UNIT 10 APPROACHES TO

BUDGETING
Structure
10.0 Objectives
10.1 Introduction
10.2 Fixed Budgeting
10.3 Flexible Budgeting
10.4 Difference between Fixed and Flexible Budgeting
10.5 Appropriation Budgeting
10.6 Zero Based Budgeting (ZBB)
10.7 Performance Budgeting
10.8 Budgetary Control Ratios
10.9 Behavioural Consideration
10.10 Let Us Sum Up
10.11 Key Words
10.12 Answers to Check Your Progress
10.13 Terminal Questions
10.14 Further Readings

10.0 OBJECTIVES
After studying this unit you will be able to know:
l different approaches for the preparation of budgets;
l the process of adjusting the budget to reflect actual conditions; and
l the differences between planned activity and actual activity.

10.1 INTRODUCTION
In the previous Unit you have learnt the preparation and review of various types
of budgets. You have also learnt about the development of the master budget
for planning and control of costs. In this unit, you will study about different
approaches to budgeting and further to examine the use of the budget as a tool
for performance evaluation and control. The actual performance is compared
with the budgeted programme and the variances are analysed and investigated
so that corrective action may be taken well in time to ensure the success of the
business.

10.2 FIXED BUDGETING

According to C.I.M.A., London, “a fixed budget is a budget which is designed to
remain unchanged irrespective of the level of activity actually attained.” Thus, a budget
prepared on the basis of a standard or fixed level of activity is known as a fixed
44 budget. It does not change with the change in the level of activity. Therefore, it
becomes an unrealistic yardstick in case the level of activity actually attained does not Approaches to
confirm to the one assumed for budgeting purposes. The management will not be in a Budgeting
position to assess the performance of different heads on the basis of budgets prepared
by them because they can serve as yardsticks only when the actual level of activity
corresponds to the budgeted level of activity. Fixed budget is useful when there is no
significant variation between the budgeted output and the actual output. It does not
consider variances due to changes in the volume. In the industries where the pattern
of demand is stable a fixed budget may be adequate, especially where the budget
period is comparatively short. In such concerns it is possible to forecast sales with a
considerable degree of accuracy.

10.3 FLEXIBLE BUDGETING

Flexible budget, also known as variable or sliding sale budget, is a budget which is
designed to furnish budgeted costs for any level of activity actually attained. Flexible
budgeting technique may be employed to adjust other budgets according to current
conditions arising out of seasonal variations or changes in the length of the working
period etc.

According to C.I.M.A., London, “a flexible budget is a budget designed to change in

accordance with the level of activity actually attained.” Thus, a budget prepared in a
manner so as to give the budgeted cost for any level of activity is known as a flexible
budget. Such a budget is prepared after considering the fixed and variable elements of
cost and the changes that may be expected for each item at various levels of
operations.

Under this method, a series of budgets would be prepared at different levels of activity.
Variable items are shown in the budget as per the level of output. Fixed costs are
shown at the same amount irrespective of level of output. Sales value is computed and
entered into the flexible budget. The position of profit or loss will be revealed at the
various levels of activity. Management will take a decision to operate at a particular
level of activity where the profit is maximum taking into account all other factors.

A flexible budget is more realistic, useful and practical. The likely changes in the actual
circumstances are taken into account while preparing a flexible budget. The technique
is highly useful for control purposes. Actual performance of an executive may be
compared with what he should have achieved in the actual circumstances and not with
what he should have achieved under quite different circumstances.

Illustration 1

A Company producing electronic watches, estimates the following factory overhead

costs for producing 5,000 units:

Rs.
Indirect Materials 16,000
Indirect Labour 30,000
Inspection Costs 16,000
Heat, Light and Power 8,000
Expendable tools 8,000
Supervision costs 8,000
Equipment depreciation 4,000
Factory rent 4,000
45
Budgeting and Indirect labour, indirect material and expendable tools are entirely variable. Heat,
Budgetary Control light and power and inspection costs are variable to the extent of 50%, 40%
respectively. Other costs are fixed costs a month.
Prepare a flexible budget for production of 4,000 and 6,000 units per month. Also
find out the average factory overheads per unit for these two production levels.
Solution
Flexible Budget
for the production of 4,000 and 6,000 units per month
5000 Units 4000 Units 6000 Units
Rs. Rs. Rs.
Overheads:
Indirect Material 16,000 12,800 19,200
Indirect Labour 30,000 24,000 36,000
Inspection Costs 16,000 14,720 17,280
Heat, Light and Power 8,000 7,200 8,800
Expendable tools 8,000 6,400 9,600
Supervision Costs 8,000 8,000 8,000
Equipment depreciation 4,000 4,000 4,000
Factory rent 4,000 4,000 4,000
94,000 81,120 1,06,880
Average factory overheads
per unit 18.80 20.28 17.81

Illustration 2
A manufacturing company is presently working at 50% capacity and produces
1000 units at a cost of Rs. 360 per unit. The details of cost are given below :
Rs.
Material 200
Labour 60
Factory Overhead 60 (Rs. 24 fixed)
Administrative overheads 40 (Rs. 20 fixed)

Rs. 360

The current selling price of the product per unit is Rs. 400. At 60% of its capacity,
material cost per unit increases by 2% and selling price per unit falls by 2%.
At 80% of its capacity, material cost per unit increases by 5% and selling price per
unit falls by 5%. Estimate profits at 60% and 80% level of output and offer your
suggestions.

46
Solution Approaches to
Budgeting
Flexible Budget
(Showing the forecast of Profit at different levels)
Elements of Cost Level of Output
50% 60% 80%
(1000 Units) (1200 Units) (1600 Units)
Rs. Rs. Rs.
Material 200 204 210
Labour 60 60 60
Factory Overhead (Variable) 36 36 36
Administrative O.H. (Variable) 20 20 20
Marginal Cost per Unit 316 320 326
Sales Per unit 400 392 380
Contribution per Unit 84 72 54
(Sales – Marginal Cost)
Total contribution 84,000 86,400 86,400
Fixed Overhead 44,000 44,000 44,000
(Rs. 24 + Rs. 20)
Profit 40,000 42,400 42,400
(Contribution – Fixed OH)

Suggestion : It is advisable to operate at 60% level of capacity as the profit at 80%

capacity is the same. More risk is involved at 80% capacity as more production, more
working capacity, more efforts still profit remains the same.

Illustration 3

The following data belongs to a manufacturing company for the year ending
31st March, 2005. You are required to prepare a flexible budget for the year 31-3-2005
and forecast the profit at 60%, 75%, 90% and 100% of capacity.

Fixed Expenses : Rs.

(Lakhs)
Wages and salaries 4.2
Rent, rates and taxes 2.8
Depreciation 3.5
Administrative expenses 4.5
Total 15.0
Semi-Variable expense : @ 50% of capacity
Maintenance and repairs 1.5
Indirect Labour 4.7
Sundry administrative expenses 2.7
Total 8.9
47
Budgeting and Variable expenses : @ 50% of capacity
Budgetary Control
Material 12.0
Labour 12.8
Other direct expenses 2.0
26.8
It is estimated that fixed expenses remain constant for all levels of production; semi-
variable expenses remain constant between 45% and 65% of capacity, increasing
by10% between 65% and 80% of capacity and 20% between 80% and 100% of
capacity.
Sales at various levels are :
50% capacity Rs. 45 lakh
60% capacity Rs. 50 lakh
75% capacity Rs. 60 lakh
90% capacity Rs. 75 lakh
100% capacity Rs. 85 lakh
Solution
Flexible Budget for the year ended 31st March, 2005
(Rs. in lakh)
Elements of Cost Level of Output
50% 60% 75% 90% 100%
Fixed expenses :
Wages and salaries 4.2 4.2 4.2 4.2 4.2
Rent, Rates and taxes 2.8 2.8 2.8 2.8 2.8
Depreciation 3.5 3.5 3.5 3.5 3.5
Administrative expense 4.5 4.5 4.5 4.5 4.5
15.0 15.0 15.0 15.0 15.0
Semi-Variable Expenses :
Maintenance and repairs 1.5 1.5 1.65 1.80 1.80
Indirect labour 4.7 4.7 5.17 5.64 5.64
Sundry admn. Expenses 2.7 2.7 2.97 3.24 3.24
8.9 8.9 9.79 10.68 10.68
Variable expenses :
Material 12.0 14.4 18.0 21.60 24.0
Labour 12.8 15.36 19.2 23.04 25.6
Other direct expenses 2.0 2.40 3.0 3.60 4.0
26.8 32.16 40.2 48.24 53.6
Total cost of Production 50.7 56.06 64.99 73.92 79.28
Profit/Loss (--) 5.7 (--) 6.06 (--) 4.99 (+) 1.08 (+)5.72

48 Sales 45.00 50.00 60.00 75.00 85.00

 Approaches to
10.4 DIFFERENCE BETWEEN FIXED AND Budgeting

FLEXIBLE BUDGETING
The differences can be outlined as follows:
1) Fixed budgeting is inflexible and remains the same irrespective of the volume of
business activity, whereas flexible budgeting can be suitably recast quickly to suit
changed conditions.
2) Fixed budgeting assumes that conditions would remain static, whereas, flexible
budgeting is designed to change according to a change in the level of activity.
3) Under fixed budgeting, costs are not classified according to fixed, variable and
semi-variable, while, under flexible budgeting, costs are classified according to
nature of their variability.
4) Under fixed budgeting, actual and budgeted performances can’t be correctly
compared if the volume of output differs, while under flexible budgeting,
comparisons are realistic since the changed plan figures are placed against actual
ones.
5) Under fixed budgeting, cost cannot be ascertained if there is a change in the
circumstances, while, under flexible budgeting, costs can easily be ascertained at
different levels of activity. The task of fixing prices becomes smooth.

10.5 APPROPRIATION BUDGETING

Generally budgets are prepared for the regular business activities and they cover the
operational activities of an organisation. However, it is not true that budgets are only
useful for operational activities, these may also prepare for any particular purpose, like
for constructing any particular building, development activities, where revenue is not
concerned, only expenditures are there. When budgets are prepared only for a
particular activity/work, that is called Appropriation Budget. These budgets are related
to only one activity /work and on completion of that particular activity the purpose of
this budget ends. Hence, this type of budget are always relate /cover different activities
in an organisation.

10.6 ZERO BASED BUDGETING (ZBB)

The technique of zero based budgeting suggests that an organisation should not only
make decisions about the proposed new programmes but it should also, from time to
time, review the appropriateness of the existing programmes. Such review should
particularly done of such responsibility centres where there is relatively high proportion
of discretionary costs.
Zero based budgeting, as the term suggests, examines a programme or function or
responsibility from “ scratch.” The reviewer proceeds on the assumption that nothing
is to be allowed. The manger proposing the activity has, therefore, to prove that the
activity is essential and the various amounts asked for are reasonable taking into
account the volume of activity. Nothing is allowed simply because it was being done or
allowed in the past. Thus, it means writing on a clean slate.
Peter A. Pyhrr defined the zero based budgeting as “an operating planning and
budgeting process which requires each manager to justify his entire budget requests in
detail from scratch (hence zero basis). Each manager states why he should spend any
money at all. This approach requires that all activities be identified as decision
packages which would be evaluated by systematic analysis ranked in order of
importance.”
49
Budgeting and Thus, a cost-benefit analysis is done in respect of every function or process. It has to
Budgetary Control be justified while framing budgets. The assumption underlying zero base budgeting is
that the budget for the previous period was zero, therefore whatever costs are likely to
be incurred or spending programmes are chalked out, justification or the full amount is
to be given. Under conventional system of budgeting, however, the justification is to be
submitted by the manager only in respect of the increase in the demand for allotment
of funds in excess over the budget for the previous period. Thus, instead of
functionally-oriented spending approach, programme-oriented and decision-oriented
approach is followed under zero based budgeting.
Advantages of ZBB
1) This system is decision oriented.
2) The technique is relatively elastic, because budgets are prepared every year as
zero base.
3) It reduces wastage, eliminates inefficiency and reduces the overall cost of
production because every budget proposal is on the basis of cost-benefit ratio
after careful evaluation of different alternatives and the one which is ‘best’ is
approved.
4) It provides for a greater possibility of goal congruence.
5) It takes into consideration inflationary trends, competitor games and consumer
behaviour.
6) It vastly improves financial planning and management information system in view
of its revolutionary approach.
Disadvantages of ZBB
1) It is possible to quantify and evaluate budget proposals involving financial matters
but computation of cost-benefit analysis is not possible in respect of non-financial
matters.
2) The cost of administration of zero based budgeting is high.
3) It may be difficult to search out various alternatives for the same activity.
4) Some decision packages are inter-related which may be difficult to rank.
5) Ranking the decision is a scientific technique. Every manager can not be
expected to have the necessary technical expertise in this matter.
6) Zero based budgeting dismisses that the past is irrelevant and thereby challenges
the fundamental theory of continuity. Budgeting is a continuous process of
estimating and forecasting about the future and is based on past happenings.

10.7 PERFORMANCE BUDGETING

Performance budgets are framed in such a manner that items of expenditure and
receipts for a budget period related to a specific responsibility centre are linked with
the physical performance of that centre. The main issue involved in the preparation of
performance budgets is the development of work programmes and performance
expectation by assignment of responsibility. It is essential for the attainment of the
objectives.
In this approach, there is not only a financial plan but also a work plan in terms of
work done or end-products produced. Thus, it gives a broader view to the budget as a
plan and programme of action rather than only as an instrument for obtaining funds. In
50 fact, it makes the integration of inputs with the outputs of a development programme.
According to National Institute of Bank Management, performance budgeting Approaches to
technique is, “ the process of analysing, identifying, simplifying and crystallising specific Budgeting
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.”
The main objectives of performance budgeting are :
i) to coordinate the physical and financial aspects,
ii) to improve the budget formulation, review and decision making at all levels of
management,
iii) to facilitate better appreciation and review by controlling authorities as the
presentation is more purposeful and intelligible,
iv) to make more effective performance audit possible, and
v) to measure progress towards long term objectives which are envisaged in a
development plan.
Performance budgeting requires preparation of periodic performance reports.
Such reports compare budget and actual data, and show variances. Their
preparation is greatly facilitated if the authority and responsibility for the
incurence of each cost element is clearly defined within the firm’s
organisational structure. The responsibility for preparing the performance
budget of each department lies on the respective department head. Periodic
reports from various sections of a department will be required by the
departmental head who will submit a summary report about his department to
the budget committee. The report will be in the form of comparison of budgeted
and actual figures both periodic and cumulative. The purpose of preparing these
reports is to promptly inform about the deviations in actual and budgeted activity
to the person who has the necessary authority and responsibility to take
necessary action to correct the deviations from the budget.
Thus, performance budgeting lays immediate stress on the achievement of
specific goals over a period of time. However, in the long-run it aims at
continuous growth of the organisation so that it continues to meet the dynamic
needs of its growing clientele. It enables the organisation to be sensitive and
adaptive, preventing it from developing rigidities which may retard the process of
growth.
A comparison of the master budget with the flexible budget and with actual
results forms the basis for analyzing difference between plans and actual
performance. The difference between operating profits in the master budget
and operating profits in the flexible budget is called an activity variance. When
the change from the master budget to the flexible budget is due to changes in
sales volume, the activity variance is known as the sales volume variance. The
variance may be favourable or unfavourable variance. Let us take the following
illustration.
Illustration 4
Z Ltd had a profit plan approved for selling 5,000 units per month at an average price
of Rs. 10 per unit. The budgeted variable cost of production was Rs. 4 per unit and
the fixed costs were budgeted at Rs 20,000, the planned income being Rs. 10,000
per month. Due to shortage of raw materials, only 4,000 units could be produced and
the cost of production increased by 50 paisa per unit. The selling price was raised by
51
Budgeting and Rs. 1.00 per unit. In order to improve the producti1on process, an expenditure of
Budgetary Control Rs. 1,000 was incurred for research and development activities.
You are required to prepare a Performance Budget and find out the variance.
Solution
Z Ltd
Performance Budget
Original Plan Adjusted Plan Actual Position Variance
(5000 units) (4000 units) (4000 units) (Rs.)
Rs. Rs. Rs.
Sales Revenue 50,000 40,000 44,000 4000 (F)
Variable Costs 20,000 16,000 18,000 2000 (U)
Contribution 30,000 24,000 26,000 2000 (F)
Fixed Costs 20,000 20,000 21,000 1000 (U)
Net Income 10,000 4,000 5,000 1000 (F)

Flexible budget variance = Rs. 5000 – Rs. 4000 = Rs. 1000 (F)
Illustration 5
From the following information prepare the performance budget of ABC Company Ltd
for the month of December, 2005.

Variables Actual (Based on Flexible Budget Master budget

actual activity of (based on actual (based on a
10,000 units sold) activity of 10,000 prediction of
units sold) 8,000 units sold)
Rs. Rs. Rs.
Sales Revenue 2,10,000 2,00,000 1,60,000
Manufacturing costs 1,05,440 1,00,000 80,000
Marketing and 11,000 10,000 8,000
administrative costs
Fixed costs 65,000 60,000 60,000

Solution
Performance Budget of ABC Co. Ltd for the month of December 2005
Variables Actuals Variance Flexible Variance Master
(based on Budget Budget
actual activity (Based on (based on a
of 10,000 actual activity prediction
units sold of 10,000 of 8000
units sold) units sold)
Rs. Rs. Rs. Rs. Rs.
Sales Revenue 2,10,000 10,000 (F) 2,00,000 40,000 (U) 1,60,000
Less: Mafg. Costs
and Administrative 1,16,440 6,440 (U) 1,10,000 22,000 (U) 88,000
costs
93,560 3,560 (F) 90,000 66,000 (U) 72,000
Less : Fixed Cost 65,000 5,000 (F) 60,000 — 60,000
Profit 28,560 1440 (U) 30,000 18,000 (F) 12,000

Total Variance from Flexible Budget = Rs. 1440 (U)

52 Total Variance from Master Budget = Rs. 18,000 – Rs. 1440 = Rs. 16,560 (F)
 Approaches to
10.8 BUDGETARY CONTROL RATIOS Budgeting

Three important ratios are commonly used by the management to find out whether the
deviations of actuals from budgeted results are favourable or otherwise. These ratios
are expressed in terms of percentages. If the ratio is 100% or more, the trend is taken
as favourable. The indication is taken as unfavourable if the ratio is less than 100.
These ratios are:

1) Activity Ratio

2) Capacity Ratio

3) Efficiency Ratio

Let us study these ratios in brief.

1) Activity Ratio

It is the measure of the level of activity attained over a period. It is obtained when the
number of standard hours equivalent to the work produced are expressed as a
percentage of the budgeted hours.

Standard hours for actual production

Activity Ratio = × 100
Budgeted hours

2) Capacity Ratio

This ratio indicates whether and to what extent budgeted hours of activity are actually
utilised. It is the relationship between the actual number of working hours and
maximum possible number of working hours in budget period.

Actual hours worked

Capacity Ratio = × 100
Budgeted hours

3) Efficiency Ratio
The ratio indicates the degree of efficiency attained in production. It is obtained when
the standard hours equivalent to the work produced are expressed as a percentage of
the actual hours spent in producing that work.

Standard hours for actual production

Efficiency Ratio = × 100
Actual hours worked

Illustration 6
A factory manufactures two types of articles namely X and Y. Article X takes 10 hours
to make and article Y requires 20 hours. In a month (25 days of 8 hours each) 500
units of X and 300 units of Y are produced. The budget hours are 8500 per month. The
factory employs 60 men in the department concerned. Compute Activity Ratio,
Capacity Ratio and Efficiency Ratio. 53
Budgeting and Solution
Budgetary Control
Standard hours for actual production Hrs.
X : 500 units × 10 5,000
Y : 300 units × 20 6,000
11,000
Budgeted Hours 8,500
Actual Hours worked (60 × 8 × 25 ) 12,000

Standard hours for actual production

Activity Ratio = × 100
Budgeted hours

11000
= × 100 = 129%
8500

Actual hours worked

Capacity Ratio = × 100
Budgeted Ratio

12000
= × 100 = 141%
8500

Standard hours for actual production

Efficiency Ratio = × 100
Actual hours worked

11,000
= × 100 = 92%
12,000

10.9 BEHAVIOURAL CONSIDERATION

Basically budgets are prepared on the basis of past data available after considering the
changes in future conditions. However, it must be kept in mind that human behaviour is
volatile in nature. So, the preferences will change in future if there are changes in level
of living, earning capacity, awareness about the new product, health consciousness,
etc. Therefore, at the time of preparing the budget, the factors which affect the
behaviour of human being, must be considered, because, these factors make drastic
changes in the demand position of any product and budget estimates will not find near
to actual data/ results.

Check Your Progress

1) State the differences between fixed and flexible budgeting.

a) ......................................................................................................................

b) ......................................................................................................................

c) ......................................................................................................................

d) ......................................................................................................................
54
2) What is meant by Appropriation Budgeting ? Approaches to
Budgeting
.............................................................................................................................

.............................................................................................................................

.............................................................................................................................

3) What are the budgetory control ratios ?

.............................................................................................................................

.............................................................................................................................

.............................................................................................................................

4) Fill in the blanks :

a) A budget which is designed to remain unchanged irrespective of the level

of activity is called ..........................

b) A budget which is prepared to change according to the level of activity is

called ..........................

c) When a budget is prepared only for a particular activity such budgeting is

called ..........................

d) A system of establishing financial plans beginning with an assumption of

no activity is called ..........................

e) The difference between operating profits in the master budget and flexible
budget is called .......................... variance.

5) State whether each of the following statement is true or false.

a) Fixed budgeting is useful when there is no significant variations [ ]

in the budgeted output and actual output

b) Incase of industries where the demand for goods is stable and [ ]

budget period is short flexible budgeting is suitable for them

c) Flexible budgeting is also called sliding scale budget. [ ]

d) Budgets are prepared only for operational activities of an [ ]

organisation

e) A zero-base budgeting is prepared on the assumption that the [ ]

budget for previous period is nil

f) Performance budgeting lays immediate stress in the achievement [ ]

of specific goals over a period of time.

g) Fixed budget is suitable for fixed expenses [ ]

h) Every item of budget has to be justified when a zero based [ ]

budgeting is prepared.

i) Fixed budget is more useful than a flexible budget. [ ]

55
Budgeting and
Budgetary Control 10.10 LET US SUM UP
A budget prepared on the basis of a standard level of activity is known as fixed budget.
It does not change with the change in the level of activity. It is useful when there is no
significant changes between the budgeted output and actual output. Flexible budget is
a budget prepared in a manner so as to give the budgeted cost for any level of activity.
The likely changes in the actual circumstances are taken into account while preparing
the flexible budget. A series of budgets would be prepared at different levels of
activity. Budgets are prepared not only for regular business activities but also for any
particular purpose. When budgets are prepared for only a particular activity it is called
appropriation budget. This type of budget cover different activities in an organisation.
Zero based budgeting suggests that an organisation should not only make decisions
about the proposed new programmes but it should also, from time to time, review the
appropriateness of the existing programmes. The underlying assumption of zero base
budgeting is that the budget for the previous period is zero, therefore whatever costs
are likely to be incurred are chalked out and full amount is to be given.
Performance budgeting requires preparation of periodic performance reports. Such
reports compare budget and actual data, and show variances. There are three
important ratios commonly used by the management to find out whether the deviations
of actuals from budgeted results are favoruable or otherwise. These ratios are :
Activity ratio, capacity ratio and efficient ratio.

10.11 KEY WORDS

Appropriation Budgeting : A budget which is prepared only for a particular
activity/work
Flexible Budget : A budget which is designed to change in accordance with the
level of activity attained.
Fixed Budget : A budget which remains unchanged whatever the actual level of
activity.
Zero-Based Budgeting : A system of establishing financial plans beginning with an
assumption of no activity and justifying each programme or activity level.

10.12 ANSWERS TO CHECK YOUR PROGRESS

4) (a) Fixed budgeting (b) flexible budgeting (c) Appropriation budgeting
(d) Zero based budgeting (e) Activity
5) a) True b) False c) True d) False e) True
f) True g) True h) True i) False

10.13 TERMINAL QUESTIONS

1) What are fixed and flexible budgets? Differentiate between these two.
2) What do you understand by zero base budgeting? How is it different from
traditional budgeting?
3) Why do accountants prepare a budget for a period that is already over when we
know the actual results by then? Explain.
4) Why is a variable costing format useful for performance evaluation?
5) What are the three important control ratios? Explain them in brief.
56
6) “Performance budgeting requires preparation of periodic performance reports’’ Approaches to
Explain. Budgeting

7) A single product manufacturing company is currently producing 12,000 units (at

60% capacity). The following particulars relating to its cost structure are
available :
Per Unit (Rs.)
Direct materials 5
Direct Labour (Variable) 2
Manufacturing overheads (60% fixed) 5
Administrative overheads (fixed) 2
Selling and distribution overheads (40% variable) 3
Cost of sales 17
Profit 3
Selling price 20
You are required to prepare a flexible budget for 60%, 80% and 100% activity
levels taking into account the following additional information :
1) if activity exceeds 60%, a 5% quantity discount on raw materials on account
of increase in the total quantity will be received
2) The present fixed cost structure will remain constant upto 90% capacity,
beyond which a 20% increase in cost is expected.
3) The present unit selling price will remain constant upto 70% activity level,
beyond which a 2 ½ % reduction in original price for increase in activity by
every 5% is contemplated.
(Ans. At 60% : Rs. 36,000, at 80% : Rs. 71,200, at 100 : Rs. 53,080)
8) The following data are available in a manufacturing company for the period of a
year.
Rs. ( ’000)
Fixed expenses :
Wages and salaries 950
Rent, rates and taxes 660
Depreciation 740
Sundry administrative expenses 650
Semi-variable expenses : (at 30% of capacity)
Maintenance and repairs 350
Indirect labour 790
Sales department salaries etc. 380
Sundry administrative expenses 280
Variable expense : (at 50% of capacity)
Materials 2,170
Labour 2,040
Other expenses 790
9800
57
Budgeting and Assume that the fixed expense remain constant for all levels of production; semi-
Budgetary Control variable expenses remain constant between 45% and 65% of capacity, increasing
by 10% between 65% and 80% capacity, and by20% between 80% and 100%
capacity.
Sales at various levels are :
Rs. (Lakhs)
50% capacity 100
60% capacity 120
75% capacity 150
90% capacity 180
100% capacity 200

Prepare the flexible budget for the year and forecast the profits at 60%, 75%
90% and 100% of capacity.

(Ans. : 60% Rs. 12 lakhs, 75% Rs. 25.2 lakh, 90% Rs. 38.4 lakhs, 100%
Rs. 47.4 lakhs)

9) A manufacturing Co. Ltd operates a system of flexible budgetary control.

A flexible budget is required to show levels of activity of 80%, 90% and 100%.
The following information is available :

1) Sales, based on normal level of activity of 80% are 8,00,000 units at Rs. 10
each. If output is increased to 90%, it is thought that the selling price should
be reduced by 2 ½% , and if output reached is 100%, it would be necessary
to reduce the original price by 5% in order to reach a wider market.

2) Prime costs are :

Direct material Rs. 3.50
Direct labour Rs. 1.25
Direct expense Rs. 0.25
Rs. 5.00

If output reaches at 90% level of activity as above, the purchase price of

raw material will be reduced by 5%.

3) Variable overheads, salesmen’s commission is 5% on sales value.

4) Semi-variable overheads at normal level of activity are :

Rs.
Supervision 80,000
Power 70,000
Heat and light 40,000
Maintenance 50,000
Indirect labour 1,00,000
Salesmen’s expenses 60,000
Transport 2,00,000
Semi-variable overheads are expected to increase by 5% if output reaches a
level of activity of 90%, and by a further 10% if it reaches the 100% level.
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 5) Fixed overheads are : Rs. Approaches to
Budgeting
Rent and rates 1,00,000
Depreciation 4,00,000
Administration 7,50,000
Sales department 2,00,000
Advertising 5,00,000
General 50,000

(Ans : 80% Rs. 10 lakhs, 90% Rs. 1363750, 100% Rs. 1507000)

10) A department of a Company X attains sales of Rs. 3,00,00 at 80% of its normal
capacity and its expenses are given below :

Administration Costs:

Salaries : Rs. 45,000, General expenses 2% of sales,

Depreciation Rs. 3,750, Rates and taxes Rs. 4,375
Selling Costs :
Salaries 8% of sales, Travelling expenses 2% of sales,
Sales expenses 1% of sales, general expenses 1% of sales.
Distribution Costs :
Wages Rs. 7,500, Rent 1% of sales, other expenses 4% of sales.
Prepare a flexible administration, selling and distribution costs budget, operating at
90% and 100% of normal capacity.
90% 100%
(Ans. : Administration costs Rs. 59,875 Rs. 60,625
Selling Costs Rs. 40,500 Rs. 45,000
Distribution Costs Rs.14,375 Rs. 26,250
Total Rs. 1,14,750 Rs. 1,31,875

11) From the following particulars relating to XYZ company for the month of
November, 2003 prepare a report comprising actual results with the flexible and
master budget.

Units produced and sold : 50,000 (Budgeted sales 45,000 units)

Selling price per unit : Rs. 10 (Budgeted Rs. 11 per unit)

Actual variable cost per unit : Rs. 5 (Budgeted Rs. 4 per unit )

Actual fixed overhead : Rs. 83, 000 (Budgeted Rs. 80,000)

Actual fixed administration cost : Rs. 96,000 (Budgeted Rs.1,00,000)

Actual Variable administration Cost : Rs. 62,500 (Budgeted Rs. 1 per unit)
(50,000 units @ 1.25 per unit)

[Ans. : Total variance from flexible budget : Rs. 1,27,500 (Unfavourable)]

Total variance from Master budget : Rs. 2,39,000
(Unfavourable) ]
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Budgeting and 12) From the following controllable and non-controllable costs relating a
Budgetary Control manufacturing company for 31st March, 2003, prepare a performance budget by
comparing actual results with the flexible and master budget :
Standard budget based on 20,000 units :
Controllable Costs : Non Controllable Costs :
Rs. Rs.
Indirect Labour 70,000 Supervision 34,000
Indirect material 20,000 Rates and taxes 12,000
Fuel and power 56,000 Insurance 2,000
Maintenance 12,000 Depreciation 15,000
1,58,000 63,000
The actual production during the year was as follows :
Controllable costs : Actual Costs Budget based on
18,000 units actuals
Rs. Rs.
Indirect labour 63,000 65,000
Indirect material 21,000 18,000
Fuel and power 56,000 51,400
Maintenance 12,000 11,600
1,52,000 1,46,000
Non-controllable costs :
Supervision 32,980 31,600
Rates and taxes 12,000 12,000
Insurance 2,000 2,000
Depreciation 15,000 15,000
61,980 61,600
[Ans. Total Variance from flexible budget : Controllable costs Rs. 6000 (U),
Non Controllable Costs : Rs. 1380 (U), Total variance from Master budget :
Controllable costs : Rs. 6000 (F) Uncontrollable costs : Rs. 1020 (F) ]

Note : These questions will help you to understand the unit better. Try to write answers
for them. But do not submit your answers to the University. These are for your
practice only.

10.14 FURTHER READINGS

Prem Chand, 1969, Performance Budgeting, Academic Books : New Delhi.
Pyhrr, Peter, A. 1973, Zero Base Budgeting, John Wiley and, Sons ; New York.`

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