What is Flexible budget and overhead variance?

What is Flexible budget and overhead variance?

Fixed or static budget

Meaning of fixed budget

A budget prepares for a predetermined activity and condition is called a static budget. It covers the difference activities related to production and sales under the given level of operation. Static budget is based on a single level of activity. It does not take into consideration any change in expenditure arising out of changes in the level of activity. It is a rigid budget and drawn on the assumption that there will be no charge in the level of activity. For example, a manufacturing concern plans to produce and sale 10, 000 units of goods for next year, the budget prepared for the units of goods is termed as a fixed budget. More precisely, the purchase budget, sales budget, cost of goods sold budget, cash budget etc made for the above are termed as fixed or static budget. A fixed or static budget will be useful only when the actual level of activity corresponds to the budgeted level of activity. A static budget is prepared under the following situations.

• The level of production and sales does not change even in long run.

• There is no necessity to produce new products.

• The changes in the needs and interest of the consumers do not affect the demand of the product.

However, due to the dynamism of business envinmont, the level of production and sales also fluctuates. Hence, a static budget does not facilitate planning and cost control which makes it necessary to prepare flexible budget.

Limitations of fixed budget

The following are the limitations of a fixed budget.

• A static budget assumes that there will not be any change in the working condition which is not a realistic assumption.

• It does not make any adjustments that arise due to the changes in production, sales and other activities.

• It hardly uses a mechanism of budgetary control as it does not make any distinction between fixed, variable and semi-variable costs.

• It does not have any mechanism of performance appraisal.

• A static budget is meaningless when the working conditions change.

• It does not provide any meaningful basis for comparison and control. It has a limited application and is not an effective tool for cost control.

• It is not helpful for the fixation of price and submission of tenders. If the budgeted and actual activities levels vary, the ascertainment of costs and fixation of prices becomes difficult.

Flexible budget

A budget that is prepared under difference level of activities is known as flexible budget. A flexible budget has difference budget costs for the difference level of activities. It is based on the assumption that there might be the changes in the production, sales and working conditions. Under flexible budget, difference levels of activities are planned are planned and the variable, semi variable and fixed costs ae calculated under those levels to calculated the profit or loss.

Institute of cost and management association (London) defines the flexible budget as ' A budget which by recognizing the difference between fixed and variable cost, designed to change in relation to each level of activities attained.

The chartered institute of management accountants, London defines "a flexible budget is a budget, which is designed to change in accordance which the level of activity actually attained."

In this way, a flexible budget gives difference budgeted costs for different levels of activities. A flexible budget is prepared after classifying the costs into fixed, variable and semi-variable as the effectiveness of a flexible depends upon the accuracy with which the expenses are classified.

Need and importance of flexible budget

The need and importance of flexible budget may be explained in the following ways.

• A flexible budget helps preparing a realistic budget.

• It assists in the smooth operation of a business even in a volatile environment.

• Since the costs are classified into variable, semi variable and fixed under flexible budget, the analysis and control of costs are easier.

• A flexible budget provides necessary information so that an effective system of performance appraisal can be enacted.
Distinction between fixed and flexible budget
The difference between fixed and flexible budget are given below.

Preparation of flexible budget

The main objective of preparing a flexible is to control the cost. To prepare a flexible budget the following steps are to be considered.

a. Determine of the range of activity level: in to first step of preparation of flexible budget, the range of activity level should be determined. For example, if the normal capacity of a factory is 10,000 units, the probable range of activity levels would be 1,000 units, 2,000 units to 10,000 units.

b. Identification of cost behavior: the cost behavior refers to the determination of relationship between cost and activity. In other words, it is identifying the cost as variable, semi- variable and fixed.

c. Segregation of mixed cost: if the cost is semi variable, it has to be segregated into variable and fixed components. For this high-low cost or least square method can be adopted as mentioned in chapter2.

d. Preparation of flexible budget: after segregating the mixed costs into variable and fixed, flexible budget is prepared under difference levels of activity.

Flexible budget can be prepared by the following methods

i. Formula method

j. Tabulation method

Formula method

Under formula method, flexible budget is prepared considering the cost factors and their relationship. It can be explained as under.

Budgeted allowance= fixed cost + (unit variable cost x level of activity)

Or, BA = FC + (UVC X LA)

Tabulation method

We can prepare flexible budget by using tabulation as well. This can also be down in two ways as shown below.

a. Without showing the semi variable costs separately: under this, the semi variable costs are segregated into variable and fixed costs and shown them in their respective heading i.e. fixed and variable.

b. Showing the semi variable costs separately: under this, the semi variable costs are serrated into variable and fixed costs and the semi variable cost for difference levels are calculated shown under its heading as shown below:

Overhead variances analysis
Concept of overhead variance analysis
Overhead costs are the sum of indirect material, indirect labour cost and indirect expenses. These expenses are not directly absorbed by a product or service or department and cannot be easily identified to a unit cost. These are costs, which cannot be wholly debited or charged directly to a particular job, product or services.
For the purposes of controlling costs, certain standards are determined are determined in advance. After competing jobs, theses standards are compared with the actual costs as to find whether any difference between the standard and actual exists. The main purpose of such comparison is to ensure the work has been completed at the cost as determine in advance. Specifically, the difference between the standard overhead and the actual is called the overhead variance. The analysis of the differences between the standard overhead and actual overhead incurred is called the overhead variance analysis. It can be done in a number of ways as mentioned below.

Out of the above mentioned variance analysis, the three overhead variance analysis has been mentioned below:
Analysis of three overhead variance
Under this method, production volumes is expenses in units of hours and well examine three elements of the overhead cost variance-spending or expenditure variance, capacity variance and efficiency variance.
a. Overhead spending or expenditure variance: the most importance of the overhead costs variance is the spending or expenditure variance. This variance is the difference between the standard overhead allowed for a give level of output and the actual overhead costs incurred during the period. This measure the difference between the actual overhead costs incurred and the correct efficiency and inefficiency in spending because the variable overhead will vary with the number of actual hours worker rather that the standard. The spending variance is typically the manager. In many cases, much of the spending variance involves controllable overhead costs. For this reason, it sometimes is called the controllable variance. This variance Is found by using the following formula:
If the budgeted overhead costs exceed the actual overhead costs (positive result), the variance indicates favorable and vice-versa.
b. Overhead capacity variance: it is that portion for the overhead variance, which is due to the difference between the standard cost of overhead absorbed on actual output and standard overhead cost. It is that portion of the variance, which is due to working at higher or lower capacity that the budgeted capacity. In short, this variance arises due to more less working hours than the budgeted working hours. This variances is found the following formula:
If the standard overhead cost for standard hours produced exceeds the standard overhead cost of normal capacity (positive result), it indicates favorable variance and vice-versa.
c. Overhead efficiency variance: it is the variance, which is due to the difference between the budgeted efficiency of production and the actual efficiency achieved. This variable is related with the efficiency of workers and plant. Basically, it is the difference between the budgeted allowances of factory overheads for standards for standard hours applied and the budgeted allowance of such overhead for the actual used. Efficiency variance is only due to the under or over application of variable overheads, because of more or less use of productive hours does not change the total amount of fixed cost. Fixed overhead have no impact in efficiency variance. This variance  is found by using the following formula:
If the standard overhead cost of standard hours produced exceeds the standard overhead cost of actual hour produced (positive result), the variance indicates favorable and vice-versa.
Calculation of overhead variances
Formula method
The way of calculating the overhead variance by using formula are given below.
a. Capacity variance= (standard hours x standard rate) – (fixed  overhead + (standard variable overhead rate x standard hours))
CV= (SH X SR) – {FO + (SVOR X SH)}
b. Efficiency variance = standard variable overhead rate (standard hours – actual hours)
EV= SVOR (SR – AH)
c. Spending variance = budgeted overhead at actual hours – actual overhead incurred
SV= FO + (SVOR X AH) _ Actual overhead paid

1. What is a flexible budget?

A budget that is prepared under different level of activities is known as flexible budget. A flexible has different budgeted costs for the different level of activities. It is based on the assumption that there might be the change in the production, sales and working conditions. Under flexible budget, different levels of activities are planned and the variable, semi variable and fixed costs are calculated under levels to calculate the profit or loss.

2. Write any five differences between static and flexible budget.

The difference between fixed and flexible budget are given below.

1. Level of activity: fixed budget is bases on only one level of budgeted activity. Under flexible budget, the budget is prepared at different levels of activities.

2. Flexibility: fixed budget is fixed, and does not change with the actual volume of output achieved but flexible budget it is flexible and can be prepared at any level of activity to be attained.

3. Comparison: comparison of actual and budget performance cannot be made correctly if the actual volume of output differs in fixed budget but comparisons are realistic as the planned figures can be compared against the actual.

4. Condition: fixed budget assumes that the working condition always remain the static where flexible budget assumes that the working condition change according to the change in external environment.

5. Cost classification: under fixed budget, there is no providing of cost classification but in flexible budget, costs are classified according to their variability i.e. variable, fixed and semi variable.

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What is Budgeting for profit planning and Types of budget

What is Budgeting for profit planning and Types of budget?

Introduction

Concept of budgeting

The their importance functions of management are planning and control. Planning relates to the future, operating the present a control for the past. For assisting the management in the functions of planning and control, two techniques are applied i.e. budget and standard costing system. Budgeting is usually operated with a system of standard costing therefore both the systems are under related these systems are not interring dependence.

Generally, the word budget is concerned with the limitation on spending. For example, government approves spending budgets for their various bodies. Then they expect the bodies to keep their expenditures within the limit prescribed by the budget. In contract most business organization use highlights potential problem on company operations and finances. Not just to limit spending, budgets highlights potential problems and advantages early, allowing manager to take steps to avoid these problems or use the advantages wisely.

A budget is a tool that helps manager in planning and control functions. In interestingly budgets helps with their control functions not only by looking forward but also looking backward. Budget, of course, deal with what manager's plan for the future. However, they can also be used to evaluate what happened in the past. Budget can be used as benchmark that allows managers to compare actual performance with estimated or desired performances.

According to Chartered institute of management accountants, London, "a financial statement or a quantitative statement prepared and approved period to a defined period of time of the policy to be purposed during that period for the purpose of attaining a given objective."

According to R.H garrison. "a budget to the detailed plan outlining the acquisitions and use of financial and other resources over some given time period. It represents the plan the future expressed in formal quantities term. The act of preparing a budget is called budgeting. The used of budget to control form's activities as budgetary control."

 Recent servers' show just how valuable budget can be study after has shown the budget to be the most widely used and highest rates tools for cost reductions and control. Advocates of budgeting go so for as to claim that the process of budgeting a manager to become a better administrator and puts planning in the forefront of the manager's mind. Actually, many seemingly health business have closed down because managers failed to drawn up, monitor and adjust budgets to changing conditions.

Budget refers  to ' accounting for future', budgeting summarized the estimated result of further transaction for the entire in must the same manner as the accounting process records and summarizes the result of completed transactions.

Futures of budget

The importance features are given below:

a. Budget is a plan: a budget is an expression of the plan of the operation of an enterprise. The operations of an enterprise are affected by a number of factor both external (such as general business conditions, government policy and size and composition of population) and interest (such as manufacturing processor, promotional programmers). A budget covers both external and internal factors and express partly, what the management expects to happen and partly what the management intends to happen.

b. It is comprehensive: a budget is comprehensive which means that it covers the activities and operations of all the segment or divisions of an organization. Budgets are prepared for each segments or division of an organization and departments of an organization.

c. It provides a co-ordinate plan: the budgets are prepared for variable segments or divisions of an organization after considering the conditions and problems of each segment. A budget helps bring co-ordination among the sections and departments of an organization.

d. It is prepared in advance: a budget is prepared in advance and includes the future courses of action. Thus, a budget is forward looking in approach.

e. It is future oriented: a budget always relates to a specified future period. A budget becomes planned to be achieved in a pre-determined time.

Objectives of preparing budget

The general objectives of preparing a budget can be summarized as follows:

a. To plan the policy of a business for the coming for achievement of the firm's objectives and its transaction into monetary and quantitative terms.

b. To determine the responsibility of each department and executive so that they are made accountable for definite and precise results.

c. To, co-ordinate the activities of a business so that each is a part of an integral total.

d. To provide for continuous comparison of actual and budgeted performance in terms of result achieved and cost incurred so that cause of any inefficiency is immediately detected and removed.

e. To control ad direct each function so that best possible results may be obtained.

f. To provides for the revision of budgets for future in the light of experience gained.

Purpose of budgeting system

A budget is a detailed plan that is expressed in quantitative terms which specified how resources will be acquired and used during a specified period of time. The procedure used to develop a budget constitutes budgeting systems. A budgeting system has five primary purposes.

a. Planning: the most obvious purpose of a budget is to quantity a plan of action. The budgeting process faces the individual who make up an organization to plan ahead. The development of a quarterly budget of an organization, for example, forecast the manager of the organization to plan for the staffing and suppliers needed to meet anticipated demand for the organization's services.

b. Facilitating communication and co-ordination: for an organization to be effective, each manager throughout the organization must be aware of the plans made by order managers. In Oder to plan reservation and ticket sale effectively manager for Nepal airlines must known the plans schedules development by the airlines router manager. The budgeting process pulls together the plans f each manager and another community services.

c. Allocating resources: generally organization's resources are limited and budgets provide on means of allocating resources among competing uses. The national Metropolitan municipality for example, must allocate its revenue among basis life services, maintenance of property and equipment and other community services.

d. Controlling profit and operations: a budget is a plan and plans are subject to change. Nevertheless, a budget serves as a useful benchmark with which actual results can be compared. For example, an insurance company can compare its actual sales of insurance policies for a year against its budgeted sales. Such comparison can hep managers evaluate the firm's effectiveness in selling insurances policies.

e. Evaluating performance and providing incentives: comparing actual result with budgeted results also helps manager to evaluate performance of individuals, department, divisions or entire companies. Since budgets are used to evaluate performance, they can also be used to provide incentive for people to perform well. For example, investment bank, like many other banks, provides incentives for managers to improve profit by awarding to managers who meet or exceed their budgeted profit goals.

Limitations of budget

The main limitations of budget may be given as follows:

a. Use of estimated figure: budget relates to figure and involves forecasting and estimations, which may not be accurate to the full extent. If the estimates are not converted, the budget target may be useless.

b. Expensive system: the installation and operation of a budgeting system is very costly, since it requires the engagement of large force of technical and qualified staff. As such budgeting may not suitable for small undertakings having limited financial resources.

c. Opposition by staff: budget provides yardsticks against which the performances of the executive and works are to be measured. The inefficiency on the part of any person involved in the organization is immediately known which calls for corrective action. As such inefficient executives and workers generally create difficulties in the way of operating this system.

d. It is simple a tool of management: the system of budgeting cannot eliminate the necessity of superior executive ability in every business decision. As such budgeting is simple a tool of management and cannot take the place of management.

e. Lack of flexibility: budgets are prepared after a lot of group done by different departments. These brininess executives treat the budgeted figures as the final figures and stick to them.

Types of budget

 A budget may be classified according to a number of bases as given below.

The difference budgets under the functional classification have mentioned below in detail.

Sales budget
A sales budget is the starting point in preparing the master budget. A sales budget is a detailed schedule of expected sales expected sales for the coming period. It is usually expressed in both amount and units. Once the sales budget has been set, a decision can be made on the level of production that will be needed to support sales and the production budget can be set well. The sales budget is constructed by multiplying the expected sales units by sales price. Generally, a sales budget is accompanied by computation of expected cash receipt for the forthcoming budget period. This computation is needed to assist in preparing the cash budget for the year. Expected cash receipts are composed of collections on sales made to customers.
Unless there is realistic sales plan, practically all other element of a plan will be out of touch with reality. The sales plan is foundation of period planning in the firm because practically all other enterprise planning is bluff on it. The primary sources of cash is sales, the capital additions needed, the amount of expenses to be planned, the manpower requirements, the production level and other important operational aspects depend on the volume of sales. In harmony with a comprehensive profit plan, both strategic long term and tactical short-term sales plan must be developed.
There are some factors which are to be considered while preparing as sales budget.
a. Past sales: a sales budget is prepared on the basis of the past sales and its trend. The effects of some external factor like climatic condition, business cycle, trade cycle, economic conditions etc are adjusted and the future sales figure are adjusted.
b. Estimation of sales manager: the estimation of difference sales managers working in sales areas are also taken into consideration while preparing a sales budget.
c. Capacity of equipment: A sale is possible only when there is sufficient production. The production depends on capacity of equipment. In this way, the capacity of equipment is one factor that affects the preparations of sales budget.
d. Available of raw material: it is necessary to have enough raw materials so as to have production and sales. So, available of raw materials is one factors that affect the sales budget.
e. Competition: the level of competition also determines sales, so, it should also be considered while preparing a sales budget.

The format of sales budget is as under,

Alternatively

Production budget
Production budget is prepared after preparing the sales budget. Production budget is an estimation of the quantity of goods to be manufactured during the budget period. In the preparation of production budget, the first step is to formulate polices relative to inventory levels. The next step is to determine the total quantity of each product that is to be manufactured during the budget period. The third step is to schedule this production to interim periods.
This budget is prepared by the production manager based upon sales budget, desired ending inventory and production capacity. Following point should be considered while preparing the production budget.
• Sales budget
• Beginning and ending inventory policy
• Installed plant capacity and existing utilization
• Policy of the management manufactured or purchase of component
• Production cycle
The format of production budget is given below:

Material consumption budget

After the preparation of production budget, a direct materials budget should be prepared to show the material that will be required in the production process. Sufficient materials will have to be available to meet production needs and to provide for the desired ending raw materials inventory. However, some quantity of material requirement will already exist in the form of a beginning g raw materials inventory. The remainder will have to be purchase form a supplier. This budget specifies the planned quantities of each raw material by time, by product and by using responsibility.

The format of material consumption budget is as under.

Material purchase budget

Direct materials are required for the production and must be purchased in each period in sufficient quantities to meet production needs and to confirm to the company's ending inventory policy. The material budget specifies the quantities and timing of each raw material needed, therefore a plan for material purchase must be developed. Material purchase budget is prepared on the basis of material consumption budget. It specifies the ending inventory raw material on the basis of material purchased and the estimated cost for each raw material.

Material purchase budget

Direct materials are required for the production and must be purchased in each period in sufficient quantities to meet production needs and to confirm to the company's ending inventory policy. The material budget specifies the quantities and timing of each raw material needed, therefore a plan for material purchase must be developed. Material purchase budget is prepared on the basis of material consumption budget. It specifies the ending inventory raw material on the basis of material purchased and the estimated cost for each raw material.

The format of material purchase budget is as under.

Direct labour budget
Direct labour is also prepared on the basis of production budget. The direct labour included the estimates to direct labour requirement necessary to product the types and quantities of output planned in the production budget. Direct labour requirement must be computed in order to know the sufficient labour time to meet production needs. By knowing in advance, the company can develop a plan to adjust the labour force as the situation may require. Planned direct labour hour can be determined by multiplying product to be produced in each period by the number of direct hour can be determined by produce a single unit. The hour of direct labour resulting from these calculations can then be multiplied by direct labour cost per hour to ob train the budgeted total direct labour cost.
The components of direct labour budget are calculated as under.
Total direct labour hour required= production unit x standard time required per unit of output
Total direct labour cost= total labour hours x labour cost of wages rafter per hour.
The above information can be obtained through the following table as well.

Overhead budget

The term ' overhead means all the expenses of an organization except direct material and direct labours. Overhead includes both fixed and variable. Estimation of expenses except direct material and direct labour is overhead budget. These are three types of overhead budget, which are given below. The last two budget are also known as operating expenses budget.

a. Manufacturing overhead budget

Manufacturing overhead is the significant portion of the production cost which is not directly identifiable with specific products. Or job. The manufacturing overhead budget provides a schedule of all costs of production, other than direct material and direct labour. Manufacturing overhead includes both fixed and variable, therefore, these costs should be broken down by cost behaviors as variable and fixed for budgeting purposes and a pre-determined overhead rate should be developed. This rate will be used to apply manufacturing overhead to the units of product throughout the budget period.

Manufacturing overhead may include cash and non-cash items both. Non-cash items like depreciation of factory building and plan and machinery are excluded and only the cash manufacturing overhead are shown in cash budget.

The format of manufacturing overhead budget is as under.

b. Office and administrative overhead budget

Administrative overheads included those expenses of the business, which will be incurred in case of administrative functions. They are incurred in the responsibility centers that provides supervision of and service to all functions of the organizations, rather than in the performance of any functions. Generally, administrative expenses are fixed installed of variable; therefore, they cannot be controlled. Most of administrative expenses except manager's salary are fixed by the management decision. Office and administrative overhead may include cash and non-cash item both. Non-cash items like depreciation on administrative overhead are shown in cash budget.

The format of office and administrative overhead budget is as under.

c. Selling and distribution overhead budget
Selling and distribution overhead include all costs related to selling and distribution of good to the customer. In most of the organization the cost is a significant portion of total overhead. Effective planning of such overhead affects the profit potential of this firm.

Selling and distribution also be fixed and variable both. Variable selling and distribution overhead will be calculated on total amount on the basis of sales unit because these costs are period cost. Selling and distribution may include cash and non-cash items like depreciation of delivery van will be exceeded and only the cash selling and distributions overheads are shown in cash budget.
The format of selling and distribution overhead budget is given below:

Cash budget

Whether the organization big or small whatever it may be if there is profit and no cash but out of that profit it could not its obligation. To meet the obligation cash is necessary; therefore, the cash budget is one of the most significant statements prepared during the budget period without cash the existence of the company is impossible. Cash budget is prepared after all the operational budgets and capital expenditure outlays have been accomplished. Cash budget provides the information regarding beginning balance of cash, cash receipt, and cash disbursement and ending balance of cash for the budgeted period. Most company prepares both long-term and short-term plans about their cash flow. The short-term cash budget is included in annual profit plan. Generally, there are two parts two parts in the cash budget (1) the planned cash receipts, (2) the planned cash disbursement. Planned cash receipt provides the information regarding sources of cash inflow in the business and planned cash disbursement provides information about utilization of cash in the various sectors of the business. The objective of cash budget is to ensure that sufficient cash is available at all times to meet the level of operations that are outlined in the various budgets.

The cash budget includes the four major sections:

a. The receipt section: it consists of the beginning balance of cash added to whatever is expected in cash in the way of cash receipts the budget period. The major sources of receipt are the sales.

b. The disbursement section: it consists of cash payment that is planned of the budget period, these payments will include raw material purchases, direct labour payments, manufacturing overhead, are income tax, capital equipment purchases, dividend payment etc.

c. The balance section: it consists of the difference the cash receipts section total and the cash disbursement section total. If a deficiency exists, the company will need to arrange for borrowed funds from its bank. If excess exists, fund borrowed in previous period can be repaid or the idle fund can be placed in short-term investment.

The format of cash budget is given below:

Master budget in case of non-manufacturing concern

Non-manufacturing concern is also known as merchandised. The examples of merchandised business are: retailer, wholesale or department store etc. the budgeting procedure in case of a merchandised business will be the same se the process discussed above for a manufacturing business except that it does need (I) production (II) raw material (III) direct labour and (IV) manufacturing overhead. Instead of production, the merchandise firms purchases the ready for sales goods and sell them. In case of merchandise firm it would prepare merchandise purchase budget instead of production budget preparation of master budget for non-manufacturing in as follows:

The following schedules are most often completed case of a merchandised firm

• Sales budget

• Merchandised purchase budget

• Operating expenses budget

• Cash budget

1. Write the meaning of budget.
A budget is a tool that helps manager in planning and control functions. Budget help with their control not only by looking forward but also looking backward. Budget, of course, deal with what manager's plan for the future. However, they can also be used to evaluate what happened in the past. Budget can be used as benchmark that allows managers to compare actual performance with estimated or desired performances.
2. Write any five feature of budget.
The importance of budget are given below.
a. Budget is a plan: a budget is an expression of the plan of the operation of an enterprise. The operations of an enterprise are affected by a number of factor both external (such as general business conditions, government policy and size and composition of population) and interest (such as manufacturing processor, promotional programmers). A budget covers both external and internal factors and express partly, what the management expects to happen and partly what the management intends to happen.
b. It is comprehensive: a budget is comprehensive which means that it covers the activities and operations of all the segment or divisions of an organization. Budgets are prepared for each segments or division of an organization and departments of an organization.
c. It provides a co-ordinate plan: the budgets are prepared for variable segments or divisions of an organization after considering the conditions and problems of each segment. A budget helps bring co-ordination among the sections and departments of an organization.
d. It is prepared in advance: a budget is prepared in advance and includes the future courses of action. Thus, a budget is forward looking in approach.
e. It is future oriented: a budget always relates to a specified future period. A budget becomes planned to be achieved in a pre-determined time.
3. Write any five functions of budget.
The function of preparing a budget can be summarized as follows:
a. To plan the policy of a business for the coming for achievement of the firm's objectives and its transaction into monetary and quantitative terms.
b. To determine the responsibility of each department and executive so that they are made accountable for definite and precise results.
c. To, co-ordinate the activities of a business so that each is a part of an integral total.
d. To provide for continuous comparison of actual and budgeted performance in terms of result achieved and cost incurred so that cause of any inefficiency is immediately detected and removed.
e. To control ad direct each function so that best possible results may be obtained.
f. To provides for the revision of budgets for future in the light of experience gained.

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What is Standard costing?

What is Standard costing? 

Standard costing

Concept of standard costing

Meaning of standard cost

Standard cost is the cost that is expected to incur while producing goods or providing services. This is also called budgeted cost or planned cost. The main objective of anticipating the cost in advance is to carry out the production activities beneath the pre determined cost. After completing the work, the actual cost is compared with the standard cost for finding the deviation or variance. In this way, the main objective of standard cost is to ascertain the deviation between the standard and actual costs as to control cost.

The features of standard cost are given below:

a. It is a pre determined cost.

b. It is a future cost since it is expected to take place in future.

c. It is estimated on the basis of past costing information.

d. It is related to product, services, process etc.

e. It is determined on the basis of normal capacity.

f. It is used to assess performance efficiency for future.

In this way, standard cost is determining the cost to be incurred in future in advance under some specific conditions.

Meaning of standard costing

Standard costing is the preparation of standard cost and applying them to measure the variations that is caused due to the difference between the standard and actual cost. Such a difference is also called variation. The main reason behind calculation of such variance is to maintain the maximum efficiency in production. It is a management accounting tools for control.

According to Brown & Howard, "standard costing is a technique of cost accounting, which compares the standard cost of each product or service with actual cost to determine the efficiency of operation, so that any remedial action may be point of immediately."

Likewise, according to institute of cost and management accounting, London "standard costing is presentation and used of standard costs, their comparison with actual cost and the analysis of variances to show their causes and point of incidence."

From the definition given above, it is clear that the technique of standard costing may comprise:

a. Ascertainment of standard costs under each element of cost i.e. on material, on labour and on overhead.

b. Measurement of actual cost.

c. Comparison of the actual costs with the standard costs to find out the variance.

d. Analysis of variance for the purpose of ascertainment of reason of variances for taking the appropriate action where necessary. So that maximum efficiency may be achieved.

Standard costing and budgetary control

Budget and standards both provided the basis for comparison with the actual results. Budgetary control is another importance technique of cost control. In budgetary control, budgets are used as a means of planning and controlling. In budgeting control,  the target of various segment are set in advance and actual performance is compared with predetermined object through which management can access the performance of difference departments. On the other hand, standard costing also sets standard and enables to determine efficiency on the basis of standard costing also sets and actual performance. But one should not be confused between the budgetary control and the standard costing. If both standard costing and budgetary control serve the same purposes then which one should be used? There are two opining about the use of these systems. One opining is that budgetary control is essential to determine standard cost. The other opinion is that standard costing system is necessary for planning budgets. If it possible then both systems will be beneficial in planning and controlling expenditures. Both are similar in their nature and in determining the results.

Difference between standard costing and budgetary control

Besides, similarities in their nature, the following are the points of distinction between these two systems.

Advantages of standard costing
The advantages of standard costing are given below.
a. Measuring efficiency: standard costing provides yardsticks against which actual costs are compared to ascertain efficiency of actual performance. Thus, standard costing helps in exercising cost control and provides information, which is helpful in cost reduction.
b. Determination of variance: by comparing actual cost with standard costs variances are determined. Analysis of variance will assist to single out inefficiency and locate person who are possible to take corrective measures at the earliest.
c. Facilitates cost control: every costing system aims to cost control and cost reduction. Standard costing helps in exercising cost control and provide information, which is helpful in cost reduction.
d. Eliminating inefficiency: standard costing will make possible to eliminate inefficiency at different steps of activities relating to materials, labour and overheads. Because setting standard require detailed study of various operations so that they may be made efficiency.
e. Helpful in taking important decisions: standard costs being predetermined costs and useful in planning and budgeting, it provides a valuable guidance to the management in taking important decision. The problem created by inflection, rising prices can be effectively taken with help of standard costing.
Disadvantages of standard costing
The disadvantages of standard costing are given below.
a. Difficulty in establishing standards: it is very difficult to establish standard costs of materials, labor and overheads. So, sometimes in accurate and out of date standards are set which do more harmful than any benefit as they provides wrong yardsticks.
b. Expensive: This system is expensive so small concerns may not afford to bear the costs. Establishment of standard costing requires high degree of technical skill.
c. Ignorance to qualitative aspects: standard costing system controls the operating part of an organization only as it ignores the other aspects like quality, lead time, service, customer's scarification and so on.
d. Assumption of constant condition: conditions of the business are changing. Hence, standard must be revised form time but it us very difficultly bringing changes in standard and is also expensive. Non-flexible standard loose their importance.
Pre-requisites or preliminaries of standard costing
The following are the pre-requisites for the establishment of standard costing in an organization.
a. Establishment of cost center
b. Determination of the types of standard
c. Setting of standards
Establishment of cost center
A cost centers is a department or part of department or items of equipment or machinery or a person or a group of persons in respect of which costs are accumulated and one where control can be exercised. Cost center are necessary for determining the cost and cost control. Hence, one of the pre-requisites of standard costing is to establish the necessary cost centers.
Determination of the types of standard
Under standard costing, the types of standard should be determined after setting up the cost centers some of the standards have been mentioned below.
a. Current standard: the standard fixed for short period is known as current standard. It reflects the performance, which should be attained during the current period. The period for current standard in normally one year.
b. Ideal standard: ideal standard represents a high level of efficiency. Ideal standard is fixed on assumption of favorable condition that may rarely exist. In this standard the deviation between target and actual performance are ignoble. Idle standard is not realistic and practicable.
c. Expected standard: this standard is based on expected conditions. This standard is based on past performances and present conditions. In these types of standard, variance between the budgeted targets and actual performance gives an idea about the efficiency or inefficiency of different individuals.
d. Basic standard: a basic standard may be defined as a standard, which is established for use for an indefinite period, which may be for a long period. These standard are revised only on the changes is specification of material and technology production.  Basic standard cannot serve as a tool for cost control because the standard is not raised for a long time. The deviation between standard cost and actual cost cannot be used as a yardstick for measuring efficiency.
e. Normal standard: this standard is average standard. Normal standard anticipated can be attained over a future period of time. This standard is based on the conditions, which will cover a future period say 7 to 10 years, concerning one trade cycle.
Setting the standard
The third pre-requisites of standard costing system is setting the standards. The act of setting the standards for material, labour and overhead comes under this. The standard may be both monetary and non monetary. The standards are fixed for each elements of cost as follows:

Analysis of variance

The objective of standard costing is to exercise cost control and reduction. The comparison of the performance target with actual performance will enable a control system cost. Control and reduction are possible through the efficiency in the use of material and labour. The deviation between standard costs and actual costs is known as variances. In simple way, the difference between standard cost and actual cost is known as variances. The variance may be favorable or unfavorable. If actual cost is less than the standard cost, the variance will be favorable. On the contrary, if actual cost is more than the standard cost, the variance will be efficiency and vice versa. Variances of different items of cost provides the  key to cost control because they disclose whether and to what extent standard set have been achieved.

Another way of classifying to variance may be controllable and uncontrollable variance variance are competed under each element of cost for which standard have been established. As the ascertainment of variances is not in itself control, each of these variances is analyzed to find out the causes or circumstances leading to it. So those, the management can exercise proper control. A suitable analysis will reveal that some of the time taken by an operator exceeds the standard time set; responsibility for the unfavorable variances may be fixed on the executive concerned. Such variances would, therefore be controllable. On the other hand, if variances arise due to external causes such as labour disputes, general increase of wages rates in a particular trade, devaluation of currency, variation in customer's demand, no responsibility can be assigned to any individual, such variances would therefore, be unfavorable variances.  Uncontrollable variance does not relate to an individual or department but it arises due to external reasons. Uncountable variance dies not relate to an individual or department but it arises due to external reasons. Analysis of variances of variance may be done in respect of each element of cost. The costs variance may be classified into three parts are as under:

a. Material variances

b. Labour/ wages variances

c. Overhead variances

Material variance
Material variances are more popularly known as materials cost variable (MCV). The material cost variance is the difference between the standard cost of material that should have been incurred is manufacturing the actual output and in cost of material that has been actually incurred. The material variances may be classified as under.
Material cost variance
Material cost variance is the difference between standard materials cost and actual material cost. Material cost variance (MCV) depends on two factors. The quantity of materials used and the price paid for materials. This material cost variance is computed after ascertaining the actual cost of material in production. Material cost variance is calculated as follows:
a. Formula method
Material cost variance= standard cost – actual cost
= (standard quantity of material x standard price per unit) – (actual quantity of materials x actual price per unit)
Or, MCV = (SQ x SP) – (AQ x AP)
Material cost variance = material usage variance + material price variance

b. Table method

MCV = M3 – M1

Where,

M1= AQ x AP;

M3 = SQ x SP

Labour idle time variance
This is sub variable of labour efficiency variance. Idle time variance occurs when workers remain idle due to  some reason during hours for which they are paid. Idle time occurs due to non-availability of raw materials, breakdown of machines, failure of power and such other abnormal circumstances.
Idle time variance is always adverse or unfavorable and needs investigation for its causes. It will show inefficiency on the part of works through they are not responsible for this. Labour idle time variance is calculated as follows:
Labour idle time variance = idle time x standard wages rate
Or, LITV = IT x SR

Labour mix variance
It is also of labor efficiency. Labour mix means gang composition. Labour mix variance refers to the same as a material mix variance. Usually, a manufacturing process requires difference types or categories or skill or work such as skilled, semi-skilled, men and women etc. the composition of actual labour gang may not be same to the standard labour mix. The changes in labour composition may be caused by the shortage of one grade of labour of labour necessitating the employment of another grade of labour. This variance shows the management how much labour cost variance is due to the change in labour composition, which may cause a favorable or unfavorable effect in the direct labour cost of the batch of actual production. Labour mix variance is calculated as follows:
a. Formula method
Labour mix variance= (actual mix/ standard mix x standard cost of standard mix) – (standard cost of actual mix)

b. Table method

LMC = L3- L2

Where, L2= ACT x SR, L2= ACT x SR2

SR, standard rate in actual mix= {A Nos. x SR)

SR, standard rate in standard mix (s.No. x SR)

Labor yield variance

It is like material yield variance, labour yield variance arises due to the difference between standard yield (output) and actual yield. If the actual production is more or less output than the output than they should have produced as per the standard, the deviation due to this effect is called labour yield variance. It is also known as labour efficiency sub variance with comparing the two outputs if actual output is more than standard, labour yield variance is favorable. If actual output is less than standard, labour yield variance is unfavorable. This variance can be calculated as follows:

1. Write the meaning or standard cost.

Standard cost is the cost them is expected to incur while producing goods or providing services. This is also called busted cost or panned cost. The main objective of anticipating the cost in advance is to carry out the production activities beneath the pre determined cost. After completing the work, the deviation or variance. In this way, the main objective of standard cost is to ascertain the advection between the standard and actual costs as to control cost.

2. What is standard costing?

Standard costing is the preparing of standard costs and applying them to measure the variation that is caused due to the difference between the standard and actual cost. Such a difference is also called variation. The main reason behind calculations off such variance is to maintain to maximum efficiency in production. It is a management accounting tools for control.

3. What is budgetary control?

Budgetary control is an importance technique of cost control. In budgetary control, budgets are used as a means of planning and controlling. In budgetary control, the target of various segments are set in advance and actual performance is compared with predetermined objects through which management can assess the performance of difference departments.

4. What are the differences between budgetary control and standard costing?

 The difference between budgetary control and standard costing are as follows:

a. Concept: standard costing is a unit concept but budgetary control is a total concept.

b. Objectives: the main objective of standard costing is to provide the basis for management control whereas the main objective of budgetary control is to aid in the planning for profit.

c. Basis: standard costs are fixed on the basis of technical information but the budgets are fixed on the basis of pat records and future expectations.

d. Use: standard costing is more sensible in case of manufacturing firms but budgeting is pervasive and common to all kinds of firms.

e. Scope: the scope of standard costing is narrow than the scope of budgetary control.

5. Write in brief about ideal standard and expected standard.

Ideal standard: ideal standard represents a high level of efficiency. Idle standard is fixed on assumption of favourative condition that may rarely exist. In this standard the deviation between target and actual performance are ignorant. Idle standard is not realistic and practicable.

Expected standard: this standard is based on expected conditions. This standard is based on past performance and present condition targets and actual performance gives an ideal about the efficiency or inefficiency of difference individuals.

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What is Reconciliation of profit between cost and financial accounts?

Reconciliation of profit between cost and financial accounts

Meaning and concept

Financial accounting is a branch of accounting that is primarily concerned with recording the financial transaction with a view to ascertain the result of operation condition. Under it, trading and profit and loss accounts are prepared to ascertain the result of business operation i.e. profit earned or loss suffered during a particular period of time. On the other hand, cost accounting is concerned with recording classifying, analysis and control of cost with the view of finding out the total cost of production. Under it, cost sheet is prepared to ascertain the profit made or loss suffered during a specific period of time.

When an organization has maintained both of these accounts, the profit or loss shown by them may not tally to each other due to some specific assumptions under them. Hence, it is necessary to find out the reasons of difference and adjust them accordingly for which, a statement is prepared called a cost recondition statement. Under it, the profit or loss shown by an account is ascertained by using the profit or loss shown by another account after adjustmenting the reasons of differences.

According to Eric L. Kohler, "reconciliation is the determining of the items necessary to bring the balances of two or more related account or statement into agreement."

As discussed earlier, reconciliation is necessary when the cost and financial accounts are maintained separately. It is not necessary where an integrated accounting system has been followed.

Need and importance of cost reconciliation statement

A bank reconciliation statement is prepared due to the following reasons.

• It helps checking the arithmetical accuracy of both set of account.

• It helps in finding out the reasons for the differences in profit or losses as shown by the accounts.

• It promotes coordination between cost and financial accounting department.

• It helps in formulation of polices regarding overheads, depreciation and stock valuation.

• It assists the management in decision making.

Causes or reasons for differences in profit or loss

The main reason of difference in profit between cost and financial accounts are as follows:

Items shown only in financial accounts

There are some items which are shown in financial accounts only. These items cause the difference in profit between the financial and cost accounting. The following are the items which are shown in financial accounts only.

Items shown only in cost account

There are some items which are shown in cost account only. These items are not shown in financial account. They are:

Over and under absorption of overhead

If there are difference between the overhead shown by the financial account and cost account, there cause in the difference in profit as shown by these accounts. Factory expenses, administrative expenses selling and distributions expenses comprise the overhead cost.

The effect of over or under absorption of overhead to profit is show in the following way.

Difference in stock valuation

If there is difference in the method of stock valuation between the financial and cost accounting, it results in the difference in profit as well. Under cost accounting, the stock valuation is done according to the cost price whereas in financial accounting it is done in cost or market price whichever is less. The profit shown by their accounts may differ due to this.

The effect stock valuation on profit is shown in the following table.

Difference in method of charging depreciation

In cost accounts depreciation is calculated on the basis of production unit or machine hour's method. In financial accounts, depreciation is generally charged on the basis of straight-line method or written down value method. Such difference in the method of charging depreciation causes disagreement in profit between cost and financial accounts. Overhead of depreciation indicates high cost resulting in low profit and under charge of depreciation indicates low cost resulting in higher profit. This has been shown below:

Preparation of cost reconciliation statement

The following steps are to be followed in preparation of bank reconciliation statement.

Step 1: in the first stage, the profit or loss shown by either cost or financial account account should be motioned as:

• Net profit as per cost account

• Net profit as per financial account

• Net loss as per cost account

• Net loss as per financial account Net profit as per cost account

Step 2: in the stage, the reasons of difference between the profit as per cost and financial accounts should be ascertained. Some of the reason of difference and their effects on profit have been shown below:

Step 3: in the third stage, the addition or subtraction is made according to the differences.

Step 4:  in the last stage, a reconciliation statement is prepared as under.

1. What do you mean by cost reconciliation?
The process of preparations of a statement in funding profit-loss of one accounting (statement) method on the basis of another accounting (statement) method is known as cost reconciliation. It is also known as the reconciliation between the cost and financial account. Cost accounting is prepared by cost accounting department where as financial accounting is prepared by financial accounting department.

The profit and loss obtained form both accounts may be different not because of error in system but because of the difference in producers and principle followed by their accounts. Thus, it is necessary to reconcile the profit between these two accounts.
2. When any the objectives of preparing cost-reconciliation statement.
The main objectives of preparing cost reconciliation statement are:
a. To check arithmetical accuracy and reliability of both accounting.
b. To co-ordinate between cost and financial accounting department.
c. To help in formulation policy regarding overhead depreciation and stock valuation.
3. Write any three causes of difference in profit and loss shown by cost and financial account.
The causes of differences in profit and loss shown by cost and financial account are as follows:
a. Items shown only in financial account and cost accounts only.
b. Over absorption and under absorption of overheads
c. Difference in stock valuation and in the method of charging depreciation.
4. List out the points which are shown only in financial account?
there are certain items which are shown only in financial account:
a. Interest on investment
b. Income tax
c. Profit or loss sales assets.

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