CHAPTER I BUDGETARY CONTROL

BUDGET Meaning of Budget

A budget is the monetary or/and quantitative expression of business plans and policies to be pursued in the future period of time. The term budgeting is used for preparing budgets and other procedures for planning, co-ordination and control of business enterprise.

Definition of Budget
According to CIMA, Official Terminology, A budget is a financial and/or quantitative statement prepared prior to a defined period of time, of the policy to be pursued during that period for the purpose of attaining a given objective. The ICMA terminology defines a budget as, a pan quantified in monetary items, prepared and approved prior to a defined period of time, usually showing planned income to be generated and/or expenditure to be incurred during that period and the capital to be employed to attain a given objective.

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BUDGETING Meaning of Budgeting

Profits is the primary measure of business success. Usually, profits do not just happen. Profits are managed. Therefore, the profitability the firm fully depends on as to what extent the management follows proper planning, effective co-ordination and dynamic control. This requires that management must plan for the future financial and physical requirements for maintain productivity and profitability of the firm is generally called Budgeting. Budgeting is a tool of planning and control. Budgeting involves the steps of setting short term objectives, specifying programs, and expressing them in the budgets. Budgeting includes sales, production, distribution and financial aspects of the firm.

Budgetary Control Meaning of Budgetary Control

Budgetary Control is the process of determining various budgeted figures for enterprises for the future period and then comparing the budgeted figures with the actual performance for calculating variances, if any. The comparison of budgeted and actual figures will enable the management to find out discrepancies and take remedial measures at a proper time. The budgetary control is a continuous process which helps in planning and co-ordination. It provides a method of control too. A budget is a means and budgetary control is the end-result.

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Definition of Budgetary Control

According to Brown and Howard, Budgetary control is a system of controlling costs which includes the preparation of budgets, co-ordinating the department and establishing responsibilities, comparing actual performance with the budgeted and acting upon results to achieve maximum profitability. According to C.L. Van Sickle, a budgetary control system is a carefully worked out financial plan, including the procedure involved in its operations for conducting the various divisions of a business for the ultimate purpose of earning a profit.

Objectives of Budgetary Control

Following are the objectives of budgetary control: Sl. No. 1. 2. 3. 4. 5. Objectives Planning and Co-ordination Clarification of Authority and Responsibility Communication Motivation Control

1. Planning and Co-ordination: Budgeting involves preparation of detailed operational plans to achieve the objectives of a business. The success of every business depends upon the planning of activities and budgeting forces planning to become more effective. As budgets are prepared covering all the activities and departments of a business, it also serves as a means of co-ordinating the efforts of all concerned in such a way that every department contributes towards the overall plan. The summary of all such plan is known as master plan. The budget forces
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every departmental manger to establish relationship with other departments and contribute to the achievement of objectives. 2. Clarification of Authority and Responsibility: Budgeting enables the superior to delegate the authority to his subordinates. This also clarifies the responsibility of each manager who can be held accountable if the targets are not reached. Thus budgeting facilitates management by exception. 3. Communication: Since all levels of management are involved in the preparation of budget, it facilitates communication process to become more effective. The objective of the business, problems involved in achieving them, and finalisation of budgets are all promptly communicated. It also co-ordinates the various functions such as sales, purchases and production more efficiently. 4. Motivation: The preparation of budgets by middle and lower management against which performance can also be judged serves as a good motivation for them. 5. Control: The control over various activities is achieved by comparing the achievements with the targets. If there are any deviations. The cause for the same is investigated and remedial action taken.

Requisites for a Successful Budgetary Control System

For making a budgetary control system successful, following requisites are required: Sl.No. 1. 2. 3. 4. Requisites Clarifying Objectives Proper Design of Authority and Responsibility Proper Communication System Budget Education
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5. 6. 7.

Participation of All Employees Flexibility Motivation

1. Clarifying Objectives: The budgets are used to realise objectives of the business. The objectives must be clearly spelt out so that budgets are properly prepared. In the absence of clear goals, the budgets will also be unrealistic. 2. Proper Delegation of Authority and Responsibility: Budget

preparation and control is done at every level of management. Even though budgets are finalised at top level but involvement of persons from lower levels of management is essential for their success. The necessities proper delegation of authority and responsibility. 3. Proper Communication System: An effective system of communication is required for a successful budgetary control. The flow of information regarding budgets should be quick so that these are implemented. The upward communication will help in knowing the difficulties in implementation of budgets. The performance reports of various levels will help top management in budgetary control. 4. Budget Education: The Employees should be properly educated about the benefits of budgeting system. They should be educated about their role in the success of this system. Budgetary control may not be taken only as a control device by the employees but it should be used as a toll to improve their efficiency. 5. Participation of All Employees: Budgeting is done for every segment of the business. It will also require the active participation and involvement of all employees. In practice the budgets are to be executed at lower levels of management. Those for whom the budgets are framed should be actively associated with their preparation and execution. The employees,
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on the basis of their past experience, may give more practical and useful suggestions. The success of budgetary control system depends upon the participation of all employee of the organisation. 6. Flexibility: Flexibility in budgets is required to make them suitable under changed circumstances. Budgets are prepared for the future, which is always uncertain. Even though budgets are prepared by considering the future possibilities but will still some occurrences later on may necessitate certain adjustments. Flexibility will make the budgets more appropriate and realistic. 7. Motivation: Budgets are to be implemented by human beings. Their successful implementation will depend upon the interest shown by the employees. All persons should be motivated to improve their working so that budgeting is successful. A proper system of motivation should be introduced for making this system a success.

Essentials of Budgetary Control

There are certain steps which are necessary for the successful implementation of a budgetary control system. They are as follows: Sl.No. 1. 2. 3. 4. 5. 6. 7. Essentials Organisation for Budgetary Control. Budget Centres. Budget Officer. Budget Manual. Budget Committee. Budget Period. Determination of Key Factor

1. Organisation for Budgetary Control: the proper organisation is essential for the successful preparation, maintenance and administration
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of budgets. A Budgetary Committee is formed which comprises the departmental heads of various departments. All functional heads re entrusted with the responsibility of ensuring proper implementation of their respective departmental budgets. An organisation chart for budgetary control is given below: The Chief Executive is the overall in charge of budgetary system. He constitutes a budget committee for preparing realistic budgets. A budget officer is the convener of the budget committee who co-ordinates the budgets of different departments. The managers of different departments are made responsible for their departmental budgets.
CHIEF EXCEUTIVE

BUDGET OFFICER

BUDGET COMMITTEE

PRODUCTION MANAGER

FINANCE MANAGER

PERSONNEL MANAGER

SALES MANAGER

ACCOUNTS MANAGER

R&D MANAGER

2. Budget Centres: A budget centre is that part of the organisation for which the budget is prepared. A budget centre may be a department,
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section of a department or any other part of the department. The establishment of budget centres is essential for covering all parts of the organisation. The budget centres are also necessary for cost control purposes. The appraisal of performance of different parts of the organisation becomes easy when different centres are established. 3. Budget Manual: A budget manual is a document which spells out the duties and also the responsibilities of the various executives concerned with budgets. It specifies the relations among various functionaries. A budget manual covers the following matter: a) A budget manual clearly defines the objectives of budgetary control system. It also gives the benefits and principles of this system. b) The duties and responsibilities of various persons dealings with preparations and execution of budgets are also given in a budget manual. It enables the management to know of persons dealing with various aspects of budgets and clarify their duties and responsibilities. c) It gives information about the sanctioning authorities of various budgets. The financial powers of different managers are given in the manual for enabling the spending of amount on various expenses. d) A proper table for budgets including the sending of performance reports is drawn so that every work starts in time and a systematic control is excreted. e) The specimen form and number of copies to be used for preparing the budget report will also be stated. Budget centres involved should be clearly stated. f) The length of various budget periods and control points is clearly given.
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g) The procedure to be followed in the entire system should be clearly stated. h) A method of accounting to be used for various expenditures should also be clearly given. A Budget manual helps in knowing in writing the role of every employee, his duties, responsibilities, the ways on undertaking various tasks etc. it also helps in avoiding ambiguity of any time 4. Budget Officer: Budget Officer: The Chief Executive, who is the top of the organisation, appoints some person as budget officer. The budget officer is empowered to scrutinise the budgets prepared but different functional heads and to make changes in them, if the situation so demands. The actual performance of different departments is

communicated to the budget officer. He determines the deviations in the budges and takes necessary steps to rectify the deficiencies, if any. He works as a co-ordinator among different departments and monitors the relevant information. He also informs the top management about the performance of different departments. The budget officer will be able to carry out his work fully well only if he is conversant with the working of all departments. 5. Budget Committee: In small scale concerns, the accountant is made responsible for preparation and implementation of budgets. In large scale concerns a committee known as Budget Committee is formed. The heads of all the important departments are made members of this committee. The committee is responsible for preparation and execution of budgets. The members of this committee put up the case of their respective departments and help the committee to take collective decisions, if necessary. The budget officer acts as co-ordinator of this committee. 6. Budget Period: A budget period is length of time for which a budget is prepared. The budget period depends upon a number of factors. It may be
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different industries or even it may be different in the same industry or business. The budget period depends upon the following considerations: a) The type of budget i.e., sales budget, production budget, raw materials purchase budget, capital expenditure budget. A capital expenditure budget may be for a longer period i.e., 3 to 5 years; purchase, sale budgets may be for one year. b) The nature of demand for the products. c) The timings for the availability of the finances. d) The economic situation of the cycles e) The length of trade cycles. All the above mentioned factors are taken in to account while fixing the period of budgets. 7. Determination of Key Factor: the budgets are prepared for all functional areas. These budgets are inter-dependent and inter-related. A proper co-ordination among different budgets is necessary for making the budgetary control a success. The constraints on some budgets may have an effect on the other budgets too. A factor which influences all other budgets is known as Key Factor or Principal Factor. There may be a limitation on the quantity of goods a concern may sell. In this case, sales will be a key factor and all other budgets will be prepared by keeping in view the amount of goods the concern will be able to sell. The raw material supply may be limited; so production, sales and cash budgets will be decided according to raw materials budget. Similarly, plant capacity may be a key factor if the supply of other factors is easily available. They key factor may not necessarily remain the same. The raw material supply may be limited at one time but it may be easily available at another time. The sales may be increased by adding more sales staff, et. Similarly, other factors may also improve at different times. The key factors also highlight the limitations of the enterprise. This will enable the
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management to improve the working of those departments where scope for improvement exists.

Advantages and Disadvantages of Budgetary Control Advantages of Budgetary Control

The budgetary control system helps in fixing the goals for the organisation as a whole and concerted efforts are made for its achievements. It enables economics in the enterprise. Some of the advantaged of budgetary control are: Sl.No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Advantages Maximisations of Profits Proper Co-ordination Provides Specifications Tool for Measuring Performance Economy Corrective Action Creates Budget Consciousness Reduced Costs Determines Weaknesses Introduction of Incentives Schemes

1. Maximisation of Profit: the budgetary control aims at the maximisation of profits of the enterprise. To achieve this aim, a proper planning and coordination of different functions is undertaken. There is a proper control over various capital and revenue expenditures. The resources are put to the best possible use. 2. Co-ordination: The working of different departments and sectors is properly co-ordinated. The budgets of different departments have a

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bearing on one another. The co-ordination of various executives and subordinates is necessary for achieving budgeted targets. 3. Specific Aims: The plans, polices and goals are decided by top management. All efforts put together to reach the common goal of the organisation. Every department is given a target to be achieved. The efforts are directed towards achieving some specific aims. If there is no definite aim then the efforts will be wasted in pursuing different aims. 4. Tool for Measuring Performance: By providing targets to various departments, budgetary control provides a toll for measuring managerial performance. The budgeted targets are compared to actual results and deviations are determined. The performance of each department is reported to the top management. This system enables the introduction of management by exception. 5. Economy: The planning of expenditure will be systematic and there will be economy in spending. The finances will be put to optimum use. The benefits derived for the concern will ultimately extend to industry and then to national economy. The national resources will be used economically and wastage will be eliminated. 6. Determining Weaknesses: The deviations in budgeted and actual performance will enable the determination of weak sports. Efforts are concentrated on those aspects where performance is less than the stipulated. 7. Corrective Action: The management will be able to take corrective measures whenever there is a discrepancy in performance. The deviations will be regularly reported so that necessary action is taken at the earliest. In the absence of a budgetary control system the deviations can be determined only at the end of the period. 8. Consciousness: it creates budget consciousness among the employees. By fixing targets for the employees, they are made conscious of their
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responsibility. Everybody knows what he is expected to do and he continues with his work uninterrupted. 9. Reduces Costs: In the present day competitive word budgetary control has a significant role to play. Every businessman tries to reduce the cost of production for increasing sales. He tries to have those combinations of products where profitability is more. 10.Introduction of Incentive Schemes: Budgetary control system also enables the introduction of incentive schemes of remuneration. The comparisons of budgeted and actual performance will enable the use of such schemes.

Limitation of Budgetary Control

Despite many good points of budgetary control there are some limitations of this system. Some of the limitations are discussed as follows: Sl.No. 1. 2. 3. 4. 5. 6. Disadvantages Uncertain Future Revision Required Discourages Efficient Persons Problem of Co-ordination Conflict among Different Departments Depends upon Support of Top Management

1. Uncertain Future: the budgets are prepared for the future period. Despite best estimates made for the future, the predictions may not always come true. The future is always uncertain and the situations which are presumed to prevail in future may change. The change in future conditions upsets the budgets which have to be prepared on the basis of

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certain assumptions. The future uncertainties reduce the utility of budgetary control system. 2. Budgetary Revisions Required: Budgets are prepared on the assumptions that certain conditions will prevail. Because of future uncertainties, assumed conditions may not prevail necessitating the revision of budgetary targets. The frequent revision of targets will reduce the value of budgets and revisions involve huge expenditures too. 3. Discourages Efficient Persons: Under budgetary control system the targets are given to every person in the organisation. The common tendency of people is to achieve the targets only. There may be some efficient persons who can exceed the targets but they will also feel contented be reaching the targets. So budgets may serve as constraints on managerial initiatives. 4. Problem of Co-ordination: The success of budgetary control depends upon the co-ordination among different departments. The performance of one department affects the results of other departments. To overcome the problem of co-ordination among different departments results in poor performance. 5. Conflict among Different Departments: Budgetary Control may lead to conflicts among functional departments. Every departmental heads worries for his departments goals without thinking of business goal. Every department tries to get maximum allocations of funds and this raises a conflict among different departments. 6. Depends upon Support of Top Management: Budgetary control system depends upon the support of top management. The management should be enthusiastic for the success of this system and should give full support for it. If any time there is a lack of support from top management then this system will collapse.

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Classifications and Types of Budgets

The budgets are usually classified according to their nature. The following are the types of budgets which are commonly used:

BUDGETS

TIME LONG TERM BUDGET SHORT TERM BUDGET

FUNCTIONS OPERATING BUDGET FINANCIAL BUDGET MASTER BUDGET

FLEXIBILITY FIXED BUDGET

FLEXIBLE BUDGET

CURRENT TERM BUDGET

Classification According to Time

1. Long Term Budgets: The budgets are prepared to depict long term planning of the business. The period of long term budgets varies between five to ten years. The long term planning is done by the top level management; it is not generally known to lower levels of management. Long time budgets are prepared for some sectors of the concern such as a capital expenditure, research and development, longterm finances, etc. These budgets are useful for those industries where gestation period is long i.e., machinery, electricity, engineering, etc.

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2. Short-Term Budgets: These budgets are generally for one or two years and are in the form of monetary terms. The consumers goods industries like sugar, cotton, textile, etc. use short-term budgests. 3. Current Budgets: The period of current budgets is generally of months and weeks. These budgets relate to the current activities of he business. According to I.C.W.A. London, Current Budget is a Budget which is established for use over a short period of time and is related to current conditions.

Classification on The Basis of Functions

1. Operating Budgets: these budgets relate to the different activities or operations of a firm. The number of such budgets depends upon the size and nature of business. The commonly used operating budgets are: a) Sales Budget b) Production Budget c) Production Cost Budget d) Purchase Budget e) Raw Material Budget f) Labour Budget g) Plant Utilisation Budget h) Manufacturing Expenses or Works Overhead Budget i) Administrative and Selling Expenses Budget, etc.

Sales Budget: A sales budget is an estimate of expected sales during a budget period. A sales budget is known as a nerve centre or backbone of the enterprise. The degree of accuracy with which sales are estimated will determine the practicability of operating budgets. A
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sales budget is the starting point on which other budgets are also based. Production Budget: The production budget is prepared in relation to the sales budget. Whatever is to be sold should be produced in time so that is delivered to the customer. It is a forecast of the production for the budget period. Production budget is prepared for the number of units to be produced and also for the cost to be incurred on materials, labour and factory overheads. Production Cost Budget: The production budget determines the number of units to be produced. When these units are converted into monetary terms, it becomes a cost of production budget. The cost of production budget is the total to be spent on producing the units stipulated in the production budget. The physical units are broken into elements i.e., material, quantity, labour, time and manufacturing overheads. The materials cost, labour cost and overheads required for manufacturing are totalled together to make it a cost of production budget. Raw Materials Budget: The material budget is concerned with determining the quantity of raw materials required for production. The programme for purchasing raw materials is adjusted according to the production budget. The materials are purchased as per the requirements of production department. Direct Labour Budget: The labour required for production may be classified into direct and indirect labour. The labour required for manufacturing the product is known as direct labour. The labour which cannot be specified with costing point of view only direct labour budget is prepared because indirect labour is made a part of manufacturing overheads.

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 Manufacturing Overheads Cost Budget: The manufacturing overheads cost is that part of works cost which arises from indirect labour, indirect materials, overheads and other factory expenses, manufacturing cost is excluded from direct material and direct labour. Manufacturing overheads cost may be classified into fixed cost, variable cost and semi-variable cost. Selling And Distribution Overhead Budget: This budget includes all expenses relating to selling, advertising and distribution of goods. These expenses may be analysed according to products, territories, salesmen, etc. the fixed expenses under this category may be estimated on the basis of past experience and anticipated changes. Variable selling and distribution overheads will vary with the anticipated sales figures. The operating budget for a firm may be constructed in terms of programmes or responsibility areas, and hence may consist of: a) Programme Budget: it consists of expected revenues and costs of various products or projects that are termed as the major programmes of the firm. Such a budget can be prepared for each product line or project showing revenues, costs and the relative profitability of the various programmes. Programme budgets are thus, useful in locating areas where efforts may be required to reduce costs and increase revenues. They are also useful in determining imbalances and adequacies in programmes so that corrective action may be taken in future. b) Responsibility Budget: When the operating budget of a firm is constructed in terms of responsibility areas it is called the responsibility budget. Such a budget shows the plan in terms of persons responsible for achieving them. it is used by the
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management as a control device to evaluate the performance of executives who are in charge of various cost centres. Their performances is compared to the targets( budgets), set for them and nature of business activities and the organisational structure. However, responsibility areas may be classified under three broad categories; i. ii. iii. Cost/Expense Centre Profit Centre Investment Centre.

2. Financial Budgets: Financial Budgets are concerned with cash receipt sand disbursements, working capital, capital expenditure, financial position and results of business operations. The commonly used financial budgets are: a) Cash Budget b) Working Capital Budget c) Capital Expenditure Budget d) Income Statement Budget e) Statement of Retained Earnings Budget f) Budgeted balance Sheet or Position Statement Budget. 3. Master Budgets: Various functional budgets are integrated into master budget. This budget is prepared by the ultimate integration of separate functional budgets. According to I.C.W.A. London, The Master is the summary budget incorporating its functional budgets. Master budget is prepared by the budget officer and it remains with the top level management. This budget is used to co-ordinate the activities of various functional departments and also to help as a control device.

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Classification on The Basis of Flexibility

1. Fixed Budget: the fixed budgets are prepared for a given level of activity; the budget is prepared before the beginning of the financial year. If the financial year starts in January then the budget will be prepared a month or two earlier, i.e., November or December. The changes in expenditure arising out of the anticipated changes will not be adjusted in the budget. There is a difference of about twelve months in the budgeted and actual figures. According to I.C.W.A. London, Fixed budget is a budget which is designed to remain unchanged irrespective of the level of activity actually attained. Fixed budgets are suitable under static conditions. If sales, expenses and costs can be forecasted with greater accuracy then this budget can be advantageously used. 2. Flexible Budget: A flexible budget consists of a series of budgets for different level of activity. It is therefore, varies with the level of activity attained. A flexible budget is prepared after taking into consideration unforeseen changes in the conditions of the business. A flexible budget is defined as a budget which by recognising the difference between fixed, semi-fixed and variable cost is designed to change in relation to the level of activity. The flexible budgets will be useful where level of activity changes from time to time. When the forecasting of demand is uncertain and the undertaking operates under conditions of shortage of materials, labour etc., then this budget will be more suited.

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SHORT NOTES ON THE FOLLOWING CONCEPTS OF BUDGETS Cash Budget

A cash budget is an estimate of cash receipts and disbursements during a future period of time. It proceeds various other budgets like materials budgets and research and development budgets. According to Soleman and Ezra The cash budget is an analysis of flow of cash in a business over a future, short or long period of time. It is a forecast of expected cash intake and outlay. The cash receipts from various sources are anticipated. The estimated cash collections for sales, debts, bills receivables interest, dividends and other incomes and sale of investments and other assets will be taken in to account. The amounts to be spent on purchase of materials, payments to creditors and meeting various other revenue and capital expenditure needs should be considered. Cash forecasts will include all possible sources from which cash will be received and the channels in which payments are to be made so that a consolidated cash position is determined. The cash budget should be co-ordinated with other activities of the business. The functional budgets may be adjusted according to the cash budget. The available funds should be fruitfully used and the concern should not suffer for want of funds.

Fixed Budget
This budget is drawn for one level of activity and one set of conditions. It has been defined as a budget which is designed to remain unchanged irrespective of the volume of output or turnover attained. It is rigid budget and
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is drawn on the assumption that there will be no change in the budgeted level of activity. It does not take into consideration any change in expenditure arising out of changes in the level of activity. Thus, it does not provide for changes in expenditure arising out of change in the anticipated conditions and activity. A fixed budget will, therefore, be useful only when the actual level of activity corresponds to the budgeted level of activity. A master budget tailored to a single output level of (say) 20,000 units of sales is a typical example of fixed budget. But, in practise, the level of activity and set conditions will change as a result of internal limitations and external factors like changes in demand and prices, shortages of materials and power, acute competition etc. it is hardly of any use as a mechanism of budgetary control because it does not make any distinction between fixed, variable and semi-variable costs and provides for no adjustments in the budgeted figures as a result of change in cost due to change in level of activity. It does not provide a meaningful basis for comparison and control. It is also not helpful at all in the fixation of price and submission of tenders.

Flexible Budget
The CIMA, England, defines a flexible budget (also called sliding scale budget) as, a budget which, by recognising the difference in behaviour between fixed and variable costs in relation to fluctuations in output, turnover, or other variable factors such as number of employees, is designed to change appropriately with such fluctuations. Thus, a flexible budget gives different budgeted costs for different levels of activity. A flexible budget is prepared after making an intelligent classification of all expenses between fixed, semivariables and variable because the usefulness of such a budget depends upon the

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accuracy with which the expenses can be classified. Such a budget is prescribed in the following cases: Where the level of activity during the year varies from period to period, either due to the seasonal nature of the industry or to variations in demand. Where the business is a new one and it is difficult to foresee the demand. Where the undertaking is suffering from shortage of a factor of production such as materials. Labour, plant capacity etc. the level of activity depends upon the availability of such a factor of production. Where an industry is influenced by changes in sales. Where there are general changes in sales. Where the business units keep on introducing new products or make changes in the design of its products frequently. Where the industries are engaged in make to order business like shipbuilding.

Difference Between Fixed Budget and Flexible Budget

Following are the main differences between Fixed and Flexible budgets: Sl. No. Point of Distinction 1 Flexibility Fixed Budget It is inflexible and does not change with the actual volume of output achieved. It assumes that conditions would remain static. Costs are not classified according Flexible Budget It is flexible and can be suitably recasted quickly according to the level of activity attained. It is designed to change according to changed conditions. Cost are classified according to the
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Condition

Classification of costs

Comparison

It clearly shows the impact of various expenses on the operational aspect of the business. Only one budget at a Under it, series of Budget fixed level o activity budgets are prepared is prepared due to an at different levels of unrealistic activity. expectation on the part of the management i.e., all conditions will remain unaltered. It is not possible to Costs can be easily Ascertainment of ascertain costs ascertained at costs correctly if there is a different levels of change in activity under this circumstances. type of budget. has more Tool for cost control It has a limited It application and is applications and can ineffective as a tool be used as a tool for for cost control. effective cost control. Fixation of prices & If the budgeted and It help in fixation of actual activity levels price and submission submission of vary, the correct of tenders due to tenders. ascertainment of correct ascertainment costs and fixation of of costs. prices becomes difficult. Forecasting

to their variability i.e. fixed, variable and semi-variable Comparison of actual and budgeted performance cannot be done correctly if the volume of output differs. It is difficult to forecast accurately the results in it.

nature of variablility.

their

Comparisons are realistic as the changed plan figures are placed against actual ones.

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Master Budget
The master budget is the summary of various functional budgets. It is prepared by integrating various budgets into one consolidated budget so as to represent the budgeted profit and loss account and the budgeted balance sheet as at the end of the budget period. In other words of Rowland and William H. Harr, the master budget is, a summary of the budget schedules in capsule form made for the purpose of presenting in one report the highlights of the budget forecast. The Institute of Management Accountant, London, defines it as, the summary budget, incorporating its component functional budgets and which is finally approved, adopted and employed. The master budget is prepared by the budget officer and requires the approval of the Budget Committee before it is put into operation. This budget is used to co-ordinate the activities of various functional departments and also to serve as a control device. The various steps involved in the preparation of this budget include the construction of: i. ii. iii. iv. v. Sales budget, as starting point. Production budget. Cost of production budget. Cash budget and The projected income statement and the balance sheet.

Performance Budgeting
Performance budget has been defined as a budget based on functions, activities and projects. Performance budgeting may be described as the budgeting system in which input costs are related to the performance, i.e., end
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results. It is a system of budgeting which provides for appraisal of performance as well as follow p measures. The performance budget as defined in the Report of the Estimates Committee on Budgetary Reform reads as follows: The performance budget is a budget based on functions, activities and projects which focus attention on the accomplishment, the general and relative importance of the work to be done and the service to be rendered rather than upon the means of accomplishments such as personnel, service, supplies, equipment, etc. Under this system, the functions of various organisational units would be split into programmes of activities, sub-programmes and component schemes, etc. and estimates would be presented for each. Performance budgeting seeks to establish relationship between inputs (costs) and their direct outputs. According to National Institute of Bank Management, performance budgeting is, the process of analysing, identifying, simplifying and crystallising specific performance objectives of a job to be achieved over a period, in the framework of the organisational objectives, the purpose and objectives of the job. The technique is characterised by its specific direction towards the business objectives of the organisation. Performance budgeting involves: i. ii. Development of performance criteria for various programmes; Assessment of performance of each programme and by each responsibility unit; iii. iv. Comparison of the actual performance with the budget; Undertaking periodic review of the programme with a view to make modifications as required.

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Programme Budgeting
Programme Budgeting, also known as Planning, Programming and Budgeting System (PPBS), is a budgetary process that is aimed at making government operations more efficient and more effective. The purpose of programme budgeting is to reform the assignments of funds within the public sector and to improve the allocation of funds between the private and public sectors. PPBS treats budgeting as an allocative process and considers budget as a statement of policy. It is not an annual exercise like a convetional revenues budget but a longterm programme say 3 to 5 years. In PPBS system, expenditure is classified according to the objectives rather than functions.

Zero-base budgeting (ZBB)

Zero base budgeting is the latest technique of budgeting and it has an increased use as a managerial tool. As the name suggests, it is starting from a scratch. The normal technique of budgeting is to use previous years cost levels as a base for preparing this years budget. This method carries previous years inefficiencies to the present year because we take last year as a guide and decide what is to be done this year when this much was the performance of the last year. In zero base budgeting every year is taken as a new year and previous year is not taken as a base. The budget for this year will have to be justified according to present situation. Zero is taken as a base and likely future activities are decided according to the present situations. In the words of Peter A Pyher, A planning and budgeting process which requires each manager to justify his entire budget request in detail from scratch (Hence zero base) and shifts the burden of proof to each manager to justify why he should spend money at all. The approach
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requires that all activities be analysed in decision packages which are evaluated by systematic analysis and ranked in order of importance. In Zero-base budgeting a manager is to justify why he wants to spend. The preference of spending on various activities will depend up to their justification and priority for spending will be drawn. It will have to prove that an activity is essential and the amounts asked for are really reasonable taking into account the volume of activity.

Activity Based Budgeting (ABB)

In the traditional method of making budgets the previous years figures are taken as the base and to it certain overages are added for increase in costs for the next period. This method is followed particularly for indirect costs because it is very difficult to establish exact relationship between the level of activities and the indirect costs. But it makes the budgets more of estimates than predetermined statement of management policy. Direct cost budgets, under conventional budgeting, are more accurate because the relationship between inputs and outputs can be clearly established. However, in the changing scenario where indirect costs outweigh the direct processing costs in many a situations, one cannot be content with rough and ready methods of yester years in dealing with the indirect costs. Activity Based Budgeting (ABB), also called Activity Based Cost Management (ABCM), helps in bridging this gap of knowledge by encouraging to make indirect cost budgets more scientifically on the basis of level of activities rather than a guess work. Activity based budgets can be prepared only if the organisation has already completed Activity Based Costing (ABC) indentifying activities/factors which drive the costs.

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Rolling Budgets Or Continuous budgets

CIMA Official Terminology defines a rolling budget as budget continuously updated by adding a further period, say a month or quarter, and deducing the earlier period. The need for preparing a rolling budget arises due to the element of uncertainty in budgeting particularly the price level changes. Rolling budgets, also known as continuous budgets, are prepared for a shortterm as the degree of uncertainty is much lower and these budgets are continuously modified/extended for the next period keeping in view the changes that might have taken place. Thus, control becomes more effective with the use of rolling budget as it is based upon recent plans However; it involves more time, effort and money in preparation of rolling budgets.

Budget Report
The work of a budget officer does not end with the preparation and approval of budgets. He has to prepare reports on a continuous basis so as to facilitate comparison of actual with budgets. The budget reports are sent to various departmental managers showing favourable or adverse variance from the budget. Based on this the departmental managers will prepare a report to be submitted to the managing director pointing out the reasons for the variances. This enable remedial actions to be taken to set right unfavourable variance. The reports so furnished will also help as guide for future planning.

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CHAPTER-II STANDARD COSTING

STANDARD COST Meaning of Standard Cost
The word standard means a bench-mark or yardstick. The standard cost is a predetermined cost which determines in advance what each product or service should cost under given circumstances.

Definition of Standard Cost

In the words of Backer and Jacobsen, Standard cost is the amount the firm thinks a product or the operation of a process for a period of time should cost, based upon certain assumed conditions of efficiency, economic conditions and other factors. The costing terminology of Chartered Institute of Management Accountants, London defines standard cost as a predetermined cost which is calculated form managements standards of efficient operation and the relevant necessary expenditure. They are the predetermined cost based on technical estimate of material, labour and overhead for a selected period of time and for a prescribed set of working conditions.

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STANDARD COSTING Meaning of Standard Costing

Standard Costing is the preparation of standard costs and applying them to measure the variations from actual costs and analysing the causes of variations with a view to maintain maximum efficiency in production. It is a technique which uses standards for costs and revenues for the purpose of control through variance analysis.

Definition of Standard Costing

In the words of Brown and Howard, standard costing may be defined as a technique of cost accounting which compares the standard cost of each product or service with actual cost to determine the efficiency of the operation so that any remedial action may be taken immediately. The terminology of Cost accountancy defines standard costing as The preparation and use of standard costs, their comparison with actual costs, and the analysis of variance to their causes, and points of incidence. The standard costing has been defined by the London Institute of Cost and Works Accountants as An estimate cost, prepared in advance of production or supply correlating a technical specification of material, and labour to the price and wage rates estimated for a selected period of time, with an addition of the apportionment of overheads expenses estimated for the same period within a prescribed set of working conditions.

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Advantages and Disadvantages of Standard Costing Advantages of Standard Costing

Following are the advantages of Standard Costing: Sl.No. 1. 2. 3. 4. 5. 6. 7. 8. Advantages Measuring Efficiency Formulation of Production and Price Policy Determination of Variance Reduction of Work Management by Exception Facilitates Cost Control Eliminating Inefficiencies Helpful in Taking Important Decisions

1. Measuring Efficiency: Standard costing is a yardstick for measuring efficiency. The comparison of actual costs with standard costs enables the management to evaluate performance of various cost centres. In the absence of standard costing system actual costs of different periods may be compared to measure efficiency. It is not proper to compare costs of different periods because circumstances of both the periods may be different. Moreover, a decision about base period with which the comparison is to be made is also difficult to be made. Standard costing gives targets with which actual performance can be compared. 2. Formulation of Production and Price Policy: Standard costing is helpful in formulating production policies. The standards are set by studying all existing conditions. It becomes easy to formulate production plans by taking into account standard costs. It is also helpful for finding prices of various products. In case tenders are to be submitted or prices are to be quoted in advance then standard costing produces necessary data for price fixation.
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3. Determination of variance: By comparing actual costs with standard costs variances are determined. Management is able to spot out the place of inefficiencies. It can fix responsibility for deviation in performance; it is possible to take corrective measures at the earliest. A regular check on various expenditures is also ensured by standard costing system. 4. Reduction of Work: In historical costing, records are maintained for determining the costs. Standard costing reduces clerical work to a considerable extent and management is supplied with useful information. In presentation is simplified and only required information is presented in such a form that management is able to interpret the information easily and usefully. 5. Management by Exception: With the use of standard costing, the targets of different individuals are fixed. If the performance is according to predetermined standards then there is nothing to worry. The attention of management is drawn only when actual performance is less than the budgeted performance. Management by exception means that everybody is given a target to be achieved and management need not supervise each and everything. The responsibilities are fixed and everybody tries to achieve his targets. If the things are going as per targets then management need not bother. Management devotes its time to other important things. So, management by exception is possible only when targets of work can be fixed. Standard costing enables the determination of targets. 6. Facilitates Cost Control: Every costing system aims at cost control and cost reduction. Standard costing helps in achieving these aims. The standards are being constantly analysed and an effort is made to improve efficiency. Whenever a variance occurs the reasons are studied and immediate corrective measures are undertaken. The action taken in spotting weak points enables cost control system.

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7. Eliminating Inefficiencies: The setting of standard for different elements of cost requires a detailed study of different aspects. The standards are differently set for manufacturing, administrative and selling expenses. Improved methods are used for setting these standards. The determination of manufacturing expenses will require time and motion study for labour and effective material control devices for materials, etc. Similar studies will be needed for finding other expenses. All these studies will make it possible to eliminate inefficiencies at different steps. The whole effort will give an improved costing system and will enable better service to the consumer. 8. Helpful in taking important decisions: Standard Costing provides useful information to the management in taking important decisions. The problem created by inflation, rising prices. Etc. can be effectively tackled with the help of standard costing. It can also be used to provide incentive plans for employees, etc.

Limitations of Standard Costing

Following are the limitation of Standard Costing: 1. Standard costing cannot be used in those concerns where non-standard products are produced. If the production is under taken according to the customers specifications then each job will involve different amount of expenditures. Under such circumstances it is not possible to set up standards for every job. Standard costing can be used only in those concerns where standardised products are manufactured. 2. The process of setting up standards is difficult task as it requires technical skill. The time and motion study is required to be undertaken for this purpose. These studies require a lot of time and money.
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3. There are no inset circumstances to be considered for fixing standards. The conditions under which standards are fixed do not remain static. With the change in circumstances the standards are also to be revised. The revision of standard is a costly process. In case the standards are not revised the same become impracticable. 4. This system is expensive and small concerns may not afford to bear the cost. For small concerns the utility from this system may be less than the cost involved in it. 5. The fixing of responsibility is not an easy task. The variances are to be classified into controllable and uncontrollable variances. The

responsibility can be fixed only for controllable variances. The determination of controllable and uncontrollable variances will be a problem. The variances may be controllable at one point of time and may become uncontrollable at another time. The problem is faced whenever a responsibility is to be fixed. 6. The industries liable for frequent technological changes will not be suitable for standard costing system. The change in production process will require a revision of standard. A frequent revision of standard will costly. So this system will not be useful for industries where methods and techniques of production are fast changing.

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DIFFERENCES BETWEEN A BUDGETARY CONTROL AND STANDARD COSTING

Following are the difference between Budgetary Control and Standard Costing: Sl. No. Budgetary control It is prepared to cover 1 various functions of a business such as purchases, sales, production, finance, etc. in other words it has a macro-approach. It is more extensive as it 2 covers all the operations of the business. It is a projection of financial 3 accounts. It can be implemented even 4 in parts, i.e., to cover one or more than one area of business. It can be operated without 5 standards. It is more management 6 oriented. It can be implemented in all 7 industries. It does not involve any 8 accounting after computing variances. Its objects are formulation of 9 policy, coordination of activities and delegation of authority. Standard costing It is prepared in respect of a cost unit. In other words it has a microapproach.

It is more intensive technique of controlling costs. It is a projection of cost accounts. It covers all items of expenses without leaving any item. So it cannot be operated in part. It cannot exits without budget. It is more engineering oriented. It is not possible in certain industries. Variances are accounted for under standard costing. Its aim is to enable management in making decisions, in price-fixing and valuation of closing stock.

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RESPONSIBILITY ACCOUNTING Meaning of Responsibility Accounting

Responsibility accounting involves accumulating and reporting costs (and revenues, where relevant) on the basis of the individual manager who has the authority to make the day-to-day decisions about those items. Under responsibility accounting, the evaluation, of a managers performance is based only on matters directly under that manager[s control. Responsibility accounting can be used at every level of management that fulfils the following conditions: Costs and revenues can be directly associated with the specific level of management responsibility. The costs and revenues are controllable at the level of responsibility with which they are associated. Budget data can be developed for evaluating the managers effectiveness in controlling the costs and revenues Responsibility accounting is an information reporting system that (1) classifies financial data according to area of responsibility in an organisation, and (2) reports each areas activities by including only the revenue and cost categories that the assigned manager can control. Responsibility accounting focuses on the reporting and not the recording of the operating cost and revenue data. Once the financial data from daily operations have been recorded in the accounting system, specific costs and revenues can be reclassified and reported for specific areas of managerial responsibility

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Definitions of Responsibility Account

Charles T. Horngen defines Responsibility accounting is a system of accounting that recognises various responsibility centres throughout the organisation and reflects the plans and actions of each of these centres by assigning particular revenues and costs to the one having pertinent responsibility. According to C.I.M.A., London. Responsibility accounting is a system, of Management Accounting under which accountability is established according to the responsibility delegated to various levels of management and management information and reporting system instituted to give adequate feedback in terms of the delegated responsibility. Under this system division of units of an organisation under specified authority in a person are developed as a responsibility centre and evaluated individually for their performance.

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CHAPTER-III ANALYSIS OF VARIANCE

VARIANCE Meaning of Variance
The deviation of the actual cost or profit or sales from the standard cost or profit or sales is known as variance.

Favourable Variance When actual cost is less than standard cost or actual profit is better than standard profit, it is known as favourable variance and such a variance is usually a sign of efficiency of the organisation.

Unfavourable Variance When actual cost is more than standard cost or actual profit or turnover is less than standard profit or turnover, it is called unfavourable or adverse variance and is usually an indicator of inefficiency of the organisation.

Controllable Variance If a variance is due to inefficiency of a cost centre (i.e., individual or department), it is said to be controllable variance. Such a variance can be corrected by taking a suitable action. For example, if actual quantity of material used is more than the standard quantity, the foreman concerned would be

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responsible for it. But if excessive use is due to defective supply of materials or wrong setting of standards, the purchasing department or cost accounting department would be responsible for it.

Uncontrollable Variance On the other hand, an uncontrollable variance does not relat3we to an individual or department but it arises due to external reasons like increase in process of materials. This type of variance is not controllable and no particular individual can be held responsible for it.

Definition of Variance
The ICMA terminology defines a variance as the difference between a standard cost and the comparable actual cost incurred during a given period. The purpose of knowing the variance is to enable the management to exercise control over cost. It enables to know whether the standards set is achieved or not.

Variance Analysis
Variance analysis is the process of computing the amount of and isolating the cause of variances between actual costs and standard cost. Thus variance analysis involves: (a) computation of individual variances and, (b) determination of the cause of each variance. The purpose of variance analysis is to enable management to improve operations, increase efficiency, utilize resources more effectively and reduce cost.

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CLASSIFICATION OF VARIANCES The variances may be classified into following categories: 1. Direct Materials Variances 2. Direct Labour Variances 3. Overheads Cost Variances 4. Sales or Profit Variances

Material Variances
Material variances are also known as material cost variances. The material cost variance is the difference between the standard cost of materials that should have been incurred for manufacturing the actual output and the cost of materials that has been actually incurred. Material Cost Variance comprises of: (i) Material Price Variance (ii) Material Usage Variance: Material usage variance may further be sub-divided into material Mix Variance and Material Yield Variance. The following chart depicts the divisions and sub-divisions of material variances:
MATERIAL COST VARIANCE

MATERIALS PRICE VARIANCE

MATERIALS USAGE VARIANCE

MATERIALS MIX VARIANCE

MATERIALS YIELD VARIANCE

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Thus, in all the following may be the material variances: a) Material Cost Variance b) Material Price Variance c) Material Usage Variance d) Material Mix Variance e) Material Yield Variance The following equations may be used for verification of material cost variances. 1. Material Cost Variance = Material Price Variance +Material Usage Variances 2. Material Usage Variance = Material Mix Variance + Material Yield Variance 3. Material Cost Variance = Material Price Variance + Material Mix Variance + Material Yield variance

a) Material Cost Variance: Material cost variance is the difference between standard materials cost and actual materials cost. Material cost variance arises due to change in price of materials and variations in use quantity of materials. Material cost variance is ascertained as such: Materials Cost Variance = Standard Material Cost Actual Material Cost Standard Material Cost = Standard Price Per unit Standard quantity of materials Actual Material Cost = Actual price per unit Actual quantity of materials If the standard cost is more than the actual cost, the variance will be favourable, and on the other hand, if the actual cost is more than the standard cost, the variance will be unfavourable or adverse. b) Materials Price Variance: Materials price variance is that part of material cost variance which is due to the standard price specified and

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actual price paid. Material price variances may arise due to the following reasons: i. ii. Changes in basic prices of materials. Failure to purchase the quantities anticipated at the time when standards were set. iii. iv. Failure to secure discount on purchases. Failure to make bulk purchases and incurring more on freight, etc. v. vi. Failure to purchase materials at proper time. Not taking cash discount when setting standards.

Materials price variance is, generally, the responsibility of Purchase Manager but there may be factors beyond his control. Materials price variance is stated as: Materials Price Variance = Actual Quantity (Standard price Actual price) In this case actual quantity of materials used is taken. The price of materials is taken per unit. If the answer is in plus, the variance will be favourable and it will be unfavourable if the result is in negative. c) Material Usage Variance: Material usage (or quantity) variance is that part of material cost which arises due to the difference in standard quantity specified and actual quantity of materials used. The difference between standard quantity and actual quantity is multiplied by standard price of material and the resultant figure will materials usage variance. This variance may arise due to the following reasons: i. ii. Negligence in use of materials. More wastage of materials by untrained workers or defective methods of production iii. Loss due to pilferage.
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iv. v. vi.

Use of material mix other than the standard mix. More or less yield from materials than the standard set. Defective production necessitating the use of additional materials

Production Manager will be responsible for materials usage variance. The prompt presentation of materials usage variance will enable corrective measures in time. Inefficiencies can be traced and corrected before large losses have occurred. Materials usage variance is calculated as follows: Materials Usage Variance = Standard Price (Standard Quantity Actual Quantity) The quantities of material specified and actually used are taken and standard price per unit is used. If the answer form the above mentioned formula is in plus, the variance will be favourable variance but if the answer is in minus the variance will be unfavourable or adverse. d) Material Mix Variance: Materials mix variance is that part of material variance which arises due to changes in standard and actual composition of mix. It results from a variation in the materials mix used in production. If material mix used in production is of a higher price and larger in quantity than the standard mix, cost of actual material mix will be more. On the other hand, the use of cheaper materials in large proportions will mean lower material cost than the standard. Materials mix variance is the difference between standard price of standard mix and standard price of actual mix. The standard price is used in calculating this variance. The variance is calculated under two situations: i. ii. When actual weight of mix is equal to standard weight of mix. When actual weight of mix is different from the standard mix
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i.

When Actual Weight and Standard Weight of Mix are Equal

In this case the formula for calculating mix variance is: Standard cost of standard mix Standard cost of actual mix. (Standard Price x Standard Quantity) (Standard Price x Actual Quantity) Or Standard unit cost (Standard Quantity Actual Quantity). In case standard quantity is revised due to shortage of one material, the formula will be: Standard unit cost (Revised Standard Quantity Actual Quantity). ii. When Actual Weight and Standard Weight of Mix are Different

When quantities of actual material mix and standard material mix are different, the formula will be:

Total Weight of Actual mix Total Weight of Standard Mix

Standard Cost of Standard Mix

(Standard Cost of Actual Mix)

In case the standard is revised due to the shortage of one material then revised standard will be used instead of standard, the formula will become:

Total Weight of Actual Mix Total Weight of Revised Standard Mix

Standard Cost of Revised Standard Mix

(Standard Cost of Actual Mix)

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e) Materials Yield Variance: This is the sub-variance of material usage variance. It results from the difference between actual yield and standard yield. A standard output is expected from the raw materials put in. The actual yield may be more or less than the specified standard. Materials yield variance is defined as that portion of the direct materials usage variance which is due to the standard yield specified and the actual yield obtained. This sub-variance is very important for processing industries in which final product of one process becomes the raw material of another process. The yield in different processes will enable to have a material control system. If actual yield is more than the standard yield, it is a sign of efficiency. A low yield indicates more consumption of raw materials. This sub-variance may arise due to low quality of materials, defective methods of production, carelessness in handling materials, etc. Material yield variance is calculated with the following formula: Standard Rate (Actual yield Standard yield)

Standard Cost of Standard mix Standard Rate Net standard output i.e., Gross output-Standard loss

There may be a situation where standard mix may be different from the actual mix. In this case the standard is revised in relation to actual mix and the question is solved with the revised standard and not with the original standard. The standard rate will be calculated as follows:

Standard Cost of Revised Standard mix Standard Rate Net standard output

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In the earlier variances if the standard was more than the actual, the variance was favourable. But, in cased of material yield variance the case is different. When actual yield is more than the standard yield, the variance will be favourable. Labour variances can be discussed as follows: a) Labour Cost Variance b) Labour Rate of Pay or wage Rate Variance c) Total Labour efficiency or Labour Time variance d) Net Labour Efficiency Variance e) Idle Time variance f) Labour Mix or Gang Composition Variance g) Labour Yield or Sub-efficiency Variance

a) Labour Cost Variance: Labour cost variance is the difference between the standard direct wages specified for the activity and the actual wages paid. Labour cost variance is the function of labour rate of pay and total labour efficiency or labour time variance. It arises due to a change in either wage rate or in time or both. Labour cost variance is calculated as follows: Labour Cost Variance = Standard Labour Cost for Actual Output Actual Labour Cost = (Standard Time for Actual Output x Standard Wage Rate) (Actual Time x Actual Wage Rate)

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The following chart depicts the divisions and sub-division of labour cost variance:
LABOURE COST VARIANCE

LABOUR RATE OF PAY VARIANCE

TOTAL LABOUR EFFICIENCY TIME VARIANCE

NET LABOUR EFFIIENCY VARIANCE

IDLE TIME VARIANCE

LABOUR MIX VARIANCE OR GANG COMPOSITION VARIANCE

LABOUR YIELD VARIANCE OR SUB-EFFICIENCY VARIANCE

b) Labour Rate of Pay or Wage Variance: It is that part of labour cost variance which arises due to a change in specified wage rate. Labour rate variance arises due to the following reasons: i. ii. iii. iv. v. Change in basic wage rate or piece-work rate. Employing persons of different grades then specifies. Payment of more overtime than fixed earlier. New Workers being paid different rates than the standard rates. Different rates being paid to workers employed for seasonal work or excessive work load.

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The responsibility for wage rate variance lies with the production cost centre. The rates are generally beyond the control of any one. The wage rates are determined by demand and supply conditions of labour conditions in labour market, wage board awards, etc. So, wage rate variance is generally uncontrollable except if it arises due to the development of wrong grade of labour fro which production foreman will be responsible. This variance is calculated by the following formula: Labour Rate of Pay Variance = Actual time (Standard Rate - Actual Rate) The variance will be favourable if actual rate is less than the standard rate and it will be unfavourable or adverse if actual rate is more than the standard rate. c) Total Labour efficiency or Labour Time variance: It is that part of labour cost variance which arises due to the difference between standard labour hours specified and the actual labour hours paid for including idle time. This variance helps in controlling efficiency of workers. The reasons for this variance are: i. ii. iii. iv. v. vi. Lack of proper supervision. Defective machinery and equipment. Insufficient training and incorrect instructions. Increase in labour turnover. Bad Working Conditions. Discontentment among workers due to unsatisfactory personal relations. vii. Use of non-standard material requiring more time to complete work.

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Labour efficiency variance is calculated as follows: Total Labour Efficiency Variance = Standard Wage Rate (Standard Time for actual Output Actual Time Paid) The actual time, while calculating this variance includes abnormal idle time. If actual time taken for doing a work is more than the specified standard time the variance will be unfavourable. On the other hand, if actual time taken for a job is less than the standard time, the variance will be favourable.

d) Net Labour Efficiency Variance: This variance is that part of total labour efficiency variance which is causal due to the difference between the standard labour hours specified and the actual labour hours worked excluding abnormal idle time. This variance is calculated as follows: (Net) Labour Efficiency Variance = Standard Rate (Standard Time for actual Output Actual Time Worked) = Standard Rate x [(St. Time) (Actual Time paid Idle Time)] e) Idle Time variance: This variance is a sub-variance of labour efficiency variance. It is the standard cost of actual time paid to workers for which they have not worked due to abnormal reasons. The Reasons for idle time may be power failure, defect in machinery, non-supply of materials, etc. Idle time may be power failure, defect in machinery, non-supply of materials, etc. Idle time variance should be segregated from the labour efficiency variance otherwise it will show inefficiency on the part of workers though they are not responsible for this. Idle time variance is always adverse and needs investigation for its causes. This variance is calculated as follows:
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Idle Time Variance Idle Hours x Standard Rate f) Labour Mix or Gang Composition Variance: This variances arises due to change in the actual gang composition than the standard gang composition. The change in labour composition may be caused by the shortage of one grade of labour necessitating the employment of another grade of labour. This variance shows to the management how much labour cost variance is due to the change in labour composition. Labour mix variance is like material mix variance and is calculated in the same way. It may be calculated in two ways: i. ii. i. When standard labour mix is equal to actual labour mix. When standard labour mix is different from actual labour mix. When standard and actual times of the labour mix are same. In this case the variance is calculated as follows: Labour Mix Variance = Standard Cost of Standard Labour Mix Standard Cost of Actual Labour Mix. Due to the non-availability of one grade of labour, there may be a change in standard labour mix, then revised standard will be used for standard mix. The formula will be: Labour Mix Variance = Standard cost of Revised Standard Labour Mix Standard Cost of Actual Labour Mix. ii. When standard and actual time of labour mix are different:

In this case the variance will be calculated as follows:

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Total Time of Actual Labour Mix Total Time Standard Labour Mix

Standard Cost of Standard Labour Mix

(Standard Cost of Actual Labour Mix)

As in the earlier case, if labour composition is revised because of nonavailability of one grade of labour then revised standard mix will be used instead of standard mix and the formula will become:

Total Time of Actual Labour Mix Total Time Revised Standard Labour Mix

Standard Cost of Revised Standard Labour Mix

(Standard Cost of Actual Labour Mix)

g) Labour Yield or Sub-efficiency Variance: The labour yield variance or the labour sub-efficiency variance arises due to the standard output specified and the actual output obtained. This variance is calculated as follows: Labour Yield/Sub-efficiency Variance = Standard Labour Cost per unit of out put (actual Yield for Actual Time)

OVERHEAD VARIANCES
Overhead costs are the operating costs of a business which cannot be identified or allocated but which can be apportioned to, or absorbed by cost centres or cost units. According to the terminology of Cost Accountancy (ICWA, London) overhead is defined as the aggregate of indirect material cost,
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indirect wages (indirect labour cost) and indirect expenses. Thus, overhead costs are indirect costs and are important for the management for the purposes of cost control. Under cost accounting, overhead costs are absorbed by cost units on some suitable basis. Under standard costing, overhead rates are predetermined in terms of either labour hours (per hour) or production units (per unit of output). The actual labour hours or actual units produced are multiplied by the standard overhead rate to determine the standard overhead cost that ought to have been incurred. Standard overhead cost so calculated is then compared with actual overhead cost to find out the variance, if any so as to take corrective measures. Overhead cost variance can, thus, be defined as the difference between the standard cost of overhead allowed for actual output (in terms of production units or labour hours) and the actual overhead cost incurred. The formula for the calculation of overhead cost variance is given below:

Overhead Cost Variance = Actual Output x Standard Overhead Rate per unit Actual Overhead Cost Or = Standard Hours for actual Output x Standard Overhead Rare per hour Actual Overhead Cost

An analytical study of the behaviour of overheads in relation to changes in volume of output reveals that there are some items of cost which tend to vary directly with the volume of output whereas, there are others which remain unaffected by variations in the volume of output achieved or labour hours spent. The former costs represent the variable overhead and the latter fixed overheads. Thus, overhead cost variances can be classified as:

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i. ii.

Variable Overhead Variance Fixed Overhead Variance

Variable Overhead Variance can further be analysed into (a) Variable Overhead Expenditure or Spending Variance, and (b) Variable Overhead Efficiency Variance. Similarly, Fixed Overhead Variance may be sub-divided into (a) Fixed Overhead Expenditure variance, and (b) Fixed Overhead Volume variance. Further, Fixed volume variance can be analysed into capacity, calendar and efficiency variances. The following diagram shows the entire classification of overhead cost variance:
TOTAL OVERHEADS COST VARIANCE

VARIABLE OVERHEAD VARIANCE

FIXED OVERHEAD VARIANCE

EXPENDITURE VARIANCE

EFFICIENCY VARIANCE

EXPENDITURE VARIANCE

VOLUME VARIANCE

CAPACITY VARIANCE

CALENDER VARIANCE

EFFICIENCY VARIANCE

i.

Variable Overhead Variance : Variable overheads vary directly with the volume of output and hence, the standard variable overhead rate remains uniform. Therefore, computation of variable overhead
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variance, also known as variable overhead cost variance parallels the material and labour cost variances. Thus, variable overhead cost for actual output and the actual variable overhead cost. It can be calculated as follows: VOCV = (Actual Output x Standard Variable Overhead Rate per unit) Actual Variable Overheads Or = (Standard Hours for Actual Output x Standard Variable Overhead Rate per hour) Actual Variable Overheads In case information relating to standard hours allowed for actual output and the actual time (hours) taken is available, variable overhead cost variance can be further analysed into: a) Variable Overhead Expenditure or Spending Variance b) Variable Overhead Efficiency Variance.

a) Variable Overhead Expenditure or Spending Variance: This is the difference between the standard variable overheads for the actual hours and the actual variable overheads incurred and can be calculated as: Variable Overhead Expenditure variance = (Actual Hours x Standard Variable Overhead Rate perhour) Actual Variable overhead Or = Actual Hours (Standard Variable Overhead Rate Actual Variable Overhead Rate)

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b) Variable Overhead Efficiency Variance: If represents the difference between the standard hours allowed for actual production and the actual hours taken multiplied with the standard variable overhead rate. Symbolically: Variable Overhead Efficiency Variance = Standard Variable Overhead Rate (Standard Hours for Actual Output) Actual Hours

ii.

Fixed Overhead Variance: This variance is calculated as: x Standard Fixed Overheads Rate Actual Fixed

Actual Output Overheads.

The standard fixed overhead rate is calculated by dividing budgeted fixed overheads by standard output specified. Fixed overheads variance may be divided into expenditure and volume variances. a) Expenditure Variance: It is that part of fixed overhead variance which is due to the difference between budgeted expenditure and actual expenditure. Overhead Expenditure Variance = Budgeted Fixed Overheads Actual Fixed Overheads b) Volume Variance: This variance shows a variation in overhead recovery due to budgeted production being more or less than the actual production. When actual production is more than the standard production, it will show an over-recovery of fixed overheads and the variance will be favourable. On the other hand, if actual production is less than the

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standard production it will show an under recovery and the variance will be unfavourable. Volume variance may arise due to change in capacity, variation in efficiency or change in budgeted and actual number of working days. Volume variance is calculated as follows: Volume Variance = Actual Output x Standard Rate Budgeted Fixed Overheads Volume variance is sub-divided into following variances: i. Capacity variance: It is that part volume variance which arises due to over-utilisation or under-utilisation of plant and equipment. The working in the factory is more or less than the standard capacity. This variance arises due to idle time caused by strikes, power failure, nonsupply of materials, break down of machinery, absenteeism etc. capacity variance is calculated as follows: Capacity Variance = Standard Rate (revised Budgeted Units Budgeted Units) Or = Standard Rate (Revised Budgeted Hrs Budgeted Hrs) ii. Calendar Variance: This variance arises due to the difference between actual number of days and the budgeted days. If may arise due to more public holidays announced than anticipated or working for more days because of change in holidays schedule, etc. if actual working days are more than budgeted, the variance will be favourable and it will be unfavourable if actual working days are less than the

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budgeted number of days Calendar variance can be expressed as follows: Decrease or Increase in number of units produced due to the difference of budgeted and actual days x Standard Rate per unit iii. Efficiency Variance: This is that portion of the volume variance which arises due to increased or reduced output because of more or less efficiency than expected. It signifies deviation of standard quantity from the actual quantity produced. This variance is related to the efficiency variance of labour. Efficiency variance is calculated as: Standard Rate (Actual Quantity Standard Quantity) Or Standard Rate per hour (Standard Hours Produced Actual Hours) If Actual quantity is more than the budgeted quantity, the variance will be favourable and it will be vice versa if actual quantity is less than the budgeted quantity.

SALES VARIANCES The variances discussed in earlier pages related to the cost of goods manufactured. The impact of different variances, favourable and unfavourable, on cost from materials, labour and overheads side has been studied. In addition, the study of sales variance is also important. The analysis of sales variances is important to study profit variances.

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A sales value variance reveals the difference between actual sales and budgeted sales. This variance may arise due to change in sale price, sales volume or sales mix. Sales variances may be classified as follows: a) Sales Value Variance b) Sales Price Variance c) Sales Volume variance d) Sales Mix Variance

a) Sales Value Variance: A Sales Value Variance is the difference between budgeted sales and actual sales. It is calculated as: Sales Value variance = Actual Value of Sales Budgeted value of Sales If actual sales are more than the budgeted sales, the variance will be favourable and on the other hand, the variance will be unfavourable if actual sales are less than the budgeted sales. b) Sales Price Variance: A sales price variance is that portion of sales value variance which arises due to the difference between the standard price specified and the actual price charged. It is calculated as: Sales Price variance = Actual Quantity (Actual Price Standard Price) c) Sales Volume variance: It is that part of sales value variance which is due to the difference between actual quantity of sales and budgeted quantity of sales. It is calculated as: Sales Volume Variance = Standard Price (Actual Quantity of Sales Standard Quantity of Sales)

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d) Sales Mix Variance: It is a sub-variance of sales volume variance. The proportion in which different quantities were budgeted may be different from the proportion of actual quantities sold, it is the difference of standard value of revised mix and standard value of actual mix.

PROFIT METHOD OF CALCULATING SALES VARIANCES

In this method the effect of change in sales quantities and sales prices on the profits of the concern is determined. A businessman may be interested more in knowing variations in profits than in sales, profit method of calculating sales variances will be useful. The variances are analysed as follows: a) Total Sales Margin Variance: Actual Profit Budgeted Profit Actual Profit = Actual quantity sold Actual profit per unit. Budgeted Profit = Budgeted quantity of Sales Budgeted profit per unit. b) Sales Marging Variance due to Selling Price: This variance arises due to the difference between actual selling price and standard selling price. This variance is calculated as: Actual Quantity (Actual Price Standard Price) c) Sales Margin Variance due to Volume: This Variance arises due to the difference between actual quantity of sales and budgeted quantity of sales. It is calculated as: Standard Profit per Unit (Actual Quantity of Sales Standard Quantity of Sales)

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