Cost Accounting

Budget and Budgetary Control 6.3

6.3.1 Concepts, Types of Budget
Introduction
Budgeting is a fundamental process in cost and management accounting that involves the formulation of a
comprehensive plan for allocating resources and achieving organizational goals within a specified period. It serves
as a financial roadmap, outlining expected revenues, expenses, and cash flows, while also providing a framework
for decision-making, performance evaluation, and resource allocation. It plays a crucial role in organizational
management by providing a structured approach to financial planning and control. It enables businesses to set clear
financial objectives, allocate resources effectively, and measure performance against predefined benchmarks.
Budgetary control, on the other hand, is the systematic process of planning, coordinating, and monitoring financial
activities to ensure that actual performance aligns with budgeted targets. It facilitates the implementation of
strategic initiatives, fosters accountability among stakeholders, and enhances transparency in financial management
practices.
What ‘budget’ means?
CIMA Official Terminology1 defines a budget as a quantitative expression of a plan for a defined period of time.
It may include planned sales volumes and revenues; resource quantities, costs and expenses; assets, liabilities and
cash flows.
A budget, since it has different purposes, might mean different things to different people. A budget is either
considered as a forecast, a means of allocating resources, a yardstick or a target. The details of each of them are
mentioned in the below mentioned lines.
Forecast
A budget typically includes forecasts of expected revenues, expenses, and other financial aspects for a specific
period, such as a fiscal year.
It helps managers to plan for the future. Given uncertainty about the future, however, it is quite likely that a budget
will become outdated as events occur and so the budget will cease to be a realistic forecast. New forecasts might be
prepared that differ from the budget. While a forecast is what is likely to happen; a budget is what an organisation
wants to happen.
There is significant difference between the two concepts. The differences are categorised below:
Both budgets and forecasts refer to the anticipated actions and events, but still there are wide differences between
budgets and forecasts as given below :

1 CIMA Official Terminology, 2005, The Chartered Institute of Management Accountants (CIMA Publishing, an imprint of Elsevier).

520 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Forecasts Budgets
● Forecasts is mainly concerned with anticipated or ● Budget is related to planned events.
probable events.
● Forecasts may cover for longer period (often in ● Budget is planned or prepared for a shorter period.
excess of a year).
● Forecast is only a tentative estimate. ● Budget is a target fixed for a period.

● Forecast results in planning. ● Result of planning is budgeting.

● The function of forecast ends with the forecast of ● The process of budget starts where forecast ends
likely events. and converts it into a budget.
● Forecast usually covers a specific business function. ● Budget is prepared for the business as a whole.

● Forecasting does not act as a tool of controlling ● Purpose of budget is not merely a planning device
measurement. but also a controlling tool.

Essentials of a Budget
An analysis of the above issues reveals the following essentials of a budget:
1. It is prepared for a definite future period.
2. It is a statement prepared prior to a defined period of time.
3. The Budget is monetary or quantitative statement of policy.
4. The Budget is a predetermined statement and its purpose is to attain a given objective.
A budget, therefore, be taken as a document which is closely related to both the managerial as well as accounting
functions of an organisation.
Objectives of Budgeting
The objectives of budgeting revolve around strategic planning, resource optimization, performance management,
and organizational effectiveness. By fulfilling these objectives, budgeting contributes to the achievement of long-
term sustainability and growth.
The specific objectives are discussed below;
• Planning: Budgeting facilitates the formulation of comprehensive financial plans that outline the allocation
of resources to achieve organizational goals. It helps in setting specific targets for revenues, expenses, and
investments, thereby providing a roadmap for future actions.
• Coordination: Budgeting promotes coordination among different departments and functions within an
organization by aligning their activities with overall strategic objectives. It ensures that various departments
work towards common goals and avoid conflicts in resource allocation.
• Control: Budgeting serves as a tool for monitoring and controlling financial activities by comparing actual
performance against budgeted targets. It helps in identifying variances, analyzing their causes, and taking
corrective actions to ensure that resources are used efficiently and effectively.
• Evaluation: Budgeting facilitates the evaluation of organizational performance by providing benchmarks
for measuring progress and success. It enables management to assess the effectiveness of strategies, identify
areas for improvement, and make informed decisions to enhance future performance.
The Institute of Cost Accountants of India 521
Cost Accounting

• Communication: Budgeting enhances communication and transparency within the organization by clearly
articulating financial goals, priorities, and expectations. It ensures that all stakeholders understand their roles
and responsibilities in achieving budgeted targets, fostering accountability and collaboration.
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 organisation. The benefits derived by an organisation from
an effective system of budgeting can be summarized as given below:
i. Budgeting facilitates planning of various activities and ensures that the working of the organisation is
systematic and smooth.
ii. Budgeting is a coordinated exercise and hence combines the ideas of different levels of management in
preparation of the same.
iii. Any budget cannot be prepared in isolation and therefore coordination among various departments is
facilitated automatically.
iv. Budgeting helps planning and controlling income and expenditure so as to achieve higher profitability and
also act as a guide for various management decisions.
v. Budgeting is an effective means for planning and thus ensures sufficient availability of working capital and
other resources.
vi. 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.
vii. As the resources are directed to the most productive use, budgeting helps in reducing the wastages and
losses.
The Budget Framework
In this section, some important aspects of the budget and the framework under which the budget is prepared are
taken up for discussion. The following are considered as important aspect of the budget framework.
Budget committee - The budget committee is the coordinating body in the preparation and administration of
budgets. It is usually headed up by the managing director as chairman of the committee and is assisted by a budget
officer who is usually a Cost Accountant. Every part of the organisation should be represented on the committee,
so there should be a representative from sales, production, marketing and so on.
The Budget Period2 - The conventional approach is that once per year the manager of each budget centre prepares a
detailed budget for one year. The budget is divided into either twelve monthly for control purposes. The preparation
of budgets on an annual basis has been strongly criticized on the grounds of rigidity as it entails a commitment for
a period of 12 months. This is risky as the budget is based on uncertain forecasts. An alternative approach is for
the annual budget to be broken down by months (quarterly basis). This may also result in a rolling budget which is
also referred as a continuous budget that is updated regularly when the earlier budget expires, or we can say it is an
extension of the current budget. A rolling budget is also known as a budget rollover.
CIMA Official Terminology1 defines the budget period as a period for which a budget is prepared and used, which
may then be subdivided into control periods.
The Budget Manual - A budget manual is prepared by the Cost Accountant. It describes the objectives and
procedures involved in the budgeting process and provides a useful reference source for managers responsible
for budget preparation. The manual may include a timetable specifying the order in which the budgets should be

2 Except for capital expenditure budgets, the budget period is usually the accounting year (sub-divided control periods).

522 The Institute of Cost Accountants of India

 Cost Accounting Techniques

prepared and the dates when they should be presented to the budget committee. The manual should be circulated
to all individuals who are responsible for preparing budgets.
CIMA Official Terminology1 defines the budget manual as a detailed set of guidelines and information about
the budget process typically including a calendar of budgetary events, specimen budget forms, a statement of
budgetary objectives and desired results, listing of budgetary activities and budget assumptions regarding, for
example, inflation and interest rates.
A budget manual generally contains the following:
a. An explanation of the objectives of the budgetary process
b. Organisational structures consisting of the organisational chart.
c. An outline of the principal budgets and the relationship between them.
d. Administrative details of budget preparation.
e. Procedural matters.
Responsibility for budgets – The person with whom the responsibility for budget lies is also known as the Budget
holder. The manager responsible for preparing each budget should ideally be the manager responsible for carrying
out the budget. For example, the preparation of particular budgets might be allocated as follows:
a. The sales manager should draft the sales budget and the selling overhead cost centre budgets.
b. The purchasing manager should draft the material purchases budget.
c. The production manager should draft the direct production cost budgets.
Budgetary Control
Before detailing the computational issues of budgets, in this section, aspects of budgetary control is being discussed.
Budgetary Control is the systematic process where management uses the budgets prepared at the beginning of
the accounting period to compare and analyse the actual results at the end of the accounting period and to set
improvement measures for the next accounting year. Thus, the whole gamut of preparation of budget and using
the same for control purpose is being considered in the budgetary control. It is applied to a system of management
and accounting control by which all operations and output are forecasted as far ahead as possible and actual results
when known are compared with budget estimates. Budgetary control is defined as the establishment of the budgets
relating to the responsibilities of executives to the requirements of a policy and the continuous comparison of
actual with budgeted result either to secure by individual action the objectives of that policy or to provide a firm
basis for its revision. The following steps are involved in budgetary control:
� Establishments of budgets for each function and section of the organisation.
� Continuous comparison of the actual performance with that of the budget so as to know the variation
from budget and placing the responsibility of executives for failure to achieve the desired results as given
in the budget.
� Taking suitable remedial action to achieve the desired objective if there is a variation of the actual performance
from the budgeted performance.
� Revision of budgets in the light of changed circumstances.
Objectives of Budgetary Control
Budgetary Control is planned to assist the management for policy formulation, planning, controlling and co-
ordinating the general objectives of budgetary control and can be stated in the following ways:
� Planning: A budget is a plan of action. Budgeting ensures a detailed plan of action for a business over a
period of time.

The Institute of Cost Accountants of India 523

Cost Accounting

� Co-ordination: Budgetary control co-ordinates the various activities of the entity or organisation and secure
co-operation of all concerned towards the common goal.
� Control: Control is necessary to ensure that plans and objectives are being achieved. Control follows
planning and co-ordination. No control performance is possible without predetermined standards. Thus,
budgetary control makes control possible by continuous measures against predetermined targets. If there is
any variation between the budgeted performance and the actual performance, the same is subject to analysis
and corrective action.

6.3.2 Budgetary Control vs Standard Costing

Details Standard Costing Budgetary Control
Meaning It is a system of accounting where It is planning exercise made by the management
predetermined costs are used for analysis of in setting budget for the forthcoming period and
variance and control of the entire organisation. analysis of actual with budgeted figure.
Expressed It may be expressed both in terms of It is expressed in monetary terms only.
quantitative and monetary measure.
Objective It is ascertained and control of cost. It is concerned with the overall profitability and
financial position of the concern.
Emphasis It emphasizes on what should be the cost. It emphasizes on the level of cost not to be
exceeded.
Projection It is projection of cost accounts. It is projection of financial accounts.
Used by Standards are usually limited to manufacturing Budgets are used by all departments.
activities only.

6.3.3 Advantages and Limitations

Advantages of Budgetary Control
The advantages of budgetary control may be summarized as follows:
1. Budgetary control facilitates reduction of cost.
2. Top management uses budgetary control in planning and formulation of policies.
3. Budgetary control facilitates effective co-ordination of activities of the various departments and functions by
setting their limits and goals.
4. Budgetary control ensures maximization of profits through cost control
5. Budgetary control evaluates the performance of different budget centers on a continuous basis.
6. Budgetary control facilitates adoption of standard costing.

Limitations of Budgetary Control

It is clear that budgetary control is an effective tool for management regarding the control aspect. However, it has
certain important limitations which are identified below:
1. Budgets are based on estimates and forecasting. There are various limitations of forecasting as it cannot be
considered as an exact science. Thus budgets are tentatively defined plan of action.

524 The Institute of Cost Accountants of India

 Cost Accounting Techniques

2. Budget may prove short or excess of actual requirement. This is more noticeable in a VUCA world where
uncertainty in business environment has become the order of the day.
3. Effective implementation of budgetary control depends upon willingness, co-operation and understanding
among people.
4. Budgeting is a time consuming process which often becomes less cost effective when changes in business
environment occur rapidly.

6.3.4 Preparation of Budgets

The Budgeting Process
Types of budgeting process
This budgeting process involves preparing the budget by the company’s senior management based on the
company’s objectives. The departmental managers are assigned the responsibility for its successful implementation.
Every department can opt to create its own budget based on the company’s broader budget allocation and goals.
The following are the four budgeting processes which are classified on the basis of the participation of the
budget holders3.
� Bottom-Up Budgeting – this is the budgeting process where all budget holders have the opportunity to
participate in setting their own budgets.
� Imposed/Top-Down Budgeting – this is the budgeting process where budget allowances are set without
permitting ultimate budget holders the opportunity to participate in the process.
� Negotiated Budget – this is the budgeting process in which budget allowances are set largely on the basis of
negotiations between budget holders and those to whom they report.
� Participative Budgeting – Participative bedgeting involves employees from lower levels who give their input
about the cost allocation. It allows lower-level employees to feel a sense of ownership and belonging to the
organisation, as they feel that they are an important part of the budgeting process. Thus, it is often reffred as
bottom – up budgeting.
Stages in the budgeting process
The important stages of the budgeting process are as follows:
1. communicating details of budget policy and guidelines to those people responsible for the preparation of
budgets;
2. determining the factor that restricts output;
3. the order of preparation of budget;
4. negotiation of budgets with superiors;
5. final acceptance of budgets;
6. ongoing review of budgets.
Step One - Communicating details of the budget policy
The annual budget is only an implementation part of the long-range plan. Top management must communicate the

3 The person who is ultimately responsible for ensuring that the budget is followed is known as the Budget Holder. Budget holders
are usually the managers and operational directors of companies who are tasked by the owners/shareholders or the board of
directors to ensure that the company follows whatever budget is laid out for them. [https://corporatefinanceinstitute.com/resources/
careers/jobs/budget-holder/].

The Institute of Cost Accountants of India 525

Cost Accounting

policy effects of the long-term plan to those responsible for preparing the current year’s budgets. Policy effects
includes planned changes in sales mix, or the expansion or contraction of certain activities. Thus, preparation of
the sales budget is the starting point.
Step Two - Determining the factor that restricts performance
In every organisation there are factors that restricts performance for a given period. In the majority of organisations
this factor is sales demand. These factors that restrict performance are referred as principal budget factor. CIMA
Official Terminology1 defines the principal budget factor as factors that limits the activities of an undertaking.
The document states that identification of the principal budget factor is often the starting point in the budget
setting process. Often the principal budget factor will be sales demand but it could be production capacity or
material supply. The principal budget factor may also be machine capacity, distribution and selling resources, the
availability of key raw materials or the availability of cash. Once this factor is defined then the remainder of the
budgets can be prepared. For example, if sales are the principal budget factor then the production manager can only
prepare his budget after the sales budget is complete.
Step Three - The order of budget preparation
Assuming that the principal budget factor has been identified as being sales, the order of budget preparation is
summarised as follows:
a. The sales budget is prepared in units of product and sales value. Along with this the finished goods inventory
budget should have to be prepared simultaneously.
b. With the information from the sales and inventory budgets, the production budget is to be prepared. The
production budget will be stated in terms of units.
c. This leads on logically to budgeting the resources for production. This involves preparing a materials usage
budget, machine usage budget and a labour budget.
d. Sequentially, a materials inventory budget will have to be prepared, to decide the planned increase or
decrease in the level of inventory held. Once the raw materials usage requirements and the raw materials
inventory budget are known, the purchasing department can prepare the raw material purchases budget.
e. During the preparation of the sales and production budgets, the managers of the cost centres of the organisation
will prepare their draft the department overhead costs budgets. Such overheads will include maintenance,
stores, administration, selling and research and development.
f. From the above information a budgeted income statement has to be prepared.
g. For the preparation of budgeted statement of financial position, the capital expenditure budget (for non-
current assets), the working capital budget (for budgeted increases or decreases in the level of receivables
and accounts payable as well as inventories), and a cash budget have to be prepared.
Step Four - Negotiation of budgets
To implement a participative approach to budgeting, the budget should be originated at the lowest level of
management and the managers at this level should submit their budget to their superiors for approval.
Step Five - Final acceptance of the budgets
When all the budgets are in harmony with each other, they are summarized into a master budget consisting of
a budgeted profit and loss account, a balance sheet and a cash flow statement. Only when the master budget is
accepted by the top management and is in consonance with all the other budgets, the top management is nods its
final acceptance. This is possible only after sufficient negotiation has taken place over the budgets between the
budget holder and the superiors.

526 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Step Six - Budget review

The budget process should not stop when the budgets have been agreed. Periodically, the actual results should be
compared with the budgeted results. This is a continuous process and is like the feedback loop.
It can be concluded that the most important aspect of the process is the identification of the principal budget factor
or key budget factor. If it is not stated specifically then sales are considered as the principal budget factor. On the
basis of this, the preparation stage of the process ensues with the preparation of the sales budget and ends with the
preparation of the master budget.
Types of Budget
Budgets can be classified based on various criteria including the following;
1. Functional Classification - Budgets can be classified according to the function or purpose they serve within
an organization.
2. Time Period Classification: Budgets can be classified based on the time period they cover.
3. Static vs. Flexible Classification: This is based on the capacity for which the budget is developed. On the
basis of capacity, budgets can be classified based on their flexibility to adjust to changing circumstances

Types of Budget

On the basis On the basis On the basis

of Time of Function of Capacity

Current Budget

Functional Fixed Budget

Long Term Master Budget
Budget
Budget

Short term
Flexible Budget
Budget

Figure 6.16: Classification of Various of Budgets

Classification on the basis of Time

� Long-Term budgets – These budgets are prepared for a longer period (more than one year). 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.

� 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.

� Current Budgets – These budgets are prepared for the current operations of the business. The planning period
of a budget generally in months or weeks.

The Institute of Cost Accountants of India 527

Cost Accounting

Classification on the basis of Function

Functional Budget : The functional budget, also referred as a departmental budget, is one which relates to any
of the functions of an organisation. The number of functional budgets depend upon the size and nature of business.
The following are the commonly used:
� Sales Budget
� Purchase Budget
� Production Budget
� Selling and Distribution Cost Budget
� Labour Cost Budget
� Cash Budget
� Capital Expenditure Budget

CIMA Official Terminology1 defines a functional budget is a budget of income and/or expenditure applicable to
a particular function frequently including sales budget, production cost budget (based on budgeted production,
efficiency and utilisation), purchasing budget, human resources budget, marketing budget and research and
development budget.

Master Budget: The master budget provides a consolidation of all the subsidiary budgets and normally
consists of:
� a budgeted income statement
� budgeted statement of financial position
� a cash budget.

Master Budget may be defined as a summary budget incorporating all the functional budgets, which has been
finally approved and adopted.

Classification on the Basis of Capacity

� Fixed Budget : A fixed budget is designed to remain unchanged irrespective of the level of activity actually
attained.
� 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.

Functional Budget

The functional budgets are prepared for each function of the organisation. These budgets are normally prepared
for a period of one year and then broken down to each month. The CIMA definition and the categorisation of the
functional budget are discussed in the previous section. Some illustration on preparation of functional budget are
given in the next section.

528 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Illustration 26
The Barker Company manufactures two models of adding machines, A and B. The following production and sales
data for the month of June 2022 are given below :
Particulars A B
Estimated inventory (units) June 1 4500 2250
Desired inventory (units) June 30 4000 2500
Expected Sales Volume (units) 7500 5000
Unit sale price (`) 75 120
Prepare a sales budget and a production budget for June 2022.

Solution:
Barker Company
(Sales Budget for June 2022)
Product Sales Volume (Unit) Unit Selling Price (₹) Total Sales Price (₹)
A 7,500 75 5,62,500
B 5,000 120 6,00,000
11,62,500
Barker Company
(Production Budget for June 2022)
Particulars Products A (units) Product B (units)
Expected Sales 7,500 5,000
Ending inventory, desired 4,000 2,500
Total 11,500 7,500
Less : Beginning inventory 4,500 2,250
Total production (In units) 7,000 5,250

Illustration 27
Prepare a Production Budget for three months ending March 31, 2022 for a factory producing four products, on the
basis of the following information:

Estimated Stock on Estimated Sales during Desired Stock on

Type of Product
January 1, 2022 January to March 2022 March 31, 2022
A 2,000 10,000 3,000
B 3,000 15,000 5,000
C 4,000 13,000 3,000
D 3,000 12,000 2,000

The Institute of Cost Accountants of India 529

Cost Accounting

Solution :
Opening Stock + Production = Sales + Closing Stock
or, Production = Sales + Closing Stock – Opening Stock
Particulars Product A Product B Product C Product D
Sales 10,000 15,000 13,000 12,000
Add: Closing Stock 3,000 5,000 3,000 2,000
13,000 20,000 16,000 14,000
Less: Opening Stock 2,000 3,000 4,000 3,000
Production (units) 11,000 17,000 12,000 11,000

Illustration 28
Budgeted production and production costs for the year ending 31st December are as follows:
Product X Product Y
Production (units) 2,20,000 2,40,000
Direct material / unit ₹12.50 ₹ 19.00
Direct wages / unit ₹ 4.50 ₹ 7.00
Total factory overheads for each type of product (variable) ₹ 6,60,000 ₹ 9,60,000
A company is manufacturing two products X and Y. A forecast about the number of units to be sold in the first seven
months is given below :
Month January February March April May June July
Product X 10,000 12,000 16,000 20,000 24,000 24,000 20,000
Product Y 28,000 28,000 24,000 20,000 16,000 16,000 18,000

It is anticipated that:
� There will be no work-in-progress at the end of any month.
� Finished units equal to half the sales for the next month will be in stock at the end of each month (including
December of previous year).
Prepare for 6 months ending 30th June, a Production Budget and a summarized cost of production budget.
Solution:
Production Budget for 6 months ending 30th June - Product X
Particulars January February March April May June
Sales 10,000 12,000 16,000 20,000 24,000 24,000
Add: Closing Stock 6,000 8,000 10,000 12,000 12,000 10,000
16,000 20,000 26,000 32,000 36,000 34,000
Less: Opening Stock 5,000 6,000 8,000 10,000 12,000 12,000
Product (units) 11,000 14,000 18,000 22,000 24,000 22,000

530 The Institute of Cost Accountants of India

 Cost Accounting Techniques

50
Closing Stock of December = Opening Stock of January = × Sales of February
100
50
and Closing Stock of January = × Sales of February
100
Total Production of Product X for 6 months = 11,000 + 14,000 + 18,000 + 22,000 + 24,000 + 22,000
= 1,11,000 units
Production Budget for 6 months ending 30th June - Product Y
Particulars January February March April May June
Sales 28,000 28,000 24,000 20,000 16,000 16,000
Add: Closing Stock 14,000 12,000 10,000 8,000 8,000 9,000
42,000 40,000 34,000 28,000 24,000 25,000
Less: Opening Stock 14,000 14,000 12,000 10,000 8,000 8,000
Product (units) 28,000 26,000 22,000 18,000 16,000 17,000
Total Production of Product Y for 6 months = 28,000 + 26,000 + 22,000 + 18,000 + 16,000 + 17,000 = 1,27,000
units
Summarized Cost of Production Budget for 6 month ending 30th June
Particulars Product X (1,11,000 units) (₹) Product Y (1,27,000 units) (₹) Total (₹)
Materials @ ₹ 12.50 = 13,87,500 @ ₹ 19 = 24,13,000 38,00,500
Direct Wages @ ₹ 4.50 = 4,99,500 @ ₹ 7 = 8,89,000 13,88,500
Variable Overhead [WN] @ ₹ 3 = 3,33,000 @ ₹ 4 = 5,08,000 8,41,000
Cost of Production 22,20,000 38,10,000 60,30,000
Working Notes:
Computation of Variable Factory Overhead Rate per unit
` 6,60,000
=
Product X = ₹3
2,20,000 units
` 9,60,000
=
Product Y = ₹ 4
2,40,000 units
Illustration 29
From the following figures prepare the raw material purchase budget for January 2022:
Materials
A B C D E F
Estimated Stock on 1st Jan 16,000 6,000 24,000 2,000 14,000 28,000
Estimated Stock on 31st Jan 20,000 8,000 28,000 4,000 16,000 32,000
Estimated Consumption 1,20,000 44,000 1,32,000 36,000 88,000 1,72,000
Standard Price per unit 25 paise 5 paise 15 paise 10 paise 20 paise 30 paise

The Institute of Cost Accountants of India 531

Cost Accounting

Solution :
Opening Stock + Purchase = Consumption + Closing Stock
or, Purchase = Consumption + Closing Stock – Opening Stock

Raw Materials Purchase Budget for January 2022

Particulars A B C D E F
Budgeted Consumption (units) 1,20,000 44,000 1,32,000 36,000 88,000 1,72,000
Add: Estimated Stock on 31st Jan (units) 20,000 8,000 28,000 4,000 16,000 32,000
1,40,000 52,000 1,60,000 40,000 1,04,000 2,04,000
Less: Estimated Stock on 1st Jan (units) 16,000 6,000 24,000 2,000 14,000 28,000
Budgeted Purchase (units) 1,24,000 46,000 1,36,000 38,000 90,000 1,76,000
Standard Price per unit 25 paise 5 paise 15 paise 10 paise 20 paise 30 paise
Budgeted Purchase Cost (₹) 31,000 2,300 20,400 3,800 18,000 52,800

Illustration 30
The following data on production, materials required for products X and Y, and Inventory pertain to the budget of
LMN Company:
Particulars Product X Product Y
Production (Units) 2000 3000
Material (Units)
A 3.0 1.0
B 4.0 6.5

Particulars Beginning Desired Ending Price / unit (`)

Material Inventory :
A 2000 3000 2
B 6000 6000 1.2

a. Determine the number of material units needed to produce products X and Y

b. Calculated the cost of materials used for production.
c. Determine the number of materials units to be pruchased.
d. Calculate the cost of materials to be purchased.
Solution:
(a) Number of material units needed to produce products X and Y
Particulars Material A Material B
Number of Product X to be produced (a) 2000 2000
Number of material units needed per product X (b) 3.0 4.0
Material required (a × b) 6000 8000

532 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Particulars Material A Material B

Number of Product Y to be produced (a) 3000 3000
Number of material units needed per product Y (b) 1.0 6.5
Material required (a × b) 3000 19500

Particulars Material A Material B

Total number of material units needed for
Production of Product X and Product Y
(6000 + 3000) 9000
(8000 + 19500) 27500
(b) Cost of materials used for production

Particulars Material A Material B

Total number of material units 9,000 27,500
Unit Price (₹) 2 1.20
Cost of materials used for production (₹) 18,000 33,000

(c) Number of materials units to be purchased

Particulars Material A Material B

Total number of material units required for production 9000 27500
Add : Desire ending inventory 3000 6000
12000 33500
Less : Beginning inventory
2000 6000
Material to be purchased
10000 27500

(d) Cost of materials units to be purchased

Particulars Material A Material B

Materials to be purchased 10000 27500
Unit Price (₹) 2.00 1.20
Material to be purchased (₹) 20,000 33,000

Illustration 31
Long Beach Tools Corporation has the following direct labour requirements for the production of a machine
tool set:

Direct Labour Required Time (Hours) Hourly Rate (`)

Machining 6 10
Assembly 10 8

The Institute of Cost Accountants of India 533

Cost Accounting

Forecasted sales of for June, July, August and September are 6000, 5000, 8000, 7000 units respectively. On June
1, beginning Inventory of the tool set was 1500. The Closing inventory (desired) each month is one-half of the
forecasted sales for the following month.
a. Prepare a production budget for the months of June, July and August.
b. Develop a direct labour budget for the months of June, July and August and for each type of direct labour.
Solution :
Long Beach Tool Corporation
Production Budget
Particulars June (units) July (units) August (units)
Forecasted Sales 6000 5000 8000
Add : Closing Inventory (Desired) 2500 4000 3500
Total Requirement 8500 9000 11500
Less : Opening Inventory 1500 2500 4000
Number of Units to be produced 7000 6500 7500

Long Beach Tool Corporation

Direct Labour Budget

Particulars June (units) July (units) August (units)

Machining:
a. Budgeted Production 7000 units 6500 units 7500 units
b. Direct Labour Hours per unit 6 hours 6 hours 6 hours
c. Total direct Labour hours required (a × b = c) 42000 hrs. 39000 hrs. 45000 hrs.
d. Direct Labour Cost [c × ₹ 10) ₹ 4,20,000 ₹ 3,90,000 ₹ 4,50,000

Particulars June (units) July (units) August (units)

Assembly :
Budgeted Production 7000 units 6500 units 7500 units
Direct Labour Hours per unit 10 hours 10 hours 10 hours
Total direct Labour hours required (a × b = c) 70000 hrs. 65000 hrs. 75000 hrs.
Direct Labour Cost [c (as calculated) × ₹ 8) ₹ 5,60,000 ₹ 5,20,000 ₹ 6,00,000

Illustration 32
You are required to prepare a Selling Overhead Budget from the estimates given below:
Amount (₹)
Advertisement (Fixed) 1,000
Salaries of the Sales Department (Fixed) 1,000
Expenses of the Sales Department (Fixed) 750
Salesmen’s Remuneration (Fixed) 3,000
Salesmen’s Commission @ 1% on sales excluding Agent’s Sales

534 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Carriage Outwards: Estimated @ 5% on sales

Agent’s Commission: 7⅟2 % on Agent’s sales
The sales during the period were estimated as follows:
� ₹ 80,000 including Agent’s Sales ₹ 8,000
� ₹ 90,000 including Agent’s Sales ₹ 10,000
� ₹ 1,00,000 including Agent’s Sales ₹ 10,500
Solution :
Selling Overhead Budget

Particulars ₹ ₹ ₹
Sales 80,000 90,000 1,00,000
A. Fixed Overhead
Advertisement 1,000 1,000 1,000
Salaries of Sales Dept. 1,000 1,000 1,000
Expenses of Sales Dept. 750 750 750
Salesmen Remuneration 3,000 3,000 3,000
Total (A) 5,750 5,750 5,750
B. Variable Overhead
Salesmen Commission 720 800 895
[(80,000 – 8,000) × 1%] [(90,000 – 10,000) × 1%] [(1,00,000 – 10,500) × 1%]
Carriage Outward 4,000 [80,000 × 5%] 4,500 [9,00,000 × 5%] 5,000 [1,00,000 × 5%]
Agent’s Commission 600 [8,000 × 7.5%] 750 [10,000 × 7.5%] 788 [10,500 × 7.5%]
Total (B) 5,320 6,050 6,683
Grand Total (A + B) 11,070 11,800 12,433
Cash Budget
A cash budget is a statement in which estimated future cash receipts and payments are tabulated in such a way
as to show the forecast cash balance of a business at defined intervals. It is an estimate of cash receipts and cash
payments prepared for each month. In this budget all expected payments, revenue as well as capital and all receipts,
revenue and capital are taken into consideration. The main purpose of cash budget is to predict the receipts and
payments in cash so that the firm will be able to find out the cash balance at the end of the budget period. This will
help the firm to know whether there will be surplus cash or deficit at the end of the budget period. It will help them
to plan for either investing the surplus or raise necessary amount to finance the deficit. Cash Budget is prepared in
various ways, but the most popular form of the same is by the method of Receipt and Payment method.

CIMA Official Terminology1 defines a cash budget as a detailed budget of estimated cash inflows and outflows
incorporating both revenue and capital items. The following illustrates the preparation of a cash budget.

The Institute of Cost Accountants of India 535

Cost Accounting

The usefulness of cash budgets

The cash budget is a very important planning tool that an organisation can use. It acts as a cash summary and
shows the cash effect of all plans made within the budgetary process. Preparing a cash budget is an essential
aspect of financial planning and control, offering valuable insights into the organization’s cash flow dynamics and
enabling proactive management of liquidity, budgetary performance, and financial risks. The cash position and the
appropriate action for each are classified below:

i. Short term surplus – in case this is projected by the cash budget, the management may take the following
actions:
� make short term investments
� make early payments to the suppliers to obtain discount
� invest in receivables and inventories to increase sales.
ii. Short-term shortfall - in case this is projected by the cash budget, the management may take the following
actions:
� arrange for overdraft if the situation demands
� take necessary arrangements to reduce receivables
� delay payments of accounts payable to the extent possible without incurring additional costs like
forgoing of discount.
iii. Long-term surplus - in case this is projected by the cash budget, the management may be said to be in
suitable position and should take up the following actions:
� make strategic plans to expand and diversify
� the firm should make arrangements to make long term investments
� Acquisition of fixed assets can also be considered.
iv. Long-term shortfall – in case this is projected by the cash budget, the management may be said to be in
suitable position and should take up the following actions:
� Raise long term finance by issue of equity and other long term source
� Consider shut down of operations or divestment
� Consider other retrenchment strategies.

Illustration on Cash Budget

Illustration 33
The following sales budget is given for Van Dyke Sales Company for the second quarter of 2022 :

Particulars April May June Total

Sales Budget (₹) 45000 50000 60000 155000
Credit sales are collected as follows:
70 percent in month of sale, 20 percent in month following sale, 8 percent in second month following sale, and 2
percent uncollectible. The accounts receivable balance at the beginning of the second quarter is ` 18,000, ` 3,600
of which represents uncollected February sales, and ` 14,400 uncollected March sales.

536 The Institute of Cost Accountants of India

 Cost Accounting Techniques

1. Calculate the total sales for February and March.

2. Compute the budgeted cash collections from sales for each month. (Without prejudice to the answer to part
1, assume that February sales equal ` 40,000 and March sales equal ` 50,000.)

Solution
1. February Sales ⇒ (1 – 0.7 – 0.2) = ₹ 3600 ⇒ 3600 ÷ (1 – 0.9) = ₹ 36000
March Sales ⇒ (1 – 0.7) = ₹ 14400 ⇒ ₹ 14400 ÷ 0.3 = ₹ 48000

2. Budgeted Cash Collections from Sales

Details April May June

Cash collection
February : 40000 (8%) 3200
March : 50000 (20%) 10,000
50000 (8%) 4000
April : 45000 (70%) 31500
45000 (20%) 9000
45000 (8%) 3600
May : 50000 (70%) 35000
50000 (20%) 10000
June : 60000 (70%) 42000
44700 48000 55600

Illustration 34
ABC Ltd a newly started company wishes to prepare Cash Budget from January. Prepare a cash budget for the first
six months from the following estimated revenue and expenses.
Overheads
Month Total Sales (₹) Materials (₹) Wages (₹) Production Selling &
(₹) Distribution (₹)
January 20,000 20,000 4,000 3,200 800
February 22,000 14,000 4,400 3,300 900
March 28,000 14,000 4,600 3,400 900
April 36,000 22,000 4,600 3,500 1,000
May 30,000 20,000 4,000 3,200 900
June 40,000 25,000 5,000 3,600 1,200

Cash balance on 1st January was ₹ 10,000. A new machinery is to be installed at ₹ 20,000 on credit, to be repaid
by two equal installments in March and April, sales commission @ 5% on total sales is to be paid within a month
following actual sales.
₹ 10,000 being the amount of 2nd call may be received in March. Share premium amounting to ₹ 2,000 is also
obtained with the 2nd call may be received in March. Period of credit allowed by suppliers – 2 months; period of
credit allowed to customers – 1 month, delay in payment of overheads 1 month. Delay in payment of wages ½
month. Assume cash sales to be 50% of total sales.

The Institute of Cost Accountants of India 537

Cost Accounting

Solution :
Cash Budget for the period January to June (for first 6 month) (in `)
Particulars January February March April May June
Opening Balance (A) 10,000 18,000 29,800 27,000 24,700 33,100
Add: Receipts (B)
Cash Sales [WN 1] 10,000 11,000 14,000 18,000 15,000 20,000
Collection from Debtors [WN 1] - 10,000 11,000 14,000 18,000 15,000
Share Call Money - - 10,000 - - -
Share Premium - - 2,000 - - -
Total (A + B) 20,000 39,000 66,800 59,000 57,700 68,100
Payments (C)
Creditors for Materials - - 20,000 14,000 14,000 22,000
Wages [WN 2] 2,000 4,200 4,500 4,600 4,300 4,500
Production O/H - 3,200 3,300 3,400 3,500 3,200
Selling & Distribution - 800 900 900 1,000 900
Sales Commission - 1,000 1,100 1,400 1,800 1,500
Installment of Machinery - - 10,000 10,000 - -
Total (C) 2,000 9,200 39,800 34,300 24,600 32,100
Closing Balance (A + B – C) 18,000 29,800 27,000 24,700 33,100 36,000
Working Notes :
1. Calculation of Cash Sales and Collection from Debtors
Month Total Sales (₹) Cash Sales (50%) (₹) Credit Sales (50%) (₹) Collection Month
January 20,000 10,000 10,000 February
February 22,000 11,000 11,000 March
March 28,000 14,000 14,000 April
April 36,000 18,000 18,000 May
May 30,000 15,000 15,000 June
June 40,000 20,000 20,000 July
2. Calculation of Payment of Wages (in `)
Payment Month
Month Wages
January February March April May June
January 4,000 2,000 2,000 - - - -
February 4,400 - 2,200 2,200 - - -
March 4,600 - - 2,300 2,300 - -
April 4,600 - - - 2,300 2,300 -
May 4,000 - - - - 2,000 2,000
June 5,000 - - - - - 2,500
2,000 4,200 4,500 4,600 4,300 4,500

538 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Fixed and Flexible Budget

It has been discussed previously that on the basis of capacity, budgets can also be classified as fixed or flexible.
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 80% of its total capacity and prepare a budget showing the projected profit
or loss at that capacity, then it prepares a fixed budget.
CIMA official terminology1 defines a fixed budget as a budget set prior to the control period and not subsequently
changed in response to changes in activity, costs or revenues. It may serve as a benchmark in performance evaluation.
For preparation of the fixed budget, sales forecast will have to be prepared along with the cost estimates. Cost
estimates can be prepared by segregating the costs according to their behavior i.e. fixed and variable. Cost
predictions should be made element wise and the projected profit or loss can be worked out by deducting the costs
from the sales revenue.
A fixed budget is a budget which is set for a single activity level. While a flexible budget is a budget which
recognises different cost behaviour patterns and is designed to change as volume of activity changes. It is important
to note that Master budgets are based on planned volumes of production and sales but do not include any provision
for the event that actual volumes may differ from the budget. In this sense they may be described as fixed budgets.
As such preparation of flexible budgets are significantly different from what has been discussed so far. The functional
budgets which has been discussed so far are all based on a single level of activity and, as such, are fixed budgets.
Advantages of Flexible Budget
Flexible budget, as such, is preferred way of budgeting as it gives a projection of profit at various activity levels.
The following is a list of various advantages of the flexible budget.:
1. In flexible budget, all possible volume of output or level of activity can be covered.
2. Overhead costs are analysed into fixed variable and semi-variable costs.
3. Expenditure can be forecasted at different levels of activity.
4. It facilitates comparison of related activities which are essential for intelligent decision making.
5. A flexible budget can be prepared with standard costing or without standard costing.
6. Flexible budget facilitates ascertainment of costs at different levels of activity. Thus, fixation of price, placing
tenders and acceptance of quotations can be based on flexible budgets.
Preparation of flexible budgets4
There are basically two steps in preparing the flexible budget which are stated below:
Step 1
The first step in the preparation of a flexible budget is the determination of cost behaviour patterns, which means
deciding whether costs are fixed, variable or semi-variable.
� Fixed costs remain constant over various activity levels.
� For non-fixed costs, divide each cost figure by the related activity level. If the cost is a variable cost, the
cost per unit will remain constant. If the cost is a semi-variable cost, the unit rate will reduce as activity
levels increase.
4 For preparation of flexible budget, students are advised to:
1. Observe the various costs given and classify them as fixed or variable.
2. If the costs are semi variable, then students would have to segregate the cost into its variable element and its fixed element. (the
methods of segregation is specified in previous modules)

The Institute of Cost Accountants of India 539

Cost Accounting

Step 2

The second step in the preparation of a flexible budget is to calculate the budget cost allowance for each cost item.

Budget cost allowance = budgeted fixed cost* + (number of units × variable cost per unit)**

* nil if the cost is variable in nature.

** nil for fixed cost

It is very important to note that semi-variable costs need to be segregated into their fixed and variable components
so that the budget cost allowance can be calculated.

Illustration 35
A company manufactures a single product and has produced the following flexible budget for the year

Level of activity
Particulars 70% 80% 90%
(₹) (₹) (₹)
Turnover 2,10,000 2,40,000 2,70,000
Direct Material 17,780 20,320 22,860
Direct labour 44,800 51,200 57,600
Production overhead 30,500 32,000 33,500
Administrative Overhead 17,000 17,000 17,000
Total Cost 1,10,080 1,20,520 1,30,960
Profit 99,920 1,19,480 1,39,040

Calculate the (a) Direct material Cost, (b) Direct labour cost, and (c) Production overhead, if the budget is fixed at
45% level of activity.
Solution:

(a) Direct materials cost is variable cost.

Check :

Cost per %
17,780
70% : = 254
70
20,320
80% : = 254
80
22,860
90% : = 254
90
So, Direct materials at 45% level of activity = 254 × 45 = ` 11,430

540 The Institute of Cost Accountants of India

 Cost Accounting Techniques

(b) Direct labour is a variable cost.

Check :
Cost per %
44,800
70% : = 640
70
51,200
80% : = 640
80
57,600
90% : = 640
90
So, Direct labour at 45% level of activity = 640 × 45 = ` 28,800

(c) Production overhead is a semi-variable cost.

Check :
Cost per %
30,500
70% : = 436
70
32,000
80% : = 400
80
33,500
90% : = 372
90
Variable cost of (90% – 70%) activity = (33,500 – 30,500)
Or, Variable cost portion in Production overhead of 20% = ` 3,000
Or, Variable cost of 1% change in activity = 3,000/20 = ` 150
Now, Fixed cost portion in Production overhead = 33,500 – (90 × 150) = ` 20,000
Therefore, Total Production overhead cost at 45% level of activity = 20,000 + (45 × 150) = ` 26,750

Illustration 36
The monthly budgets for manufacturing overheads of a concern for two levels of activity were as follows :

Capacity 60% 100%

Budgeted Production (units) 600 1,000
(₹) (₹)
Wages 1,200 2,000
Consumable stores 900 1,500
Maintenance 1,100 1,500
Power and fuel 1,600 2,000
Depreciation 4,000 4,000
Insurance 1,000 1,000
Total Cost 9,800 12,000

The Institute of Cost Accountants of India 541

Cost Accounting

You are required to:

i. Indicate which of the items are fixed, variable and semi-variable.
ii. Prepare a budget for 80% capacity, and
iii. Find the total cost, both fixed and variable per unit of output at 60%, 80% and 100% capacity.
Solution:
(i) Statement showing segregation of the items in Fixed, Variable and Semi-Variable
Items of Cost Nature of Cost Variable Cost p.u Fixed
Wages Variable 1,200
= ₹ 2. p.u.
600
Consumable stores Variable 900
= ₹ 1.50 p.u.
600
Maintenance Semi-Variable Change in total Cost Total Cost – Variable Cost
=
Change in Output = 1,100 – (600 × 1)
= ₹ 500
1,500 – 1,100
=
1,000 – 600

400
= = ₹ 1. p.u.
400
Power and fuel Semi-Variable Change in total Cost Total Cost – Variable Cost
=
Change in Output = 1,600 – (600 × 1)
= ₹ 1,000
2,000 – 1,600
=
1,000 – 600
400
= = ₹ 1. p.u.
400
Depreciation Fixed ₹ 4,000
Insurance Fixed ₹ 1,000

(ii) Budget at 80% Capacity

Production 1,000 × 80% = 800 units (₹)

Wages 800 × 2 = 1,600
Consumable stores 800 × 1.50 = 1,200
Maintenance 800 × 1 + 500 = 1,300
Power and fuel 800 × 1 + 1,000 = 1,800
Depreciation 4,000
Insurance 1,000
Total Cost 10,900

542 The Institute of Cost Accountants of India

 Cost Accounting Techniques

(iii)

Capacity 60% 80% 100%

Production 600 units 800 units 1000 units
p.u. Total p.u. Total p.u. Total
(₹) (₹) (₹) (₹) (₹) (₹)
Variable Costs
Wages 2.00 1,200 2.00 1,600 2.00 2,000
Consumable stores 1.50 900 1.50 1,200 1.50 1,500
Maintenance 1.00 600 1.00 800 1.00 1,000
Power and Fuel 1.00 600 1.00 800 1.00 1,000
Total Variable Costs 5.50 3,300 5.50 4,400 5.50 5,500
Fixed Costs
Maintenance 500 500 500
Power and Fuel 1,000 1,000 1,000
Depreciation 4,000 4,000 4,000
Insurance 1,000 1,000 1,000
Total Fixed Costs 6,500 6,500 6,500 6,500 6,500 6,500
600 800 1,000

= 10.83 = 8.125 = 6.50

Total Costs 16.33 9,800 13.625 10,900 12.00 12,000

Illustration 37

A factory engaged in manufacturing plastic toys is working at 40% capacity and produces 10,000 toys per month.
The present cost break up for one toy is as under:

Material : ` 10

Labour : ` 3

Overheads : ` 5 [60% fixed]

The selling price is ` 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.

The Institute of Cost Accountants of India 543

Cost Accounting

Solution:
Flexible Budget
At 40%, 50% and 90% Capacity Utilization
40% Capacity 50% Capacity 90% Capacity
Partticulars
Uilization Uilization Uilization
Production - Units 10,000 12,500 22,500
Selling Price Per Unit ` 20 ` 19.40 ` 19

Sales Value [units × selling price] ` 2,00,000 ` 2,42,500 ` 4,27,500

Variable Costs :
Material ` 10 per unit ` 1,00,000 ` 1,21,250* ` 2,13,750**

Labour ` 3 per unit ` 30,000 ` 37,500 ` 67,500

Overheads ` 2 per unit (` 5 × 40%) ` 20,000 ` 25,000 ` 45,000

Total Variable Costs ` 1,50,000 ` 1,83,750 ` 3,26,250

Fixed Costs (` 5 × 60% × 10,000) ` 30,000 ` 30,000 ` 30,000

Total Costs [Variable Cost + Fixed Cost] ` 1,80,000 ` 2,13,750 ` 3,56,250

Profit/Loss [Sales – Total Costs] ` 20,000 ` 28,750 ` 71,250

* 12,500 units × ` 9.70 per unit = ` 1,21,500

** 22,500 units × ` 9.50 per unit = ` 2,13,750
Zero Base Budgeting (ZBB)
Zero Base Budgeting (ZBB) is method of budgeting whereby all activities are revaluated each time budget is
formulated and every item of expenditure in the budget is fully justified. Thus, the ZBB involves from scratch or
zero. ZBB (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 incremental budgeting
or traditional budgeting, previous year’s figures are taken as base and based on the same the budgeted figures for
the next year are worked out. Thus, the previous year is taken as the base for preparation of the budget. However,
the main limitation of this system of budgeting is that an activity is continued in the future only because it is
being continued in the past. Hence in ZBB, 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 ZBB also focuses on programs or activities instead
of functional departments based on line items, which is a feature of traditional budgeting. It is an extension of
program budgeting. In program budgeting, programs are identified and goals are developed for the organisation
for the particular program. By inserting decision packages in the system and ranking the packages, the analysis is
strengthened and priorities are determined.
Applications of Zero Based Budgeting: The following stages/steps are involved in the application of ZBB:
� Each separate activity of the organisation is identified and is called as a decision package. Decision package
is actually nothing but a document that identifies and describes an activity in such a manner that it can be
evaluated by the management and rank against other activities competing for limited resources and decide
whether to sanction the same or not.

544 The Institute of Cost Accountants of India

 Cost Accounting Techniques
� It should be ensured that each decision package is justified in the sense it should be ascertained whether the
package is consistent with the goal of the organisation or not.
� If the package is consistent with the overall objectives of the organisation, the cost of minimum efforts
required to sustain the decision should be determined.
� Alternatives for each decision package are considered in order to select better and cheaper options.
� Based on the cost and benefit analysis a particular decision package/s should be selected and resources are
allocated to the selected package.
Benefits from Zero Based Budgeting :
ZBB was first introduced by Peter A. Pyhrr, a staff control manager at Texas Instruments Corporation, U.S.A. He
developed this technique and implemented it for the first time during the year 1969-70 in Texas in the private sector
and popularized its wider use. He wrote an article on ZBB in Harvard Business Review and later wrote a book
on the same. The ZBB concept was first applied in the State of Georgia, U.S.A. when Mr. Jimmy Carter was the
Governor of the State. Later after becoming the President of U.S.A, Mr. Carter introduced and implemented the
ZBB in the country in the year 1987. ZBB has a wide application not only in the Government Departments but also
in the private sector in a variety of business. In India, the ZBB was applied in the State of Maharashtra in 80s and
early 90s. Benefits from ZBB can be summarized in the following manner:
� 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 results
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 organisation 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.

The Institute of Cost Accountants of India 545

Cost Accounting

Performance Budgeting
It is budgetary system where the input costs are related to the performance i.e. the end results. This budgeting is used
extensively in the Government and Public Sector Undertakings. It is essentially a projection of the Government
activities and expenditure thereon for the budget period. This budgeting starts with the broad classification of
expenditure according to functions such as education, health, irrigation, social welfare etc. Each of the functions is
then classified into programs sub classified into activities or projects. The main features of performance budgeting
are as follows:
� Classification into functions, programs or activities
� Specification of objectives for each program
� Establishing suitable methods for measurement of work as far as possible
� Fixation of work targets for each program.
Objectives of each program are ascertained clearly and then the resources are applied after specifying them clearly.
The results expected from such activities are also laid down. Annual, quarterly and monthly targets are determined
for the entire organisation. These targets are broken down for each activity centre. The next step is to set up various
productivity or performance ratios and finally target for each program activity is fixed. The targets are compared
with the actual results achieved. Thus, the procedure for the performance budgets include allocation of resources,
execution of the budget and periodic reporting at regular intervals.
The budgets are initially compiled by the various agencies such as Government Department, public undertakings
etc. Thereafter these budgets move on to the authorities responsible for reviewing the performance budgets. Once
the higher authorities decide about the funds, the amount sanctioned are communicated and the work is started. It
is the duty of these agencies to start the work in time, to ensure the regular flow of expenditure, against the physical
targets, prevent over runs under spending and furnish report to the higher authorities regarding the physical
progress achieved.
In the final phase of performance budgetary process, progress reports are to be submitted periodically to higher
authorities to indicate broadly, the physical performance to be achieved, the expenditure incurred and the variances
together with explanations for the variances.

Further Illustrations
Illustration 38
Draw a Material Procurement Budget (Quantitative) from the following information:
Estimated sales of a Product 40,000 units. Each unit of the Product requires 3 units of Material A and 5 units of
Material B.
Estimated opening balances at the commencement of the next year:

Finished product = 5,000 units

Material A = 12,000 units

Material B = 20,000 units

Opening stock of Material on order:

Material A = 7,000 units

Material B = 11,000 units

546 The Institute of Cost Accountants of India

 Cost Accounting Techniques

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

Finished product = 7,000 units
Material A = 15,000 units
Material B = 25,000 units
Material on order:
Material A = 8,000 units
Material B = 10,000 units
Solution:

Production = Sales + Closing Stock – Opening Stock

= 40,000 +7,000 – 5,000 = 42,000 units
Raw Materials Purchase Budget
Particulars Product A units Product B units
Materials Required 42,000 × 3 = 1,26,000 42,000 × 5 = 2,10,000
Add: Closing Stock 15,000 25,000
Add: Closing Stock of Material on Order 8,000 10,000
1,49,000 2,45,000
Less: Opening Stock 12,000 20,000
Less: Opening Stock of Material on Order 7,000 11,000
Raw Material Purchase 1,30,000 2,14,000
Illustration 39

A company manufactures Product A and Product B during the year 31st December, 2021, it is expected to sell
15,000 kg of Product A and 75,000 kg of Product B at ₹ 30 and ₹ 16 per kg respectively. The direct materials P, Q
and R are mixed in the proportion of 3 : 5 : 2 in the manufacture of Product A, and Materials Q and R are mixed
in the proportion of 1 : 2 in the manufacture of Product B. The actual and budgeted inventories for the year are
given below:

Opening Stock Estimated Closing Stock Anticipated cost per kg

(kg) (kg) (₹)
Material P 4,000 3,000 12
Material Q 3,000 4,000 10
Material R 30,000 9,000 8
Product A 3,000 1,500 –
Product B 4,000 4,500 –
Prepare the Production Budget and Materials Budget showing the expenditure on purchase of materials for the year
ending 31st December, 2021.
The Institute of Cost Accountants of India 547
Cost Accounting

Solution:
Production Budget for Product A and Product B

Particulars Product A units Product B units

Sales 15,000 75,000
Add: Closing Stock 1,500 4,500
16,500 79,500
Less: Opening Stock 3,000 4,000
Production 13,500 75,500
Material Purchase Budget for the year ending December 31st, 2021

Particulars P Q R Total
Materials required for Product A in the ratio of 3 : 5 : 2 4,050 6,750 2,700 13,500
Materials required for Product B in the ratio of 1 : 2 – 25,167 50,333 75,500
Total requirement 4,050 31,917 53,033 89,000
Add: Closing Stock 3,000 4,000 9,000 16,000
7,050 35,917 62,033 1,05,000
Less: Opening Stock 4,000 3,000 30,000 37,000
Purchases (in units) 3,050 32,917 32,033 68,000
Cost per kg 12 10 8
Total Purchase Cost (₹) 36,600 3,29,170 2,56,264 6,22,034

Illustration 40
The following details apply to an annual budget for a manufacturing company:

Quarter 1st 2nd 3rd 4th

Working Days 65 60 55 60
Production (units per working day) 100 110 120 105
Raw material purchases (% by weight of annual total) 30% 50% 20% –
Budgeted purchase price / kg (₹) 1 1.05 1.125 –

Quantity of raw material per unit of production 2 kg. Budgeted closing stock of raw material 2,000 kg. Budgeted
opening stock of raw material 4,000 kg (Cost ₹ 4,000).
Issues are pried on FIFO Basis. Calculate the following budgeted figures:
(a) Quarterly and annual purchase of raw material by weight and value.
(b) Closing quarterly stocks by weight and value.

548 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Solution:
(a) Quarterly and annual purchase of raw material by weight and value

Quarter Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total

Production (units) 65 × 100 = 60 × 110 = 55 × 120 = 60 × 105 = 26,000
6,500 6,600 6,600 6,300
Material Required (kg) 13,000 13,200 13,200 12,600 52,000
(Production × 2 kg p.u) 2,000
Add: Closing Stock (kg)
54,000
Less: Opening Stock (kg) 4,000
Annual Purchase by 50,000
weight (kg)
Quarterly Purchase by 30% × 50,000 = 50% × 50,000 = 20% × 50,000 = –
weight (kg) 15,000 25,000 10,000
Budgeted Purchase Price 1 1.05 1.125
per kg (`)
Quarterly and Annual 15,000 × 1 = 25,000 × 1.05 = 10,000 × 1.125 52,500
Purchase by Value (₹) 15,000 26,250 = 11,250
(b) Closing quarterly stock by weight and value
Store Ledger (FIFO)

Receipt Issue Balance (Closing Stock)

Quarter Quantity Amount Quantity Amount Quantity Amount
Rate Rate Rate
(kg) (₹) (kg) (₹) (kg) (₹)
Opening 4,000 1 4,000
1 15,000 1 15,000 13,000 1 13,000 6,000 1 6,000
2 25,000 1.05 26,250 13,200 13,560 17,800 1.05 18,690
 6, 000   1   6, 000 
 7, 200  1.05   7, 560 
     

3 10,000 1.125 11,250 13,200 1.05 13,860 14,600 16,080

 4, 600   1.05   4.830 
10, 000  1.125  11, 250 
     

4 – – – 12,600 13,830 2,000 1.125 2,250

 4.600   1.05   4, 830 
 8, 000  1.125   9, 000 
     

The Institute of Cost Accountants of India 549

Cost Accounting

Illustration 41
Prepare a Cash Budget for the three months ending 30th June, 2022 from the information given below:
(a)
Sales Materials Wages Overheads
Month
(₹) (₹) (₹) (₹)
February 14,000 9,600 3,000 1,700
March 15,000 9,000 3,000 1,900
April 16,000 9,200 3,200 2,000
May 17,000 10,000 3,600 2,200
June 18,000 10,400 4,000 2,300
(b) Credit terms are:
Sales / Debtors: 10% sales are on cash, 50% of the credit sales are collected next month and the balance in the
following month.
Creditors: Materials after 2 month
1
Wages : in next month
4 1
Overhead : in next month
2
(c) Cash and bank balance on 1st April, 2022 is expected to be ₹ 6,000.
(d) Other relevant information are:
(i) Plant and machinery will be installed in February, 2022 at a cost of ₹ 96,000. The monthly installment
of ₹ 2,000 is payable from April onwards.
(ii) Dividend @ 5% on preference share capital of ₹ 2,00,000 will be paid on 1st June.
(iii) Advance to be received for sale of vehicles ₹ 9,000 in June.
(iv) Dividends from investments amounting to ₹ 1,000 are expected to be received in June.
Solution:
Cash Budget for the 3 months ending 30th June, 2022
Particulars April (₹) May (₹) June (₹)
Opening Balance (A) 6,000 3,950 3,000
Add: Receipts (B)
Cash Sales [WN 1] 1,600 1,700 1,800
Collection from Debtors [WN 1] 13,050 13,950 14,850
Advance from Sale of Vehicles – – 9,000
Dividend – – 1,000
Total (A + B) 20,650 19,600 29,650
Payments (C)
Creditors for
Materials 9,600 9,000 9,200
Wages [WN 2] 3,150 3,500 3,900
Overheads [WN 3] 1,950 2,100 2,250
Installment of Plant and Machinery 2,000 2,000 2,000
Preference Dividend – – 10,000

550 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Particulars April (₹) May (₹) June (₹)

Total (C) 16,700 16,600 27,350
Closing Balance (A + B – C) 3,950 3,000 2,300

Working Notes:
1. Calculation of Cash Sales and Collection from Debtors Amount (₹)

Total Cash Credit Collection

Month
Sales Sales Sales March April May June
February 14,000 1,400 12,600 6,300 6,300 _ _

March 15,000 1,500 13,500 _ 6,750 6,750 _

April 16,000 1,600 14,400 _ _ 7,200 7,200

May 17,000 1,700 15,300 _ _ _ 7,650

June 18,000 1,800 16,200 _ _ _ _

13,050 13,950 14,850
2. Calculation of Payment of Wages (Amount in `)

Month Wages (`) March (₹) April (₹) May (₹) June (₹)
March 3,000 2,250 750 – –
April 3,200 – 2,400 800 –
May 3,600 – – 2,700 900
June 4,000 – – – 3,000
3,150 3,500 3,900
3. Calculation of Payment of Overheads

Overheads Overheads
Month
(₹) March (₹) April (₹) May (₹) June (₹)
March 1,900 950 950 1,000 1,100

April 2,000 1,000 1,100 1,150

May 2,200

June 2,300
1,950 2,100 2,250

The Institute of Cost Accountants of India 551

Cost Accounting

Illustration 42
For production of 10,000 units the following are budgeted expenses:

Cost Per unit (₹)

Direct Materials 48
Direct Labour 24
Variable Overheads 20
Fixed Overheads (₹ 1,20,000) 12
Variable Expenses (Direct) 4
Selling Expenses (10% Fixed) 12
Administration Expenses (₹ 40,000 Fixed) 4
Distribution Expenses (20% Fixed) 4
128
Prepare a budget for production of 7,000 units and 9,000 units.
Solution:
Flexible Budget at Different Capacities and Determination of Overhead Rates

10,000 units 7,000 units 9,000 units

Particulars Cost p.u. Total Cost p.u. Total Cost p.u. Total
(₹) (₹) (₹) (₹) (₹) (₹)
Variable Cost
Direct Materials 48 4,80,000 48 3,36,000 48 4,32,000
Direct Labour 24 2,40,000 24 1,68,000 24 2,16,000
Variable Overheads 20 2,00,000 20 1,40,000 20 1,80,000
Variable Expenses 4 40,000 4 28,000 4 36,000
Selling Expenses (90% × 12) 10.80 1,08,000 10.80 75,600 10.80 97,200
Distribution Expenses (80% × 4) 3.20 32,000 3.20 22,400 3.20 28,800
Total Variable Cost (A) 110 11,00,000 110 7,70,000 110 9,90,000
Fixed Cost
Fixed Overheads 12 1,20,000 1,20,000 1,20,000
Selling Expenses (10% × 12) 1.20 12,000 12,000 12,000
Administration Expenses 4 40,000 40,000 40,000
Distribution Expenses (20% × 4) 0.80 8,000 8,000 8,000
Total Fixed Cost (B) 18 1,80,000 1,80,000 1,80,000
Total Cost (A + B) 128 12,80,000 9,50,000 11,70,000

552 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Illustration 43

Draw up a flexible budget for overhead expenses on the basis of the following data and determine the overhead
rates at 70%, 80% and 90%

Plant Capacity at 80% capacity

Variable Overheads: ₹
Indirect Labour 12,000
Stores including spares 4,000
Semi-Variable:
Power (30% - Fixed, 70% - Variable) 20,000
Repairs (60% - Fixed, 40% - Variable) 2,000
Fixed overheads:
Depreciation 11,000
Insurance 3,000
Salaries 10,000
Total Overheads 62,000
Estimated Direct Labour Hours 1,24,000

Solution:
Flexible Budget at Different Capacities and Determination of Overhead Rates

Plant Capacity 80% (₹) 70% (₹) 90% (₹)

Variable Overhead:
Indirect Labour 12,000 12, 000
 70%  10, 500
12, 000
 90%  13, 500
80% 80%
Stores including spares 4,000 4, 000 4, 000
 70%  3, 500  90%  4, 500
80% 80%

Total Variable Overhead (A) 16,000 14,000 18,000

Semi Variable: [WN 1]
Power 20,000 18,250 21,750
Repairs 2,000 1,900 2,100
Total Semi Variable (B) 22,000 20,150 23,850

The Institute of Cost Accountants of India 553

Cost Accounting

Plant Capacity 80% (₹) 70% (₹) 90% (₹)

Fixed:
Depreciation 11,000 11,000 11,000
Insurance 3,000 3,000 3,000
Salaries 10,000 10,000 10,000
Total Fixed (C) 24,000 24,000 24,000
Total (A + B + C) 62,000 58,150 65,850
Labour Hours 1,24,000 1, 24, 000 1, 24, 000
 70%  1, 08, 500  90%  1, 39, 500
80% 80%
Labour Hour Rate 0.50 0.536 0.472
(₹ / hour)
 62,000   58,150   65,850 
     
 1,24,000 hr   1,08,500 hr   1,39,500 hr 

Working Notes:
1. Calculation of Semi Variable Costs

80% 70% 90%

Plant Capacity
(₹) (₹) (₹)
Semi Variable:
a. Power –
14,000
14,000 14,000 × 90% = 15,750
Variable 70% × 70% = 12,250 80%
80%
6,000 6,000
Fixed 30% 6,000
20,000 18,250 21,750
b. Repairs –
800 800
Variable 40% 800 × 90% = 900
× 70% = 700 80%
80%
1,200 1,200
Fixed 60% 1,200
2,000 1,900 2,100

554 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Illustration 44
From the following information relating to 2021 and conditions expected to prevail in 2022, prepare a budget for
2022.

2021 Actual: Amount (₹)

Sales (40,000 units) 1,00,000
Raw materials 53,000
Wages 11,000
Variable Overhead 16,000
Fixed Overhead 10,000
2022 Prospects:
Sales (60,000 units) 1,50,000
Raw materials 5% increase in price
Wages 10% increase in wage rate
5% increase in productivity
Additional Plant:
One Lathe 25,000
One Drill 12,000
10% Depreciation to be considered
Solution:
Budget showing Costs and Profits for the year 2022

Amount (₹)
i. Sales 1,50,000
ii. Costs
60,000 105
Raw Materials [53,000 × × ]
40,000 100 83,475
60,000 110 105
Wages [11,000 × × × ] 19,058
40,000 100 100

60,000 105
Variable Overheads [16,000 × × ] 24,000
40,000 100

10 13,700
Fixed Overheads [10,000 + (25,000 + 12,000) × ]
100
Total Cost 1,40,233
iii. Profit (i. – ii.) 9,767

The Institute of Cost Accountants of India 555

Cost Accounting

Illustration 45
Production costs of a factory for a year are as follows:

Amount (₹)
Direct Wages 80,000
Direct Materials 1,20,000
Production Overheads: Fixed 40,000
Variable 60,000
During the forthcoming year it is anticipated that:
a. The average rate for direct labour remuneration will fall from ₹ 0.80 per hour to ₹ 0.75 per hour.
b. Production efficiency is currently at 5% less than the whole capacity, in the forth coming year it will be at full
capacity.
c. Price per unit of direct material and of other materials and services which comprise overheads will remain
unchanged.
d. Production in the coming year will increase by 331/3%. Draw up a production cost budget.
Solution:
Production Cost Budget for the forthcoming year

Particulars ₹
0.75 100 1,05,263
i. Wages [80,000 × 1331/3% × × ]
0.80 95
ii. Materials [1,20,000 × 1331/3% ] 1,60,000
iii. Variable Overhead [60,000 × 1331/3% ] 80,000
iv. Fixed Overhead 40,000
Production Cost (i + ii + iii) 3,85,263
Illustration 46
A company manufacturers two products A and B and the budgeted data for the year are as follows:

Product A (₹) Product B (₹)

Sales price per unit 100 75
Direct materials per unit 20 10
Direct wages per unit 5 4
Total works overhead 10,105 9,009
Total marketing overhead 1,200 1,100

556 The Institute of Cost Accountants of India

 Cost Accounting Techniques

The sales manager forecasts the sales in units as follows:

Product A Product B
January 28 10
February 28 12
March 24 16
April 20 20
May 16 24
June 16 24
July to January (next year) per month 18 20
It is assumed that (i) there will be no work in progress at the end of any month, and (ii) finished units is equal to
half the sales for the following month will be kept in stock.

Prepare (a) A Production Budget for each month and (b) A Summarized Profit and Loss Statement for the year
ending in December.
Solution:
(a) Production Budget (in units)

Particulars JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC Total
Product A
Sales 28 28 24 20 16 16 18 18 18 18 18 18 240
Add: Cl. Stock 14 12 10 8 8 9 9 9 9 9 9 9
42 40 34 28 24 25 27 27 27 27 27 27
Less: Op. Stock 14 14 12 10 8 8 9 9 9 9 9 9
28 26 22 18 16 17 18 18 18 18 18 18 235
Product B
Sales 10 12 16 20 24 24 20 20 20 20 20 20 226
Add: Cl. Stock 6 8 10 12 12 10 10 10 10 10 10 10
16 20 26 32 36 34 30 30 30 30 30 30
Less: Op. Stock 5 6 8 10 12 12 10 10 10 10 10 10
11 14 18 22 24 22 20 20 20 20 20 20 231

1
Closing Stock of January = × Sales of February
2
1
and, Opening Stock of January = Closing Stock of December = × Sales of January
2
1
or, Opening Stock of January = × Sales of January
2

The Institute of Cost Accountants of India 557

Cost Accounting

(b) Summarised Production Cost Budget

Particulars Product A Product B Total

Production 235 units 231 units
(₹) (₹) (₹)
Direct Material: 235 @ ₹ 20 = 4,700 231 @ ₹ 10 = 2,310 7,010
Direct Labour 235 @ ₹ 5 = 1,175 231 @ ₹ 4 = 924 2,099
Works Overheads 10,105 9,009 19,114
Total Production Cost 15,980 12,243 28,223
Production Cost p.u. 15,980 = ₹ 68 p.u 12, 243 = ₹ 53 p.u
235 units 231 units

Summarised Profit and Loss Statement for the year

Particulars Product A (₹) Product B (₹) Total (₹)

Sales 240 × 100 = 24,000 226 × 75 = 16,950 40,950
Less: Cost of Goods Sold 240 × 68 = 16,320 226 × 53 = 11,978 28,298
Marketing Overhead 1,200 1,100 2,300
Profit 6,480 3,872 10,352

Illustration 47
Three Articles X, Y and Z are produced in a factory. They pass through two cost centers A and B. From the data
furnished compile a statement for budgeted machine utilization in both the centers.
(a) Sales budget for the year

Annual Budgeted Opening Stock of fin-

Product Closing Stock
Sales (units) ished products (units)
X 4,800 600 Equivalent to 2 months sales
Y 2,400 300 -do-
Z 2,400 800 -do-
(b) Machine hours per unit of product

Cost Centers
Product
A B
X 30 70
Y 200 100
Z 30 20

558 The Institute of Cost Accountants of India

 Cost Accounting Techniques

(c) Total number of machines

Cost Centre
A 284
B 256
Total 540
(d) Total working hours during the year: Estimated 2,500 hours per machine.
Solution:
Calculation of units of Production of Different Products (in units)
Particulars Product X Product Y Product Z
Sales 4,800 2,400 2,400
Add: Closing Stock 4,800 2,400 2,400
× 2 months × 2 months × 2 months =
12 months 12 months 12 months
= 800 = 400 400
Less: Opening Stock 600 300 800
Production 5,000 2,500 2,000
Machine Hours Utilisation Budget
Cost Centers
Particulars A B
X Y Z Total X Y Z Total
Production (units) 5,000 2,500 2,000 5,000 2,500 2,000
Hours required p.u. 30 200 30 70 100 20
Total Machine hours 1,50,000 5,00,000 60,000 7,10,000 3,50,000 2,50,000 40,000 6,40,000
required
Number of Machines 60 200 24 284 140 100 16 256
required [WN]
Working Notes:
Number of Machines required:
284
Cost Centre A : Product X = × 1,50,000 = 60 machines
7,10,000
284
Product Y = × 5,00,000 = 200 machines
7,10,000
284
Product Z = × 60,000 = 24 machines
7,10,000
256
Cost Centre B : Product X = × 3,50,000 = 140 machines
6,40,000
256
Product Y = × 2,50,000 = 100 machines
6,40,000
256
Product Z = × 40,000 = 16 machines
6,40,000

The Institute of Cost Accountants of India 559

Cost Accounting

Illustration 48
Prepare a Production Budget for three months ending March 31, 2022 for a factory producing four products, on the
basis of the following information.

Estimated Stock on Estimated Sales during Desired Stock on March

Type of Product
January 1, 2022 January to March 2022 31, 2022
A 2,000 10,000 3,000
B 3,000 15,000 5,000
C 4,000 13,000 3,000
D 3,000 12,000 2,000
Solution:
Opening Stock + Production = Sales + Closing Stock
or, Production = Sales + Closing Stock – Opening Stock

Particulars Product A Product B Product C Product D

Sales 10,000 15,000 13,000 12,000
Add: Closing Stock 3,000 5,000 3,000 2,000
13,000 20,000 16,000 14,000
Less: Opening Stock 2,000 3,000 4,000 3,000
Production (units) 11,000 17,000 12,000 11,000
Illustration 49
Budgeted production and production costs for the year ending 31st December are as follows:

Product X Product Y
Production (units) 2,20,000 2,40,000
Direct material / unit ₹12.50 ₹ 19.00
Direct wages / unit ₹ 4.50 ₹ 7.00
Total factory overheads for each type of product (variable) ₹ 6,60,000 ₹ 9,60,000
A company is manufacturing two products X and Y. A forecast about the number of units to be sold in the first seven
months is given below:

Month January February March April May June July

Product X 10,000 12,000 16,000 20,000 24,000 24,000 20,000
Product Y 28,000 28,000 24,000 20,000 16,000 16,000 18,000
It is anticipated that:
(a) There will be no work-in-progress at the end of any month.
(b) Finished units equal to half the sales for the next month will be in stock at the end of each month (including
December of previous year).
Prepare for 6 months ending 30th June a Production Budget and a summarised cost of production budget.

560 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Solution
Production Budget for 6 months ending 30th June - Product X

Particulars January February March April May June

Sales 10,000 12,000 16,000 20,000 24,000 24,000
Add: Closing Stock 6,000 8,000 10,000 12,000 12,000 10,000
16,000 20,000 26,000 32,000 36,000 34,000
Less: Opening Stock 5,000 6,000 8,000 10,000 12,000 12,000
Product (units) 11,000 14,000 18,000 22,000 24,000 22,000
50
Closing Stock of December = Opening Stock of January = × Sales of January
100
50
and Closing Stock of January = × Sales of February
100
Total Production of Product X for 6 months = 11,000+14,000+18,000+22,000+24,000+22,000 = 1,11,000 units
Production Budget for 6 months ending 30th June - Product Y

Particulars January February March April May June

Sales 28,000 28,000 24,000 20,000 16,000 16,000
Add: Closing Stock 14,000 12,000 10,000 8,000 8,000 9,000
42,000 40,000 34,000 28,000 24,000 25,000
Less: Opening Stock 14,000 14,000 12,000 10,000 8,000 8,000
Product (units) 28,000 26,000 22,000 18,000 16,000 17,000
Total Production of Product Y for 6 months = 28,000+26,000+22,000+18,000+16,000+17,000 = 1,27,000 units
Summarised Cost of Production Budget for 6 month ending 30th June

Particulars Product X (1,11,000 units) (₹) Product Y (1,27,000 units) (₹) Total (₹)
Materials @ ₹ 12.50 = 13,87,500 @ ₹ 19 = 24,13,000 38,00,500
Direct Wages @ ₹ 4.50 = 4,99,500 @ ₹ 7 = 8,89,000 13,88,500
Variable Overhead @ ₹ 3 = 3,33,000 @ ₹ 4 = 5,08,000 8,41,000
Cost of Production 22,20,000 38,10,000 60,30,000
Working Notes:
1. Computation of Variable Factory Overhead Rate per unit
` 6,60,000
Product X = =`3
2,20,000 units
` 9,60,000
Product Y = =`4
2,40,000 units
Illustration 50
Draw a Material Procurement Budget (Quantitative) from the following information:
Estimated sales of a Product 40,000 units. Each unit of the Product requires 3 units of Material A and 5 units of
Material B.

The Institute of Cost Accountants of India 561

Cost Accounting

Estimated opening balances at the commencement of the next year:

Finished product = 5,000 units
Materia A = 12,000 units
Material B = 20,000 units
Material on order:
Material A = 7,000 units
Material B = 11,000 units
The desirable closing balance at the end of the next year:
Finished product = 7,000 units
Materia A = 15,000 units
Material B = 25,000 units
Material on order:
Material A = 8,000 units
Material B = 10,000 units
Solution:
Production = Sales + Closing Stock – Opening Stock
= 40,000 +7,000 – 5,000 = 42,000 units
Raw Materials Purchase Budget

Particulars Product A (units) Product B (units)

Materials Required 42,000 x 3 = 1,26,000 42,000 x 5 = 2,10,000
Add: Closing Stock 15,000 25,000
Add: Closing Stock on Order 8,000 10,000
1,49,000 2,45,000
Less: Opening Stock 12,000 20,000
Less: Opening Stock on Order 7,000 11,000
Raw Material Purchase 1,30,000 2,14,000
Illustration 51
From the following figures prepare the raw material purchase budget for January 2022:

Materials
A B C D E F
Estimated Stock on 1 Jan
st
16,000 6,000 24,000 2,000 14,000 28,000
Estimated Stock on 31st Jan 20,000 8,000 28,000 4,000 16,000 32,000
Estimated Consumption 1,20,000 44,000 1,32,000 36,000 88,000 1,72,000
Standard Price per unit 25 p. 5 p. 15 p. 10 p. 20 p. 30 p.

562 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Solution:
Opening Stock + Purchase = Consumption + Closing Stock
or, Purchase = Consumption + Closing Stock – Opening Stock
Raw Materials Purchase Budget for January 2022
Particulars A B C D E F Total
Estimated Consumption (units) 1,20,000 44,000 1,32,000 36,000 88,000 1,72,000
Add: Estimated Stock on 31st Jan 20,000 8,000 28,000 4,000 16,000 32,000
(units)
1,40,000 52,000 1,60,000 40,000 1,04,000 2,04,000
Less: Estimated Stock on 1st Jan 16,000 6,000 24,000 2,000 14,000 28,000
(units)
Estimated Purchase (units) 1,24,000 46,000 1,36,000 38,000 90,000 1,76,000
Standard Price per unit 25 p. 5 p. 15 p. 10 p. 20 p. 30 p.
Estimated Purchase Cost (₹) 31,000 2,300 20,400 3,800 18,000 52,800 1,28,300
Illustration 52
A company manufactures Product A and Product B during the year 31st December, 2021, it is expected to sell
15,000 kg of Product A and 75,000 kg of Product B at ₹ 30 and ₹ 16 per kg respectively. The direct materials P, Q
and R are mixed in the proportion of 3 : 5 : 2 in the manufacture of Product A, and Materials Q and R are mixed in
the proportion of 1 : 2 in the manufacture of Product B. The actual and budgeted inventories for the year are given
below:

Opening Stock Estimated Closing Stock Anticipated cost per kg

kg kg ₹
Material P 4,000 3,000 12
Material Q 3,000 6,000 10
Material R 30,000 9,000 8
Product A 3,000 1,500 -
Product B 4,000 4,500 -
Prepare the Production Budget and Materials Budget showing the expenditure on purchase of materials for the year
ending 31st December, 2021.
Solution:
Production Budget for Product A and Product B

Particulars Product A (units) Product B (units)

Sales 15,000 75,000
Add: Closing Stock 1,500 4,500
16,500 79,500
Less: Opening Stock 3,000 4,000
Production 13,500 75,500

The Institute of Cost Accountants of India 563

Cost Accounting

Material Purchase Budget for the year ending December 31st, 2021
Particulars P Q R Total
Materials required for Product A in the ratio of 3 : 5 : 2 4,050 6,750 2,700 13,500
Materials required for Product B in the ratio of 1 : 2 - 25,167 50,333 75,500
Total requirement 4,050 31,917 53,033
Add: Closing Stock 3,000 6,000 9,000
7,050 37,917 62,033
Less: Opening Stock 4,000 3,000 30,000
Purchases (in units) 3,050 34,917 32,033
Cost per kg 12 10 8
Total Purchase Cost (₹) 36,600 3,49,170 2,56,264 6,42,034
Illustration 53
The following details apply to an annual budget for a manufacturing company.
Quarter 1st 2nd 3rd 4th
Working Days 65 60 55 60
Production (units per working day) 100 110 120 105
Raw material purchases (% by weight of annual total 30% 50% 20% -
Budgeted purchase price / kg (₹) 1 1.05 1.125 -
Quantity of raw material per unit of production 2 kg. Budgeted closing stock of raw material 2,000 kg. Budgeted
opening stock of raw material 4,000 kg (Cost ₹ 4,000).
Issues are pried on FIFO Basis. Calculate the following budgeted figures.
(a) Quarterly and annual purchase of raw material by weight and value.
(b) Closing quarterly stocks by weight and value.
Solution:
a) Quarterly and annual purchase of raw material by weight and value
Particulars Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total
Production (units) 65 x 100 = 60 x 110 = 55 x 120 = 60 x 105 26,000
6,500 6,600 6,600 = 6,300
Material Required (kg) 13,000 13,200 13,200 12,600 52,000
(Production x 2 kg p.u)
Add: Closing Stock (kg) 2,000
54,000
Less: Opening Stock (kg) 4,000
Annual Purchase by weight (kg) 50,000
Quarterly Purchase by weight (kg) 30% x 50,000 = 50% x 50,000 20% x 50,000 = -
15,000 = 25,000 10,000
Budgeted Purchase Price per kg 1 1.05 1.125
Quarterly and Annual Purchase 15,000 x 1 = 25,000 x 1.05 10,000 x 1.125
by Value (₹) 15,000 = 26,250 = 11,250 52,500

564 The Institute of Cost Accountants of India

 Cost Accounting Techniques

b) Closing quarterly stock by weight and value

Store Ledger (FIFO)

Quarter Receipt Issue Balance (Closing Stock)

Quantity Amount Quantity Amount Quantity Amount
Rate Rate Rate
(kg) ₹ (kg) ₹ (kg) ₹
Opening 4,000 1 4,000
1 15,000 1 15,000 13,000 1 13,000 6,000 1 19,000
2 25,000 1.05 26,250 13,200 13,560 17,800 1.05 18,690
3 10,000 1.125 11,250 13,200 1.05 13,860 14,600 16,080
4 - - - 12,600 13,830 2,000 1.125 2,250
Illustration 54
You are required to prepare a Selling Overhead Budget from the estimates given below:

Amount (₹)
Advertisement (Fixed) 1,000
Salaries of the Sales Department (Fixed) 1,000
Expenses of the Sales Department (Fixed) 750
Salesmen’s Remuneration (Fixed) 3,000

Salesmen’s Commission @ 1% on sales affected

Carriage Outwards: Estimated @ 5% on sales
Agent’s Commission: 7 on sales
The sales during the period were estimated as follows:
a) ₹ 80,000 including Agent’s Sales ₹ 8,000
b) ₹ 90,000 including Agent’s Sales ₹ 10,000
c) ₹ 1,00,000 including Agent’s Sales ₹ 10,500
Solution:
Selling Overhead Budget

Particulars ₹ ₹ ₹
Sales 80,000 90,000 1,00,000
(A) Fixed Overhead
Advertisement 1,000 1,000 1,000
Salaries of Sales Dept. 1,000 1,000 1,000
Expenses of Sales Dept. 750 750 750
Salesmen Remuneration 3,000 3,000 3,000
Total (A) 5,750 5,750 5,750

The Institute of Cost Accountants of India 565

Cost Accounting

(B) Variable Overhead

Salesmen Commission 720 800 895

[(80,000 – 8,000) x 1%] [(90,000 – 10,000) x 1%] [(1,00,000 – 10,500) x 1%]

Carriage Outward 4,000 4,500 5,000

[80,000 x 5%] [9,00,000 x 5%] [1,00,000 x 5%]

Agent’s Commission 600 750 788

[8,000 x 7.5%] [10,000 x 7.5%] [10,500 x 7.5%]

Total (B) 5,320 6,050 6,683
Grand Total (A + B) 11,070 11,800 12,433
Illustration 55
Prepare a Cash Budget for the three months ending 30th June, 2022 from the information given below:
a)

Month Sales (₹) Materials (₹) Wages (₹) Overheads (₹)

February 14,000 9,600 3,000 1,700

March 15,000 9,000 3,000 1,900

April 16,000 9,200 3,200 2,000

May 17,000 10,000 3,600 2,200

June 18,000 10,400 4,000 2,300

Credit terms are:
Sales / Debtors: 10% sales are on cash, 50% of the credit sales are collected next month and the balance in the
following month.
Creditors: Materials 2 month
Wages 1/4 month
Overhead 1/2 month
c) Cash and bank balance on 1st April, 2022 is expected to be ₹ 6,000.
d) Other relevant information are:
i) Plant and machinery will be installed in February, 2022 at a cost of ₹ 96,000. The monthly installment of
₹ 2,000 is payable from April onwards.
ii) Dividend @ 5% on preference share capital of ₹ 2,00,000 will be paid on 1st June.
iii) Advance to be received for sale of vehicles ₹ 9,000 in June.
iv) Dividends from investments amounting to ₹ 1,000 are expected to be received in June.

566 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Solution:
Cash Budget for the 3 months ending 30th June, 2022

Particulars April May June

₹ ₹ ₹
Opening Balance (A) 6,000 3,950 3,000

Add: Receipts (B)

Cash Sales 1,600 1,700 1,800

Collection from Debtors 13,050 13,950 14,850

Advance from Sale of Vehicles - - 9,000

Dividend - - 1,000
Total (A + B) 20,650 19,600 29,650
Payments (C)

Creditors for

Materials 9,600 9,000 9,200

Wages 3,150 3,500 3,900

Overheads 1,950 2,100 2,250

Installment of Plant and Machinery 2,000 2,000 2,000

Preference Dividend - - 10,000

Total (C) 16,700 16,600 27,350
Closing Balance (A + B – C) 3,950 3,000 2,300
Working Notes:
1. Calculation of Cash Sales and Collection from Debtors Amount (₹)

Credit Collection Month

Month Total Sales Cash Sales
Sales March April May June
February 14,000 1,400 12,600 6,300 6,300 - -

March 15,000 1,500 13,500 - 6,750 6,750 -

April 16,000 1,600 14,400 - - 7,200 7,200

May 17,000 1,700 15,300 - - - 7,650

June 18,000 1,800 16,200 - - - -

13,050 13,950 14,850

The Institute of Cost Accountants of India 567

Cost Accounting

2. Calculation of Payment of Wages

Payment Month
Wages
Month March April May June
₹
₹ ₹ ₹ ₹
March 3,000 2,250 750 - -
April 3,200 - 2,400 800 -
May 3,600 - - 2,700 900
June 4,000 - - - 3,000
3,150 3,500 3,900
3. Calculation of Payment of Overheads

Payment Month
Overheads
Month March April May June
₹
₹ ₹ ₹ ₹
March 1,900 950 950
April 2,000 1,000 1,000
May 2,200 1,100 1,100
June 2,300 1,150
1,950 2,100 2,250

Illustration 56
For production of 10,000 units the following are budgeted expenses:

Cost Per unit

₹
Direct Materials 48
Direct Labour 24
Variable Overheads 20
Fixed Overheads (₹ 1,20,000) 12
Variable Expenses (Direct) 4
Selling Expenses (10% Fixed Fixed) 12
Administration Expenses (₹ 40,000 fixed) 4
Distribution Expenses (20% fixed) 4
128
Prepare a budget for production of 7,000 units and 9,000 units.

568 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Solution:
Flexible Budget

Particulars 10,000 units 7,000 units 9,000 units

Cost p.u. Total Cost p.u. Total Cost p.u. Total
₹ ₹ ₹ ₹ ₹ ₹
Variable Cost
Direct Materials 48 4,80,000 48 3,36,000 48 4,32,000
Direct Labour 24 2,40,000 24 1,68,000 24 2,16,000
Variable Overheads 20 2,00,000 20 1,40,000 20 1,80,000
Variable Expenses 4 40,000 4 28,000 4 36,000
Selling Expenses (90% x 12) 10.80 1,08,000 10.80 75,600 10.80 97,200
Distribution Expenses (80% x 4) 3.20 32,000 3.20 22,400 3.20 28,800
Total Variable Cost (A) 110 11,00,000 110 7,70,000 110 9,90,000
Fixed Cost
Fixed Overheads 12 1,20,000 1,20,000 1,20,000
Selling Expenses (10% x 12) 1.20 12,000 12,000 12,000
Administration Expenses 4 40,000 40,000 40,000
Distribution Expenses (20% x 4) 0.80 8,000 8,000 8,000
Total Fixed Cost (B) 18 1,80,000 1,80,000 1,80,000
Total Cost (A + B) 128 12,80,000 9,50,000 11,70,000
Illustration 57
Draw up a flexible budget for overhead expenses on the basis of the following data and determine the overhead
rates at 70%, 80% and 90%

Plant Capacity at 80% capacity

Variable Overheads: ₹
Indirect Labour 12,000
Stores including spares 4,000
Semi-Variable:
Power (30% - Fixed: 70% - Variable) 20,000
Repairs (60% - Fixed: 40% - Variable) 2,000
Fixed overheads:
Depreciation 11,000
Insurance 3,000
Salaries 10,000
Total Overheads 62,000
Estimated Direct Labour Hours 1,24,000

The Institute of Cost Accountants of India 569

Cost Accounting

Solution:
Flexible Budget at Different Capacities and Determination of Overhead Rates

Plant Capacity 80% 70% 90%

₹ ₹ ₹
Variable Overhead:
12,000 12,000
Indirect Labour 12,000 × 70% = 10,500 × 90% = 13,500
80% 80%
Stores including spares 4,000 4,000 4,000
× 70% = 3,500 × 90% = 4,500
80% 80%
Total Variable Overhead (A) 16,000 14,000 18,000

Semi Variable:
Power 20,000 18,250 21,750
Repairs 2,000 1,900 2,100
Total Semi Variable (B) 22,000 20,150 23,850
Fixed:
Depreciation 11,000 11,000 11,000
Insurance 3,000 3,000 3,000
Salaries 10,000 10,000 10,000
Total Fixed (C) 24,000 24,000 24,000
Total (A + B + C) 62,000 58,150 65,850
Labour Hours 1,24,000 1,24,000 1,24,000
× 70% = 1,08,500 × 90% = 1,39,500
80% 80%
Labour Hour Rate (₹ / hour) 0.50 0.536 0.472
`62,000 `58,150 `68,850
[ ] [ ] [ ]
1,24,000 hr 1,08,500 hr 1,39,500 hr
Working Notes:
1. Calculation of Semi Variable Costs
Plant Capacity 80% (₹) 70% (₹) 90% (₹)
Semi Variable:
Power
14,000 14,000
Variable 70% 14,000 × 70% =12,250 × 90% =15,750
80% 80%
Fixed 30% 6,000 6,000 6,000
20,000 18,250 21,750
Repairs
800 800
Variable 40% 800 × 70% =700 × 90% =900
80% 80%
Fixed 1,200 1,200 1,200
2,000 1,900 2,100

570 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Illustration 58
From the following information relating to 2021 and conditions expected to prevail in 2022, prepare a budget for
2022.

2021 Actual: Amount (₹)

Sales (40,000 units) 1,00,000
Raw materials 53,000
Wages 11,000
Variable Overhead 16,000
Fixed Overhead 10,000
2022 Prospects:
Sales (60,000 units) 1,50,000
Raw materials 5% increase in price
Wages 10% increase in wage rate
5% increase in productivity
Additional Plant:
One Lathe 25,000
One Drill 12,000
10% Depreciation to be considered

Solution:
Budget showing Costs and Profits for the year 2022

₹
i. Sales 1,50,000
ii. Costs
60,000 105 83,475
Raw Materials [53,000 × × ]
40,000 100
60,000 110 100 17,285
Wages [11,000 × × × ]
40,000 100 105 24,000
60,000
Variable Overheads [16,000 × ] 13,700
40,000
10
Fixed Overheads [10,000 + (25,000 + 12,000) × ]
100
Total Cost 1,38,460
iii. Profit (i. – ii.) 11,540

The Institute of Cost Accountants of India 571

Cost Accounting

Illustration 59
Production costs of a factory for a year are as follows:

Amount (₹)
Direct Wages 80,000
Direct Materials 1,20,000
Production Overheads: Fixed 40,000
Variable 60,000
During the forthcoming year it is anticipated that:
a. The average rate for direct labour remuneration will fall from ₹ 0.80 per hour to ₹ 0.75 per hour.
b. Production efficiency will be reduced by 5%.
c. Price per unit of direct material and of other materials and services which comprise overheads will remain
unchanged, and
d. Production in the coming year will increase by 331/3% Draw up a production cost budget.
Solution:
Production Cost Budget for the forthcoming year

Particulars ₹
0.75 100 1,05,263
i. Wages (80,000 × 1331/3% × × )
0.80 95
ii. Materials (1,20,000 × 1331/3%) 1,60,000
iii. Variable Overhead (60,000 × 133 /3%)
1
80,000
iv. Fixed Overhead 40,000
Production Cost 3,85,263

Illustration 60
A company manufacturers two products A and B and the budgeted data for the year are as follows:

Product A Product B

₹ ₹
Sales price per unit 100 75

Direct materials per unit 20 10

Direct wages per unit 5 4

Total works overhead 10,105 9,009

Total marketing overhead 1,200 1,100

572 The Institute of Cost Accountants of India

 Cost Accounting Techniques

The sales manager forecasts the sales in units as follows:

Product A Product B
January 28 10
February 28 12
March 24 16
April 20 20
May 16 24
June 16 24
July to January (next year) per month 18 20

It is assumed that (i) there will be no work in progress at the end of any month, and (ii) finished unis equal to half
the sales for the following month will be kept in stock.
Prepare (a) A Production Budget for each month and (b) A Summarized Profit and Loss Statement for the year.
Solution:
(a) Production Budget (in units)

Particulars JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC Total
Product A
Sales 28 28 24 20 16 16 18 18 18 18 18 18 240
Add: Cl. Stock 14 12 10 8 8 9 9 9 9 9 9 9
42 40 34 28 24 25 27 27 27 27 27 27
Less: Op. Stock 14 14 12 10 8 8 9 9 9 9 9 9
28 26 22 18 16 17 18 18 18 18 18 18 235
Product B
Sales 10 12 16 20 24 24 20 20 20 20 20 20 226
Add: Cl. Stock 6 8 10 12 12 10 10 10 10 10 10 10
16 20 26 32 36 34 30 30 30 30 30 30
Less: Op. Stock 5 6 8 10 12 12 10 10 10 10 10 10
11 14 18 22 24 22 20 20 20 20 20 20 231

Closing Stock of January = 1/2 × Sales of February

And, Opening Stock of January = Closing Stock of December = 1/2 × Sales of January

or, Opening Stock of January = 1/2 × Sales of January

The Institute of Cost Accountants of India 573

Cost Accounting

(b) Summarised Production Cost Budget

Particulars Product A Product B Total

Production 235 units 231 units
₹ ₹ ₹
Direct Material: 235 @ ₹ 20 = 4,700 231 @ ₹ 10 = 2,310 7,010
Direct Labour 235 @ ₹ 5 = 1,175 231 @ ₹ 4 = 924 2,099
Works Overheads 10,105 9,009 19,114
Total Production Cost 15,980 12,243 28,223
Production Cost p.u. `15,980 `12,243
[ ] = ₹ 68 p.u. [ ] = ₹ 53 p.u.
235 units 231 units
Summarised Profit and Loss Statement for the year

Particulars Product A (₹) Product B (₹) Total (₹)

Sales 240 × 100 = 24,000 226 × 75 = 16,950 40,950
Less: Cost of Goods Sold 240 × 68 = 16,320 226 × 53 = 11,978 28,298
Marketing Overhead 1,200 1,100 2,300
Profit 6,480 3,872 10,352
Illustration 61
Three Articles X, Y and Z are produced in a factory. They pass through two cost centers A and B. From the data
furnished compile a statement for budgeted machine utilization in both the centers.
(a) Sales budget for the year
Product Annual Budgeted Sales Opening Stock of finished Closing Stock
(units) products (units)
X 4,800 600 Equivalent to 2 months sales
Y 2,400 300 -do-
Z 2,400 800 -do-
(b) Machine hours per unit of product
Cost Centers
Product
A B
X 30 70
Y 200 100
Z 30 20
(c) Total number of machines
Cost Centre
A 284
B 256
Total 540
(d) Total working hours during the year: Estimated 2,500 hours per machine.

574 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Solution:
Calculation of units of Production of Different Products

Particulars Product X (Units) Product Y (Units) Product Z (Units)

Sales 4,800 2,400 2,400
Add: Closing Stock 4,800 2,400 2,400
× 2 = 800 × 2 = 400 × 2 = 400
12 12 12
Less: Opening Stock 600 300 800
Production 5,000 2,500 2,000
Machine Hours Utilisation Budget

Cost Centers
Particulars A B
X Y Z Total X Y Z Total
Production (units) 5,000 2,500 2,000 5,000 2,500 2,000
Hours required p.u. 30 200 30 70 100 20
Total Machine hours 1,50,000 5,00,000 60,000 7,10,000 3,50,000 2,50,000 40,000 6,40,000
required
Number of Machines 60 200 24 284 140 100 16 256
required

Working Notes:
284
Cost Centre A Product X = × 1,50,000 = 60 machines
7,10,000
284
Product Y = × 5,00,000 = 200 machines
7,10,000
284
Product Z = × 60,000 = 24 machines
7,10,000
256
Cost Centre B Product X = × 3,50,000 = 140 machines
6,40,000
256
` Product Y = × 2,50,000 = 100 machines
6,40,000
256
Product Z = × 40,000 = 16 machines
6,40,000

The Institute of Cost Accountants of India 575

Cost Accounting

Exercise
A. Theoretical Questions:

~ Multiple Choice Questions

1. The cost of a product under marginal costing system includes

a. Prime cost plus variable overhead
b. Prime cost plus fixed overhead
c. Prime cost plus factory overhead
d. Only prime cost

2. The difference between absorption costing and marginal costing is in regard to the treatment of
a. Direct materials
b. Fixed overhead
c. Prime cost
d. Variable overhead

3. Fixed costs are treated as

a. Overhead costs
b. Prime costs
c. Period costs
d. Conversion costs

4. When sales and production (in units) are same then profits under
a. Marginal costing is lower than that of absorption costing
b. Marginal costing is higher than that of absorption costing
c. Marginal costing is equal to that of absorption costing
d. None of the above

5. When sales exceed production (in units) then profit under

a. Marginal costing is higher than that of absorption costing
b. Marginal costing is equal to that of absorption costing
c. Marginal costing is lower than that of absorption costing
d. None of the above

576 The Institute of Cost Accountants of India

 Cost Accounting Techniques

6. Which of the following factors responsible for change in the break-even point?
a. Change in selling price
b. Change in variable cost
c. Change in fixed cost
d. All of the above

7. Variable cost
a. Remains fixed in total
b. Remains fixed per unit
c. Varies per unit
d. Nor increase or decrease

8. Marginal Costing technique follows the following basic of classification

a. Element wise
b. Function Wise
c. Behaviour wise
d. Identifiability wise

9. P/V ratio will increase if the

a. There is a decrease in fixed cost
b. There is an increase in fixed cost
c. There is a decrease in selling price per unit.
d. There is a decrease in variable cost per unit.

10. The technique of differential cost is adopted when

a. To ascertain P/V ratio
b. To ascertain marginal cost
c. To ascertain cost per unit
d. To make choice between two or more alternative courses of action

11. Which of the following would not be used to estimate standard direct material prices?
a. The availability of bulk purchase discounts
b. Purchase contracts already agreed
c. The forecast movement of prices in the market
d. Performance standards in operation

12. What is an attainable standard?

The Institute of Cost Accountants of India 577

Cost Accounting

a. A standard which includes no allowance for losses, waste and inefficiencies. It represents the level
of performance which is attainable under perfect operating conditions
b. A standard which includes some allowance for losses, waste and inefficiencies. It represents the
level of performance which is attainable under efficient operating conditions
c. A standard which is based on currently attainable operating conditions
d. A standard which is kept unchanged, to show the trend in costs

13. Budgets are shown in-Terms

a. Qualitative
b. Quantitative
c. Materialistic
d. both (b) and (c)

14. Which of the following is not an element of master budget?

a. Capital Expenditure Budget
b. Production Schedule
c. Operating Expenses Budget
d. All above

15. Which of the following is not a potential benefit of using a budget?

a. Enhanced coordination of firm activities
b. More motivated managers
c. Improved inter-departmental communication
d. More accurate external financial statements

16. Which of the following is a long-term budget?

a. Master Budget
b. Flexible Budget
c. Cash Budget
d. Capital Budget

17. Materials become key factor, if

a. quota restrictions exist
b. insufficient advertisement prevails
c. there is low demand
d. there is no problem with supplies of materials

18. The difference between fixed cost and variable cost assumes significance in the preparation of the

578 The Institute of Cost Accountants of India

 Cost Accounting Techniques

following budget
a. Master Budget
b. Flexible Budget
c. Cash Budget
d. Capital Budget

19. The budget that is prepared first of all is _________.

a. Master budget
b. Sales budget assuming that it is the key factor
c. Cash Budget
d. Capital expenditure budget

20. Sales budget is a ________ .

a. expenditure budget
b. functional budget
c. master budget
d. None of these

21. When a company wants to prepare a factory overhead budget in which the estimated costs are directly
derived from the estimates of activity levels, which of the following budget should be prepared by the
company?
a. Flexible budget
b. Fixed budget
c. Master budget
d.. R & D budget

22. Which of the following budgets facilitates classification of fixed and variable costs:
a. Capital expenditure budget
b. Flexible budget
c. Cash budget
d. Raw materials budget

23. The entire budget organisation is controlled and headed by a senior executive known as:
a. General Manager
b. Accountant
c. Budget Controller
d. None of the above

The Institute of Cost Accountants of India 579

Cost Accounting

24. Which of the following is generally a long term budget:

a. Cash budget
b. Sales budget
c. Research and Development budget
d. Capital expenditure budget

25. A flexible budget requires a careful study of

a. Fixed, semi-fixed and variable expenses
b. Past and current expenses
c. Overheads, selling and administrative expenses.
d. None of these.

26. The basic difference between a fixed budget and flexible budget is that a fixed budget _____________
a. is concerned with a single level of activity, while flexible budget is prepared for different levels of
activity
b. Is concerned with fixed costs, while flexible budget is concerned with variable costs.
c. is fixed while flexible budget changes

d. None of these.

Answer:
1 A 2 B 3 C 4 C 5 A 6 D 7 B 8 C
9 D 10 D 11 D 12 B 13 D 14 B 15 D 16 D
17 A 18 B 19 B 20 B 21 A 22 B 23 C 24 D
25 A 26 A

~ State True or False

1. Excess of Actual cost over Standards Cost is treated as unfavourable variance.

2. Variances are calculated for both material and labour.

3. While fixing standards, normal losses and wastages are taken into account.

4. Standard costing is an ideal name given to the estimate making.

5. Pre-determined standards provide a yardstick for the measurement of efficiency.

6. Material cost variance and labour cost variance are always equal.

7. Fixing standards is the work of industrial engineer or the production people and not of cost accountant.

580 The Institute of Cost Accountants of India

 Cost Accounting Techniques

8. Standards costing are more profitability employed in job order industries than in process type industries.

9. Budget is a means and budgetary control is the end result.

10. To achieve the anticipated targets, Planning, Co-ordination and Control are the important main tasks of
management, achieved through budgeting and budgetary control.

11. A key factor or principal factor does not influence the preparation of all other budgets.

12. Budgetary control does not facilitate introduction of ‘Management by Exception’.

13. Generally, budgets are prepared to coincide with the financial year so that comparison of the actual
performance with budgeted estimates would facilitate better interpretation and understanding.

14. A flexible budget is one, which changes from year to year.

15. A flexible budget recognises the difference between fixed, semi-fixed and variable cost and is designed
to change in relation to the change in level of activity.

16. Sales budget, normally, is the most important budget among all budgets.

17. The principal factor is the starting point for the preparation of various budgets.

18. A budget manual is the summary of all functional budgets.

Answer:
1 T 2 T 3 T 4 F 5 T 6 F 7 F 8 F
9 T 10 T 11 F 12 F 13 T 14 F 15 T 16 T
17 T 18 F 19 20 21 22 23 24

~ Fill in the Blanks

1. ________ are not assigned to the product but are recognized as expenses in the period incurred. All
nonmanufacturing costs are period costs
2. Only difference between variable costing and absorption costing is the classification of ________
3. Under marginal costing the difference in the magnitude of ________ does not affect the unit cost of
production.
4. ________ compare favourably with the economist’s definition of marginal cost, viz. that marginal cost
is the amount which at any given volume of output is changed if output is increased or decreased by one
unit.
5. Historical costing uses post period costs while standards costing uses ________ costs.
6. Three types of standards are ________, ________, ________.
7. The ________ is usually the co-ordinator of the standards committee.

The Institute of Cost Accountants of India 581

Cost Accounting

8. Basically there are two types of standards viz; ________ and ________.
9. When actual cost is less than the standards cost, it is known as ________ variance.
10. A flexible budget is geared toward _____________ rather than a single level of activity.
11. _____________ is a system for reporting revenue and cost information to the individual responsible for
the revenue-causing and/or cost-incurring function.
12. Budgets are useful for ________________ the operating activities and _______________ of a business
enterprise.
13. The _______________ is the starting point in preparing the master budget (given that sales are the
principal budget factor.
14. Responsibility Accounting is a system of accounting that recognizes various _____________ throughout
the organisation.

Answer:

1 Period Cost 2 fixed factory overhead

3 opening stock and closing stock 4 Differential Costs
5 Predetermined 6 Basic Ideal and Current
7 Cost Accountants 8 ideal standard attainable standard
9 Favourable 10 A range of activity
11 Responsibility accounting 12 forecasting, financial position
13 Sales Budget 14 responsibility centres

~ Essay Type Questions

1. Define ‘variable cost’ and ‘fixed cost’ with help of diagrams.
2. Contrast the economist’s view of costs and revenues with that taken in management accounting.
3. What happens to the breakeven point when the sales price per unit falls?
4. What happens to the breakeven point when the variable cost per unit falls?
5. What happens to the breakeven point when fixed overheads increase?
6. Give three examples of applications of CVP analysis.
7. Explain how CVP analysis helps in the following decisions:
i. special orders;
ii. abandonment decisions;
iii. situations of limiting factors;
iv. a decision on buying in services.

582 The Institute of Cost Accountants of India

 Cost Accounting Techniques

8. Explain the situations where full cost pricing may be appropriate.

9. What are the limitations of full cost pricing?

10. Explain the situations where marginal cost pricing may be appropriate.

11. Describe the difference between budgeted and standard costs.

12. Describe the different purposes of a standard costing system.

13. State practical application of standard costing system.

14. What are the possible causes of (a) material price and (b) material usage variances?

15. Explain why it is preferable for the material price variance to be computed at the point of purchase rather
than the point of issue.

16. What are the possible causes of (a) wage rate and (b) labour efficiency variances?

17. Explain the reason for excluding idle time variance from labour efficiency variance.

18. ‘Idle time variance is always adverse’ – Explain.

19. What is generally meant by the term budget? What are the essentials of a budget?

20. State the main differences between budgets and forecasts?

21. Explain budgetary control? What are the objectives of Budgetary Control?

22. Distinguish between Standard Costing and Budgetary control?

23. Write short notes on:

i. Budget Centre.

ii. Budget Officer.

iii. Budget Committee.

iv. Budget Manual.

v. Budget Period.

vi. Key Factor.

vii. Performance of Budgeting.

24. Briefly explain the different types of budgets with diagram for the classification.

25. What do you understand by Cash Budget? Discuss the procedure for preparing the cash budget.

26. What do you understand by Master Budget?

27. What do you understand by Fixed Budget and Flexible Budget? What are the advantages of Flexible
Budget?

The Institute of Cost Accountants of India 583

Cost Accounting

B. Numerical Questions:

~ Numericals Multiple Choice Questions

1. If sales are ₹ 90,000 and variable cost to sales is 75%, contribution is

a. ₹ 21,500

b. ₹ 22,500

c. ₹ 23,500

d. ₹ 67,500

2. If sales are ₹ 1,50,000 and variable cost are ₹ 50,000. Compute P/V ratio.

a. 66.66%

b. 100%

c. 133.33%

d. 65.66%

3. Contribution is ₹ 3,00,000 and sales is ₹ 15,00,000. Compute P/V ratio.

a. 15%

b. 20%

c. 22%

d. 17.5%

4. Variable cost to sales ratio is 40%. Compute P/V ratio.

a. 60%

b. 40%

c. 100%

d. None of the these

5. Fixed cost is ₹ 30,000 and P/V ratio is 20%. Compute breakeven point.

a. ₹ 1,60,000

b. ₹ 1,50,000

c. ₹ 1,55,000

d. ₹ 1,45,000

584 The Institute of Cost Accountants of India

 Cost Accounting Techniques

6. Standard price of material per kg ₹ 20, standards consumption per unit of production is 5 kg. Standard
material cost for producing 100 units is
a. ₹ 20,000
b. ₹ 12,000
c. ₹ 8,000
d. ₹ 10,000

7. Standard cost of material for a given quantity of output is ₹ 15,000 while the actual cost of material used
is ₹ 16,200. The material cost variance is:
a. ₹ 1,200 (A)
b. ₹ 16,200 (A)
c. ₹ 15,000 (F)
d. ₹ 31,200 (A)

8. Standard price of material per kg is ₹ 20, standard usage per unit of production is 5 kg. Actual usage
of production 100 units is 520 kgs, all of which was purchase at the rate of ₹ 22 per kg. Material usage
variance is
a. ₹ 400 (F)
b. ₹ 400 (A)
c. ₹ 1,040 (F)
d. ₹ 1,040 (A)

9. Standard price of material per kg is ₹ 20, standard usage per unit of production is 5 kg. Actual usage
of production 100 units is 520 kgs, all of which was purchase at the rate of ₹ 22 per kg. Material cost
variance is
a. ₹ 2,440 (A)
b. ₹ 1,440 (A)
c. ₹ 1,440 (F)
d. ₹ 2,300 (F)

10. Standard quantity of material for one unit of output is 10 kgs. @ ₹ 8 per kg. Actual output during a given
period is 800 units. The standards quantity of raw material
a. 8,000 kgs
b. 6,400 kgs
c. 64,000 kgs
d. None of these

The Institute of Cost Accountants of India 585

Cost Accounting

11. What is the labour rate variance if standard hours for 100 units of output are 400 @ ₹ 2 per hour and
actual hours taken are 380 @ ₹ 2.25 per hour?
a. ₹ 120 (adverse)
b. ₹ 100 (adverse)
c. ₹ 95 (adverse)
d. ₹ 25 (favourable)

12. In a period, 11280 kilograms of material were used at a total standard cost of ` 46,248. The material
usage variance was ` 492 adverse. What was the standard allowed weight of material for the period?
a. 11600 kg
b. 11160 kg
c. 12190 kg
d. 10590 kg

13. The operations to produce a unit of product L require 9 active hours. Budgeted idle time of 10% of total
hours paid for is to be incorporated into the standard times for all products. The wage rate is ` 4 per hour.
The standard labour cost of one unit of product L is:
a. ` 10.00

b. ` 36.00
c. ` 39.60

d. ` 40.00

Answer:

1 B 2 A 3 B 4 A 5 B 6 D 7 A 8 B
9 B 10 A 11 C 12 B 13 D

Unsolved Case
1. Leisure Furniture Ltd produces furniture for hotels and public houses using specific designs prepared by
firms of interior design consultants. Business is brisk and the market is highly competitive with a number
of rival companies tendering for work. The company’s pricing policy, based on marginal costing (variable
costing) techniques, is generating high sales. The main activity of Home Furniture Ltd is the production of
a limited range of standard lounge suites for household use. The company also offers a service constructing
furniture to customers’ designs. This work is undertaken to utilise any spare capacity. The main customers of
the company are the major chains of furniture retailers. Due to recession, consumer spending on household
durables has decreased recently and, as a result, the company is experiencing a significant reduction in orders
for its standard lounge suites. The market is unlikely to improve within the next year. The company’s pricing
policy is to add a percentage mark-up to total cost.

586 The Institute of Cost Accountants of India

 Cost Accounting Techniques

Required

Explain why different pricing policies may be appropriate in different circumstances, illustrating your
Solution: by reference to Leisure Furniture Ltd and Home Furniture Ltd.

2.1 Decathlon LLP manufactures cricket bats using high quality wood and skilled labour using mainly traditional
manual techniques. The manufacturing department is a cost centre within the business and operates a standard
costing system based on marginal costs. At the beginning of April, the production director attempted to
reduce the cost of the bats by sourcing wood from a new supplier and deskilling the process a little by using
lower grade staff on parts of the production process. The standards were not adjusted to reflect these changes.
The variance report for April is shown below (extract):

Variances Adverse (`) Favourable (`)

Material price 5100
Material usage 7500
Labour rate 43600
Labour efficiency 48800
Labour idle time 5400

The production director pointed out in his April board report that the new grade of labour required significant
training in April and this meant that productive time was lower than usual. He accepted that the workers were
a little slow at the moment but expected that an improvement would be seen in May. He also mentioned that
the new wood being used was proving difficult to cut cleanly resulting in increased waste levels.

Sales for April were down 10 per cent on budget and returns of faulty bats were up 20 per cent on the
previous month. The sales director resigned after the board meeting stating that SW had always produced
quality products but the new strategy was bound to upset customers and damage the brand of the business.

Required:

Assess the performance of the production director using all the information above taking into account both
the decision to use a new supplier and the decision to deskill the process.

3.2 Thorne Co. values, advertises and sells residential property on behalf of its customers. The company has
been in business for only a short time and is preparing a cash budget for the first four months of 2022.

Year 2021 2022 2022 2022 2022

Month December January February March April
Units Sold 10 10 15 25 30

The average price of each property is ` 1,80,000 and Thorne Co. charges a fee of 3 per cent of the value of
each property sold. Thorne Co. receives 1 per cent in the month of sale and the remaining 2 per cent in the

1 Adopted from Management and Cost Accounting (10th edition) by Colin Drury.
2 Adopted from Management and Cost Accounting, eighth edition by Colin Drury

The Institute of Cost Accountants of India 587

Cost Accounting

month after sale. The company has nine employees who are paid on a monthly basis. The average salary per
employee is ` 35,000 per year. If more than 20 properties are sold in a given month, each employee is paid
in that month a bonus of ` 140 for each additional property sold.

Variable expenses are incurred at the rate of 0.5 per cent of the value of each property sold and these
expenses are paid in the month of sale. Fixed overheads of ` 4,300 per month are paid in the month in which
they arise. Thorne Co. pays interest every three months on a loan of ` 200 000 at a rate of 6 per cent per year.
The last interest payment in each year is paid in December. An outstanding tax liability of ` 95,800 is due to
be paid in April. In the same month Thorne Co. intends to dispose of surplus vehicles, with a net book value
of ` 15,000, for ` 20,000. The cash balance at the start of January 2022 is expected to be a deficit of ` 40,000.

Required :

Thorne company appoints you to

a. Prepare a monthly cash budget for the period from January to April. The budget must clearly indicate
each item of income and expenditure, and the opening and closing monthly cash balances.

b. Discuss the factors to be considered by Thorne Co. when planning ways to invest any cash surplus
forecast by its cash budgets.

c. Discuss the advantages and disadvantages to Thorne Co. of using over draft finance to fund any cash
shortages forecast by its cash budgets.

588 The Institute of Cost Accountants of India