
1
271831
4

0
387172
5
111111
1
276061
4

0
403979
1
111111
1
292868
0

0
436435
90
111111
1
325324
8

0
459097
7
111111
1
347986
5

0
472096
1
111111
1
360985
0

Illustration 7
On the basis of the following information prepare flexible budget.
Capacity (%)
Sales Units
Selling price p u
(Rs.)
Variable cost p u
(Rs.)
Direct material p u
(Rs.)
Direct wages p u
(Rs.)
Direct expenses p u
(Rs.)
Variable overheads
p u (Rs.)
Contribution per
unit (Rs.)
P/V Ratio
Fixed cost (Rs.)

50
5000
40

60
6000
40

70
7000
40

80
8000
39.5

90
9000
39

100
10000
38.5

22

22

22

22

22

22

10

10

10

10

10

10

18

18

18

17.5

17

16.5

45
90000

45
9180
0

-45
93600

44.30
9540
0

43.59
97200

42.86
99000

Solution:
Sales
(Rs.)
Variable
cost (Rs.)
Direct
material
Direct
wages
Direct
expenses
Variable
overhead
s
Contributi
on (Rs.)
Fixed cost

200000

240000

280000

316000

351000

385000

110000

132000

154000

176000

198000

220000

50000

60000

70000

80000

90000

100000

40000

48000

56000

64000

72000

80000

10000

12000

14000

16000

18000

20000

10000

12000

14000

16000

18000

20000

90000

108000

126000

140000

153000

165000

90000

91800

93600

95400

97200

99000

(Rs.)
BEP (Rs.)
Margin of
Safety
(Rs.)
Profit
(Rs.)
Notes:

200000
0

204000
36000

208000
72000

215331.4
100668.6

222988
128012

231000
154000

16200

32400

44600

55800

66000

1) Sales are adjusted at various capacity levels with reference to 100% capacity.
2) At a higher level of capacity utilisation it is possible to reduce the selling price.
3) Per unit variable cost is a constant.
4) Fixed cost increases @ 2% on the original level of fixed cost for every range of 10%
capacity.

7. Summary

Budget is a statement in financial terms, prepared prior to a defined period of time.

Budgetary Control is the establishment of budgets relating to the responsibilities of
executives to the requirements of a policy, and the continuous comparison of actual
with budgeted results, either to secure by individual action the objective of that

policy or to provide a basis for its revision.

Flexible Budget is a budget designed to change in accordance with the level of

activity actually attained.

Fixed Budget is a budget designed to remain unchanged irrespective of the level of

activity actually attained.

Master Budget is summary budget, incorporating all functional budgets, which are

finally approved, adopted and employed.

Budget Manual is a document, which sets out, inter alia, the responsibilities of the
persons engaged in the routine of and the forms and records required for budgetary

control.
Zero Based Budgeting is an operating planning and budgeting process which required
each manager to justify his entire budget in detail from scratch.

8. Exercises
8.1 Multiple Choice Questions
1) A budget is

A] an aid to management
B] a post mortem analysis
C] a substitute of management.
2) The principal budget factor for consumer goods manufacturer is normally
A] sales demand
B] labor supply
C] both sales and labor
3) The budgeted standard hours of a factory is 12, 000. The capacity utilization ratio for
April 2007 stood at 90% while the efficiency ratio for the month came to 120%. The
actual production in standard hours for April 2007 was
A] 10, 800
B] 12, 960
C] 14, 400
D] 12, 800
4) A budget is a projected plan of action in
A] physical units
B] monetary terms
C] physical units and monetary units.
5) The document which describes the budgeting organizations, procedures etc is
known as
A] Budget centre
B] Principal Budget Factor
C] Budget Manual
6) Flexible budgets are useful for
A] Planning purpose only
B] Planning, performance evaluation and feedback control
C] Control of performance only
7) The scarce factor of production is known as,
A] Key factor
B] Linking factor
C] Critical factor

D] Production factor.

8.2 Theory Questions

1.
2.
3.
4.
5.

What do you mean by a budget?

What do you understand by budgetary control?
What are the advantages of budgetary control?
Briefly explain the different types of budgets.
What do you understand by Cash Budget? Discuss the procedure for preparing the

cost budget.
6. What are the differences between fixed budget and flexible budget?

8.3 Exercises
Exercise 1
A manufacturing company is currently working at 50% capacity and produces 10, 000 units
at a cost of Rs.180 per unit as per the following details.
Materials:

Rs.100

Labor:

Rs.30

Factory Overheads: Rs.30 [40% fixed]

Administrative Overheads: Rs.20 [50%
fixed] Total Cost Per Unit: Rs.180
The selling price per unit at present is Rs.200. At 60% working, material cost per unit
increases by 2% and selling price per unit falls by 2%. At 80% working, material cost per
unit increases by 5% and selling price per unit falls by 5%.
Prepare a Flexible Budget to show the profits/losses at 50%, 60% and 80% capacity
utilization.

Exercise 2
Prepare a Cash Budget from the following information for ABC Ltd.
Particulars
Opening Cash

1st Quarter IInd Quarter III rd Quarter IVth Quarter

[Rs.]
[Rs.]
[Rs.]
[Rs.]
10, 000

Collections from
customers
Payments:

1,25, 000

1,50, 00
0

1,60, 000

2,21, 00
0

Purchase of
Materials
Other expenses

20, 000

35, 00
0
20, 00

35, 000

54, 20
0
17, 00

Salaries and wages

90, 000

0
95, 00
0

95, 000

25, 000

20, 000

0
1,09, 20
0

Particulars

1st Quarter
[Rs.]

Income tax

IInd Quarter III rd Quarter IVth Quarter

[Rs.]
[Rs.]
[Rs.]

5, 000
20, 000

Machinery Purchase

The company desires to maintain a cash balance of Rs.15, 000 at the end of each
quarter. Cash can be borrowed or repaid in multiples of Rs.500 at an interest rate
of 10% p.a. Management does not want to borrow cash more than what is
necessary and wants to repay as early as possible. In any event, loans cannot be
extended beyond a quarter. Interest is computed and paid when principal is
repaid. Assume that borrowing takes place at the beginning and repayments are
made at the end of the quarter.
[ ICWAI Intermediate]

Exercise 3
. From the following data, prepare a Production Budget for XYZ Ltd for a period of
6 months ending 30th June.
Product

Opening Stock Closing Stock Sales Forecast Normal Loss in

1st January
30th June
Units
Production [%]
2008
2008
8,000
10,000
60,000
4
- units
Units

9,000

50,000

50,000

12,000

14,000

80,000

Exercise 4
Zenith Ltd. has prepared the following Sales Budget for the first five
months of 2008
Month

Sales Budget [units]

January

10,800

February

15,600

March

12,200

April

10,400

May

9,800

Inventory of finished goods at the end of every month is to be equal to 25% of

sales estimate for the next month. On 1st January 2008, there were 2,700 units of
product on hand. There is no work in progress at the end of any month.
Every unit of product requires two types of materials in the
following quantities. Material A: 4 kg
Material B: 5 kg

Materials equal to one half of the requirements of the next months production are
to be in hand at the end of every month. This requirement was met on 1st January
2008.
Prepare the following budgets for the quarter ending on 31st March 2008
I]

Production Budget Quantity Wise

I]

Materials Purchase Budget Quantity Wise.