Cost Accounting & Management Accounting Flexible Budget & Zero Base Budgeting Lecture-40 Main Ahmad Farhan

ParticularsFlexible budget at 17,600 units Production level 16,000 units Production level 24,000 units Direct material26,40024,00036,000 Direct Labor17,60016,00024,000 Consumable Other variable overhead 3,6963,3605,040 Total variable cost48,40044,00066,000 Depreciation10,000 Other fixed cost5,000 Total63,40059,00081,000 Solution

Working Cost at 16,000 activity level Direct material = 30,000 / 20,000 x 16,000 = 24,000 Direct labor = 20,000 / 20,000 x 16,000 = 16,000 Consumables = 800 / 20,000 x 16,000 = 640 Other variable overhead = 4,200 / 20,000 x 16,000 = 3,360 Total variable cost 44,000 Add Fixed cost Depreciation 10,000 Other fixed cost 5,000 Total cost 59,000

Working Cost at 24,000 activity level Direct material = 30,000 / 20,000 x 24,000 = 36,000 Direct labor = 20,000 / 20,000 x 24,000 = 24,000

Question Capacity level Cost (Hrs) (Rs) 12009, , ,600 Prepare a flexible budget at 1100 hours

Solution CapacityCost Highest level1,2009,800 Lowest level 8007, ,200 Variable rate = Cost variance Capacity variance = 2,200 / 400 = 5.50 per hour

Solution Variable cost at 1,200 capacity level = 1200 x 5.50 = 6,600 Fixed cost = Total cost – Variable cost = 9,800 – 6,600 = 3,200

Solution Flexible budget at 1,100 capacity level Y = a + bx Y = Budgeted cost a = Fixed cost b = Variable cost X = Capacity level Y = a + bx = 3,200 + (5.50 x 1,100) = 3, ,050 = 9,250

Budget Variance 1. Volume variance 2. Expenditure variance

Normal capacity 20,000 units Budgeted cost at normal capacity level Rs 70,000 Actual capacity 17,600 units Budgeted cost at actual capacity Rs 63,400 Actual cost Rs 66,500

Volume Variance Original budget at normal capacity70,000 Flexible budget at actual capacity 63,400 (Fav)6,600

Expenditure Variance Flexible budget at actual capacity63,400 Actual cost incurred at actual capacity 66,500 (Unfav) 3,100

Total Variance Volume Variance 6,600 Add Expenditure variance +(3,100) 3,500 Original budget at normal capacity70,000 Less Actual cost incurred 66,500 3,500 OR

Budget / Control Ratios 1. Activity Ratio 2. Capacity Ratio 3. Efficiency Ratio

Activity Ratio Flexible budget at actual capacity Original budget at normal capacity X 100

Capacity Ratio Actual cost incurred Original budget at normal capacity X 100

Efficiency Ratio Original budget at actual capacity Actual cost incurred X 100

Activity Ratio Flexible budget at actual capacity Original budget at normal capacity = Rs 63,400 / 70,000 x 100 = 90.57% X 100

Capacity Ratio Actual cost incurred Original budget at normal capacity = Rs 66,500 / 70,000 x 100 = 95% X 100

Efficiency Ratio Original budget at actual capacity Actual cost incurred = Rs 63,400 / 66,500 x 100 = 95.34% X 100

Activity ratio = Capacity ratio x Efficiency ratio 90.57% = 95% x 95.34% = 0.95 x = or 90.57%

Problems in Traditional Budget 1. Programmers and activities involving wasteful expenditures are not identified. 2. Inefficiencies of a prior year are carried forward in determining subsequent years levels of performance. 3. Managers are not encouraged to identify and evaluate alternative means of accomplishing the same objective. 4. Decision making is irrational in the absence of rigorous analysis of all proposed cost and benefit. 5. Key problems and decision areas are not highlighted. 6. Manager tend to inflate their budget request resulting in more demand for funds than their availability these results in recycling the entire budget process.

Advantages of Zero Base Budget 1.It provides the organization with a systematic way to evaluate different operations and programs undertaken. It enables management to allocate resources according to the priority of the programs. 2. No arbitrary cuts or increases in budget estimates are made. It enables the management to approve departmental budget on the basis of cost- benefit analysis. 3. It links budgets with corporate objectives. 4. It helps in identifying areas of wasteful expenditure. 5. It ensures that each and every program undertaken by management is really essential for the organization and is being performed in the best possible way.