Unit 4: Budgetary control & contemporary costing developments
Cost Accounting notes · PTU syllabus (BCOM 201-18)
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Unit summary
Budgets plan the future in numbers, and modern costing techniques help firms compete on cost and quality. This unit covers budgetary control — concept and classification of budgets, cash and flexible budgets, zero-base budgeting — and contemporary developments: activity-based costing, JIT, target costing, life-cycle costing, value analysis, Kaizen costing, TQM and back-flush costing.
After this unit you can
- Explain budgetary control and the classification of budgets
- Prepare cash and flexible budgets
- Explain zero-base budgeting
- Explain activity-based costing, JIT, target costing, life-cycle costing, value analysis, Kaizen, TQM and back-flush costing
PTU syllabus topics
- Budgetary control concept and classification
- cash and flexible budgets
- zero base budgeting
- activity-based costing
- Just-In-Time
- target costing
- life cycle costing
- value analysis
- Kaizen costing
- Total Quality Management
- back-flush costing
- Activity-based costing
- Overheads traced to activities that cause them
- Just-in-time
- Materials arrive exactly when needed
- Target costing
- Start from market price, work back to allowable cost
- Kaizen costing
- Small continuous cost reductions
- Life cycle costing
- Cost over the product's whole life
Topic 1
Budgetary control: concept
- Budget: a quantitative statement, for a defined period, of the policies, plans, objectives and goals established by management (CIMA).
- Budgetary control: establishment of budgets relating to responsibilities of executives and continuous comparison of actual with budgeted results to secure objectives or revise them.
- 1
Define objectives
- 2
Set up budget centres and committee
- 3
Prepare budget manual
- 4
Fix budget period
- 5
Identify key (limiting) factor
- 6
Prepare functional and master budgets
- 7
Compare actual with budget
- 8
Analyse variances and take corrective action
- Key (principal budget) factor: the factor that limits activity — usually sales; can be materials, labour or plant capacity.
- Advantages: planning, coordination, control, motivation, cost consciousness. Limitations: based on estimates, rigidity, time and cost, may cause conflict.
Topic 2
Classification of budgets
By time
Long-term, short-term, current
By function
Sales, production, materials, labour, overheads, cash, capital expenditure, master budget
By flexibility
Fixed budget, flexible budget
By technique
Zero-base, performance, programme budgets
- Master budget: the summary budget incorporating all functional budgets — budgeted P&L and balance sheet.
- Production budget: Units to produce = Budgeted sales + Desired closing stock − Opening stock.
Topic 3
Cash budget and flexible budget
Cash budget
Estimates cash receipts and payments to show expected cash surplus or deficit each month.
Example
Opening cash ₹20,000. July: receipts from debtors ₹60,000; payments — creditors ₹45,000, wages ₹12,000, overheads ₹8,000. Closing cash = 20,000 + 60,000 − 65,000 = ₹15,000 (becomes opening balance for August).
- Uses: plan borrowing and investment of surplus, ensure liquidity, time capital expenditure.
Flexible budget
A budget designed to change with the level of activity attained — fixed costs remain constant, variable costs change in proportion, semi-variable costs are split.
| Item | 60% capacity | 80% capacity | 100% capacity |
|---|---|---|---|
| Units | 6,000 | 8,000 | 10,000 |
| Variable cost @ ₹20 | 1,20,000 | 1,60,000 | 2,00,000 |
| Semi-variable (₹20,000 fixed + ₹5/unit) | 50,000 | 60,000 | 70,000 |
| Fixed cost | 80,000 | 80,000 | 80,000 |
| Total cost | 2,50,000 | 3,00,000 | 3,50,000 |
| Cost per unit | 41.67 | 37.50 | 35.00 |
Activity
One level only
Several levels
Comparison
Misleading if actual activity differs
Meaningful at actual activity
Suitable
Stable conditions
Changing conditions
Topic 4
Zero-base budgeting (ZBB)
ZBB requires every activity to be justified from scratch (zero base) each budget period, rather than adjusting last year's figures. Introduced by Peter Pyhrr at Texas Instruments (1970s).
- 1Identify decision units
- 2Prepare decision packages
Purpose, costs, benefits, alternatives
- 3Rank decision packages by priority
- 4Allocate resources to top-ranked packages
- Advantages: removes inefficient activities, better resource allocation, questions every expense.
- Limitations: time-consuming, needs skilled managers, difficult to rank intangible activities.
Topic 5
Contemporary costing developments
Activity-based costing (ABC)
Overheads are traced to activities (cost pools) and then to products using cost drivers — number of set-ups, purchase orders, inspections, machine hours.
- 1Identify activities
- 2Create activity cost pools
- 3Identify cost drivers
- 4Compute cost driver rates
- 5Assign overheads to products by driver usage
Example
Set-up cost pool ₹60,000 for 30 set-ups = ₹2,000 per set-up. Product A needs 20 set-ups (₹40,000) while Product B needs 10 (₹20,000) — even if B uses more machine hours.
- Gives more accurate product costs where overheads are large and products diverse.
Other techniques
| Technique | Key idea |
|---|---|
| Just-in-Time (JIT) | Produce and buy only when needed; near-zero inventory; pull system (Toyota) |
| Target costing | Target cost = Target selling price − Desired profit; design product to meet it |
| Life-cycle costing | Track costs over the product's entire life — R&D, design, production, marketing, disposal |
| Value analysis | Examine each component to reduce cost without reducing function, quality or reliability |
| Kaizen costing | Continuous small cost reductions during the manufacturing stage |
| Total Quality Management (TQM) | Organisation-wide commitment to quality and customer satisfaction; cost of quality — prevention, appraisal, internal and external failure |
| Back-flush costing | Costs recorded only at completion or sale, then "flushed back" to inventory — suits JIT environments |
Exam tip
Target costing works before production (design stage); Kaizen costing works during production — a neat contrast for exam answers.
Key terms
- Budgetary control
- Comparing actual results with budgets to control performance
- Flexible budget
- A budget that adjusts to different levels of activity
- Zero-base budgeting
- Every activity justified from zero each period
- Cost driver
- A factor that causes the cost of an activity
- Target costing
- Setting cost from target price minus desired profit
Quick revision
- Budgetary control steps: objectives → budget centres → manual → key factor → budgets → variances.
- Classification by time, function, flexibility, technique.
- Cash budget shows monthly surplus or deficit.
- ZBB: decision packages ranked by priority.
- Modern techniques: ABC, JIT, target, life-cycle, value analysis, Kaizen, TQM, back-flush.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.Define budgetary control.
- Q2.What is a key factor?
- Q3.What is a master budget?
- Q4.Distinguish fixed and flexible budgets.
- Q5.What is zero-base budgeting?
- Q6.What is target costing?
Long-answer questions
- Q1.Explain the concept, steps, advantages and limitations of budgetary control.
- Q2.Explain the classification of budgets and prepare a flexible budget.
- Q3.Explain zero-base budgeting and its process.
- Q4.Explain activity-based costing and other contemporary costing techniques.
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