Q1.

Solu:-Fixed Budget:- A budget which is made without regard to potential

variations in business activity. Such budgeting might be effective for companies with
low variable costs, but otherwise is likely to be inaccurate OR a fixed budget is one
used by a company that has no allowances for possible changes in their budgetary
needs. This is practical where a company has some reasonable control over any
possible expenses. And can forecast with some degree off accuracy what their
potential costs may be for a given period. However, this means normally doesn’t have
much success when the company has too many variables in its future expenses that
can’t be predicted. In such cases any type of fixed budget would not serve as a
realistic fiscal plan for that given company for its operating purposes.

The flexible budget is a performance evaluation tool. It cannot be prepared before

the end of the period. A flexible budget adjusts the static budget for the actual level of
output. The flexible budget asks the question: “If I had known at the beginning of the
period what my output volume (units produced or units sold) would be, what would
my budget have looked like?” The motivation for the flexible budget is to compare
apples to apples. If the factory actually produced 10,000 units, then management
should compare actual factory costs for 10,000 units to what the factory should have
spent to make 10,000 units, not to what the factory should have spent to make 9,000
units or 11,000 units or any other production level.

The flexible budget variance is the difference between any line-item in the flexible
budget and the corresponding line-item from the statement of actual results.

The following steps are used to prepare a flexible budget:

1. Determine the budgeted variable cost per unit of output. Also determine the
budgeted sales price per unit of output, if the entity to which the budget applies
generates revenue (e.g., the retailer or the hospital).

2. Determine the budgeted level of fixed costs.

3. Determine the actual volume of output achieved (e.g., units produced for a factory,
units sold for a retailer, patient days for a hospital).

4. Build the flexible budget based on the budgeted cost information from steps 1 and
2, and the actual volume of output from step 3.
Flexible budgets are prepared at the end of the period, when actual output is known.
However, the same steps described above for creating the flexible budget can be used
prior to the start of the period to anticipate costs and revenues for any projected level
of output, where the projected level of output is incorporated at step 3. If these steps
are applied to various anticipated levels of output, the analysis is called pro forma
analysis. Pro forma analysis is useful for planning purposes. For example, if next
year’s sales are double this year’s sales, what will be the company’s cash, materials,
and labor requirements in order to meet production needs?

Zero-based budgeting is a technique of planning and decision-making which

reverses the working process of traditional budgeting. In traditional incremental
budgeting, departmental managers justify only increases over the previous year
budget and what has been already spent is automatically sanctioned. No reference is
made to the previous level of expenditure. By contrast, in zero-based budgeting, every
department function is reviewed comprehensively and all expenditures must be
approved, rather than only increases. Zero-based budgeting requires the budget
request be justified in complete detail by each division manager starting from the
zero-base. The zero-base is indifferent to whether the total budget is increasing or
decreasing.

The term "zero-based budgeting" is sometimes used in personal finance to describe

the practice of budgeting every dollar(Or Rupees)of income received, and then
adjusting some part of the budget downward for every other part that needs to be
adjusted upward. It is more technically correct to refer to this practice as "zero-sum
budgeting".
Zero based budgeting also refers to the identification of a task or tasks and then
funding resources to complete the task independent of current resourcing.
Advantages of zero-based budgeting

• Efficient allocation of resources, as it is based on needs and benefits.

• Drives managers to find cost effective ways to improve operations.

• Detects inflated budgets.

• Useful for service departments where the output is difficult to identify.

• Increases staff motivation by providing greater initiative and responsibility in

decision-making.

• Increases communication and coordination within the organization.

 • Identifies and eliminates wasteful and obsolete operations.

• Identifies opportunities for outsourcing.

• Forces cost centers to identify their mission and their relationship to overall
goals.

Disadvantages of zero-based budgeting

1. Difficult to define decision units and decision packages, as it is time-
consuming and exhaustive.
2. Forced to justify every detail related to expenditure. The R&D department is
threatened whereas the production department benefits.
3. Necessary to train managers. Zero-based budgeting must be clearly
understood by managers at various levels to be successfully implemented.
Difficult to administer and communicate the budgeting because more
managers are involved in the process.
4. In a large organization, the volume of forms may be so large that no one
person could read it all. Compressing the information down to a usable size
might remove critically important details.
Honesty of the managers must be reliable and uniform. Any manager that exaggerates
skews the results.

EXAMPLES

Management have identified that the following budgeted costs are fixed:

Direct labor = $8,400Overheads = $53,000

It is now possible to identify the expected variable cost per unit produced and sold:
 Now that managers are aware of the fixed costs and the variable costs per unit it is
possible to ‘flex’ the original budget to produce a budget cost allowance for 1,000
units produced and sold.

The budget cost allowance for each item is calculated as follows:

Cost allowance = budgeted fixed cost + (number of units produced and sold x variable
cost per unit)

The budget cost allowance for direct labor is calculated as follows:

• Cost allowance for direct labor = $8,400 + (1,000 units x $4) = $12,400
• The budgeted sales price per unit is $120,000 / 1,200 = $100 per unit.

If it is assumed that sales revenues follow a linear variable pattern (because the
sales price remains constant) the full flexible budget can now be produced.

To make sure that you followed it, let’s do further example. Move on…

Following the example of the calculation of the budget cost allowance for direct
labor, calculate a revised budget cost allowance for all costs for an activity of 1,000
units and produce a revised variance statement for April.
 Firstly, we need to compute the cost allowance for the overhead. Here we go:

Cost allowance for overhead = $53,000 + (1,000 units x $7) = $60,000

Next, we can make “flexible budget comparison” for April as below:

More Notes:

• This revised analysis shows that in fact the profit was $7,610 higher than would have
been expected from a sales volume of 1,000 units.
• The largest variance is a $10,000 favorable variance on sales revenue. This has arisen
because a higher price was charged than budgeted.
Q1 Solu:-Various type of Cost used in Decision Making.

•Relevant Costs

•Irrevelant Costs.

•Incremental Costs/Differential Costs

•Shutdown Costs.

•Sunk Costs.

•Opportunity Costs

•Imputed Costs.

•Out of Pocket Costs

•Replacement Costs.

•Conversion Costs.
Relevant cost: Cost which is influenced by the decision is a Relevant cost, and
hence is important for decision making.
Irrelevant cost: Cost which is not affected by the decision is a Irrelevant cost, it is
the same regardless the choice we made. Therefore, it should be ignored while
taking decision. Committed fixed cost are Irrelevant costs
Incremental costs/Differential cost: This is by far the most important concept of
cost for decision-making process. Differential cost are the additional cost which are
incurred if management chooses one course of action as oppose to another. They
are the extra, or incremental costs, caused by the particular decision.
Shut down cost: A cost which is incurred irrespective of plant is in operation or is
shutdown, e.g., the cost of rent, rates, depreciation, maintenance expenses, etc.
Sunk cost: A cost which is incurred in the past and is not relevant to the decision
making, e.g., written down value of plant is irrelevant for replacement of
machinery.
Opportunity cost: “The net selling price, rental value or transfer value which
could be obtained at a point-in time if a particular assets were to be sold, hired or
put to some alternative use available to the owner at that time, is the opportunity
cost”.-I.C.M.A.
Imputed cost: It is the notional cost to be considered for making costs comparable.
For example rent of own building, interest on own capital, etc., are not actually paid
but may be taken as costs notionally.
Out of pocket cost: This is the cost which is payable in cash as against costs such
as depreciation which does not involve cash payment.
Replacement cost: It is the cost of replacing a material or asset by purchase from
the market at current prices.
Conversion cost: This is the cost of production, excluding cost of direct materials.
It is the aggregate of direct wages, direct expenses and overhead costs of converting
raw materials into finished product.

Q2:-Cash Budget

CASH BUDGET

PARTICULAR APRIL MAY JUNE

OPENING
BALANCE 6000 3950 3000
SALE
CASH(10%) 1600 1700 1800
CREDI 1305 1485
T 0 13950 0

ADVAN OF SALE OF
VEHICLE- 9000
DIVIDEND 1000
2065 2965
0 19600 0

LESS
MATERIAL
WAGES 9600 9000 9200
3150 3500 3900
P&M 2000 2000 2000
1000
DIVIDEND 0
INCOME TAX 2000
OVERHEAD 1950 2100 2250

CLOSING
BALANCE 3950 3000 300