Purpose of Budget

Purpose of Budget

1. Communicate the plans

The budgets may be a source of communication plans to the relevant manager. Because the budgets are formal documents of the organization and prepared in a formal and structure way. Therefore it is not possible for manager to ignore the budgets.

2. Budget Set Targets

Budget can set performance targets for the organization and budget can be used as source document to evaluate performance of the manager. The performance evolution is critical for the employees because usually it is linked with the reward announcement for the employee. Therefore budget can play important role for improving the performance of manager and employees.

3. Budget set Limits

When the budgets are formally approved then it becomes an authorized expenditure limits and any expenditure which does not fall under these limit require special approval. Furthermore any expenditure which is not mentioned in the budget will also go to management for approval. Therefore budget put an effective control over expenditure.

4. Set a Direction

Budget is basically linking different department in formal way. Budget is prepared in a structured way and it takes into account the every department and therefore budget set a direction of moving forward. The budget is a linkage between different departments. Each department can get an idea about other department direction and activities from the budget.

5. Budget is Medium Term

The budget is normally considered to be a medium term plan and it provides a linkage between short term and long term planning. The budget is normally prepared for one year keeping in view the long term objective of the organization. The budget gives a direction to short term plan for achieving the long term plan.

Stages of budget preparation

1. Identify the key budget Factor

The first step is to identify the key factor for budget. The normal key factor is sales

2. Prepare budget for key factor

The second step is to prepare sales budget. The sales budget provides bases for other functional budgets. Therefore a great care must be exercised while preparing the sales budget. If budgets of key factor are not accurately prepared the whole process of budget will be at stake.

3. Other function budget

The other functional budget will be prepared in logical sequence. The typical sequence would be budget for production, and then budget for inventories, labor .

4. Submit the budget

The budget is submitted to the budget approving authority for review. The budget is reviewed by the budget committee and budget is explained to budget committee. The committee may require the further explanation and may also recommends the changes in the proposed budgets. The budget is amended in accordance with recommendation of the budget committee.

5. Master Budget

The functional budgets are incorporated into master budget. The master budget is overall budeget for whole organization.

6. Approve the budget

Submit the budget to board of director for approval. The key objective is explained to board of directors and board of director approves the budget in principal. The budget may be approved by board of director without any change or may approve the budget after some changes and amendments.

7. Communicate the budget

The budget is communicated to the relevant manager for implementation. The manager has a formal approved document in their hands and this document provides a basic guideline for activities to be carried out and range of those activities especially in financial terms.

8. Monitor the budget

The budget may be divided into shorter budget. For example monthly and quarterly budget. It is necessary to sub divide the budget for control purpose. The management keeps a close eye on periodical budget. The variance is calculated and required adjustment is made to achieve the overall objective.

Characteristic of high performance working system

The following are the important characteristic of high performance working system


1. Best people selected and Retained

The first important thing is to select the best people for the job and then retain those people for a reasonable amount of time.


2. Performance based reward structure

There must be a difference between performing and non performing people in terms of reward. This system will improve the performance of the non performing people.


3. Management structure and hierarchy is necessary

There must be system of command and control and each individual must not be the king of his own desire. The management hierarchy may vary situation to situation.


4. Accommodation and flexibility

The organization must give some space to the employee to express their view and ideas. The management must ensure participation in the organization.


5. Training is important

The training is important to improve efficiency of the individual. The training will also act as motivating factor for the employee


6. Culture of openness and honesty

The organization must encourage the culture of openness and honest in the organization. The employees must trust each other similarly the employee should have trust on the management commitment and promises.

7.Respect for employee

The organization must feel that they important for organization.

Types of Pricing Strategies

Cost plus pricing strategy

The fixed profit percentage is added to the product and product is offered into the market. There are two methods of setting price under this strategy either a percentage of profit is added to cost price or selling price of product.

Advantages of cost plus pricing strategy

1.Profit is known

This method is investor knows the profit on investment how much he will earn on his investment. The ultimate need of the investor to earn a profit from the investment is satisfied by adopting this strategy.

2.Suitable for big contraction contract bidding: -

The big project involves big investment therefore it is suitable method to calculate the profit from a construction contract using this method and offering a bid for the contract.

Disadvantages of cost plus pricing strategy

1. Ignore the competitor price

This method ignores the prices in the market. You are in the market so you need to compare the prices before setting price of your product. The prices set in isolation will bring a disaster result for your product.  The competitor prices play important role to decide the market share.

2. Ignore Demand

This method ignore the market demand which is one of the more important factor of setting prices if you will not adjust the price according to demand there is fair chance that your product will lying the market.

Marginal cost plus profit

Under this method a profit margin is added to variable cost.

Advantages of Marginal cost plus profit Strategy

1.Short term boost in sales

This method is really helpful to give a short term boost to your product sale by adjusting profit to your variable cost and offer reduced price in the market. Some industries are offering a very low percentage of profit therefore by adjusting the profit margin on marginal cost can attract huge demand for your product. The short term raise will also have positive impact on long term sale as some customer will be retained by you as some customer has low tendency for switching for short term gain.

2.Suitable in low fixed cost

This method is very helpful to earn high profit if your fixed cost is low. The high sale volume will increase contribution and after deducting the low fixed cost your book will be showing healthy profit.

3.Raise demand for off peak

This method is really helpful to generate extra profit for off peak hour, a small percentage of profit is added to variable cost and this will result in extra contribution. The off peak usage may also raise the demand of peak hour because of new customer are using the product and those customer will also put some share in peak hour. The famous example for this practice is telecom operator is offering lower rate at off peak time.

Disadvantages of marginal cost plus profit strategy

1.Market force is ignored

This method ignores the market force like the competitor price and demand factor which play very important role in the pricing. The prices cannot be decided in isolation. This is real world and real market and due consideration must be given to market forces.

 2.Fixed cost is ignored

The fixed cost is important in many industries. The profit margin on variable cost is not necessarily will result in overall profit. Especially in the industry which involves high fixed cost the small percentage on variable cost is not going to recover the fixed cost.

3.Skimming price Strategy

This strategy is based on the fact some people are interested to pay high price for a new product introduced in the market. Therefore a high price is charged at the time of introduction and with the passage of time the prices are reduced.

Disadvantage of skimming price strategy

1.Brand image is at stake

The charging very high prices will bring a bad image of the brand for charging unnecessary high price for the product.

2.Future product launch problems

The charging very high prices and then lowering down with the passage of time will have negative impact on future launch of product. The customer will not willing to pay high price for next product with a view that prices will come down sharply after sometime.

3.Not suitable for low price product

This strategy will not work for the lower price product where there are many options available to the customer and lower prices offered to public will not attract the customer as the prices difference is not going to be material for the customer.

4.Not suitable in competitive market

This strategy will not work in high competitive market because in the high competitive market the competitor is going to react quickly .The competitor will get the maximum share by  reducing the prices . This strategy will only work in the high competitive market if your product offers some additional features as well.

5.Not suitable in price conscience market

Some markets are really price conscience so this strategy will not work in those markets. The market where the income level is low there is little chance that strategy will produce the desired result because low income person will not pay extra price for a product rather he would wait for price decline.

4.Market penetration Strategy

The market penetrating focus on the market capture .under these strategy lower prices are offered to the public with a view to raise high demand for the product. This strategy discourages the competition in the market. The prices are low so there is not charm for the competitor to enter in the market.

Advantages of market penetration Strategy

1.High share of market

This strategy is really helpful in getting the high share of the market for a new product. The higher share of market will result in high volumes of sales. According to the basic concept of marginal costing high volume of sales are better than low volumes because with the help of high volume you can earn high contribution and after deducting fixed cost from the contribution the company will earn high profit.

2.Discourages Competition

The lower prices discourage the competitor entry in the market because it is very risky for competitor to enter in a market with low profit margin. The competitor usually prefers the high profit market with reasonable growth opportunity.  The competitor will find it really difficult to capture the market share which is already held by existing company with low prices. Therefore the company will enjoy high profit with high volumes of sales due to monopoly.

Disadvantages of market penetration Strategy

1.High Growing Market

This strategy will not work in high growing market and competitor will react accordingly. The new entry cannot be avoided with low prices if the market has a lot of growth opportunity for example the telecom sector almost in every country of the world four to five companies can get their share even by offering higher prices than competitors.

2.Price is only one Factor

The price is only one of the factors for capturing the market. There are also other factors for example a brand name if branded competitor enter in the market even with the high price there is fair chance that he will lead the market. The other factor is product quality and features for example if your competitor enters in the market with improved product with same price or relatively high price then competitor will get his share from the market.

3.Low price may result in High loses

The lower prices are possible by keeping the profit margin low. This situation may result in heavy loses if there is fall in demand. The profit margin should be sufficient enough to cover the fixed cost as well. Some company’s takes into account only the marginal cost for pricing decision and this situation may lead for heavy losses if the due consideration is not given to fixed cost.

Absorption Costing

What is Absorption Costing

Absorption costing takes into account both the direct cost and indirect cost. The direct cost which are directly attributable to the product such as direct labour , direct material and direct over heads. The indirect cost which are not directly attributable to product. The absorption cost also includes the indirect cost in the cost of product by using an appropriate absorption rate.

Typically the indirect costs are apportioned to product cost using appropriate bases like machine hour or labor hour. The great advantage of using absorption costing it is more justified in term of financial reporting. It takes into account the full production cost and therefore inventories are accurately valued at the end of financial year. These inventories values are shown in the financial statement at full cost.

Limitation of Absorption Costing

1.Selection of appropriate absorption rate

it is very difficult to select appropriate absorption rate for consumption of overhead. The using of machine hour or labor hour rate is just a theoretical solution to the problem however in many cases it has no relevance for consumption of overhead.

2.Limited use for Decision Making

The absorption rate is normally decided on the bases of historical information available and therefore it has little role to play in the decision making. And more importantly it takes into cost which is not relevant in many cases and in decision making we only interest in relevant cost. The irrelevant cost has no role to play in decision making process.

Over and under absorbed overheads

As we know that absorption costing use a pre determined rate for absorption therefore the actual amount of expenditure are different from the estimated expenditure. Where the absorbed expenditure using absorption rate is more than actual expenditure it is called over absorbed overhead and where the absorbed overhead are less than actual expenditure it is called under absorbed.

In case of over absorbed expenditure profit is increased or expense is reduced and in case of under absorbed the profit is reduced or expense is increase

Marginal Costing

What is Marginal costing

Marginal costing takes into account only the variable cost and fixed cost are ignored. The marginal costing treats the fixed cost as period cost. The concept is really helpful in decision making. The inventories are calculated on the bases of variable cost. In other word marginal cost takes into account only those cost which vary with level of activity.

The marginal costing provides helpful information to the management for the purposes of budget preparation, short term planning, cost control etc. The other important aspect of marginal costing that it provides management the bases for mathematical calculation for decision making like break even analyses.

Limitation of marginal costing

It does not give a true picture of product cost. Especially when the fixed overhead form a major portion of product cost then the marginal costing is of little use as decision making tool.

It ignores the fixed cost so management has no controlling procedures for fixed cost and management plan or over plans about the variable cost of the product and the fixed cost remains the un touched area .Because the focus remains on the variable cost so management adopt more controls for the variable cost and the fixed cost may jump un expectedly.

This method the inventories can not be accurately calculated and therefore the figure can not be used to report in the financial statements. 

Advantages of ABC

Activity based costing based on the concept that it is activity which generates cost and therefore the cost should be allocated to generating activity. The activity based costing approach developed focusing on the fact that now a days there are many other cost involved in the production process and traditional costing concept of product is not relevant.

The activity based costing reduces the limitation of absorption based costing where the overhead are allocated using unfair bases like machine hour and labor hour which sometimes has no relevance with the cost incurred.

In activity based costing the cost driver are defined .in simple words cost driver is determinant of costs. Sometime more than one cost drivers are defined for one activity but such arrangement is not recommended. One activity one cost driver is the best suitable approach.

Advantages of ABC

Detailed information about activities: -

This costing system develops deep understanding about the cost structure in the organization. The critical activities and cost driver are become clearer to the management.

More realistic allocation of cost:- The second advantages is that under Activity based costing system the costs are allocated more rationally and more appropriately.

Disadvantages

How many activities

This is a difficult question to answer that how many activities would be define to server the process . some organization have a lot of activities and therefore the activity based costing is suitable option in that case.

Cost driver Define

The defining of relevant cost driver is also a difficult task and requires huge experience and deep understanding of the business and industry.

All overhead are not activity based

The other limitation that there are a lot overheads which are not activity based and therefore some kind of allocation bases are used for those overhead.

Not easy to implement

The activity based costing require deep understanding of underlying concept and sometime lower tier management find it a difficult and complex process whereas the absorption costing is simple to understand and easy to implement.

Advantages back flush accounting system

The back flush accounting system the cost is allocated to the product at the end of the production process. This is unlike the traditional system where cost is regularly updated during the production process.

The back flush accounting system is only suitable where there is a short process of production and inventory is very low. The back flush accounting system there is no concept of work in progress.

This system basically is not a system because the cost can not allocated to production it is a more like a achievement reporting system.

Advantages back flush accounting system

No detail and complex accounting is required

The biggest advantage of this method that no complicated process of accounting is required. it is to important to remember that accounting for a production process is not an easy task and it vary from industry to industry and sometime organization to organization. Therefore there is no tailor made solution for production process accounting.

There are only two stages where the accounting record is maintained one is at the time of purchase of inventory and other at the time of completion of production. There two points are also know as trigger points in back flush accounting system.

Information about achievement of goal

This system informs management about the achievement of a production goal set by management. Basically this system is goal achieving reporting system and have little role in product costing.

Limitation of back flush accounting system

Only in few cases

This system can be applied only in few circumstances where the production process is very short and the inventory level is negligible.

Management not in a position to control

This system creates no information for the management to monitor the performance and control the activities. So you can say that this system runs automatically and stop automatically and there is no interference is involved from outside.

Concept of limiting factor

Concept of Limiting Factor

The normally organization produce the product depend on the ability to sale but sometime there is a demand for the product but due to shortage of resources the organization can not produced the required demand. The scarce resource place a limit on the production and this is called limiting factor. There may be single limiting factor and multiple limiting factors.

Determination of Limiting Factor

·     

Limiting factor can be easily calculated with the help of simple budget technique. How much resources are required for given demand and how much resources are available and if resources available are less than demand then this are a limiting factor situation.

Single Limiting Factor

In case of single limiting factor the profit can be maximized by maximizing the contribution. The product are ranked in accordance of contribution . The product providing the maximum contribution shall be produced first , the product providing second high contribution will be produced in second place . This process will continue till the limiting factor put a cap on further production.

Multiple Limiting Factors

In case of two or more limiting factors the decision will be made through linear programming because each limiting factor will give a different product mix and it would be really complex situation to take appropriate decision. The linear programming technique would give you a correct answer in the situation . The Linear programming is a mechanical type of process to give you the suitable option.

Linear Programming 

There are two stages of linear programming for limiting factor

1.       Defining the objective

2.       Formulating the constraints

Defining the objective

In most cases the objective is to maximize the contribution and this objective is expressed in the form of formula.

Formulating the Constraint

The second stages are to formulate you constraints. There may be maximums or minimum limit which will be expressed accordingly in accordance with mathematical guidelines. One of the requirement of linear requirement is no negative values can be used to calculate the final results.

The characteristics of good information

The characteristics of good information

The word data and information used interchangeable; however, there is huge difference between information and data. Information is extracted from the processing of data, and it is only information which can be used in performing management function.

The following are the important characteristic of information

1.       Reliable: - The information is extracted from a source which can be trusted ,otherwise wrong information will result in wrong decision. for example that you are getting information from a accounting software or production software so you must be sure that reports generated by the software are accurate and therefore can be trusted. The reliable information mean that source from which information is being extracted can be trusted.

2.       Accurate: - The information must be accurate, it means that information must be free from mistakes. some time information is prepared in hast which may result in many mistakes in the information.it is important to remember that sometime management may be interested in reasonable accurate information because to get 100% accurate information may be time consuming job.

3.       Timely: - The information must be provided in time. in business world timely information is essential requirement for the decision making. for example the management can only control the cost if the information is available in time if the information about the costs are provided at the end of project then it is of no use. The frequency of information provision vary from situation to situation.

4.       Cost effective :- The information must be cost effective. There is close relationship between quality of information and its cost normally more sophisticated and accurate information cost you a lot. for example if you need a different reports for your production process , this may require a huge investment in a software because only a quality software can generate an accurate report of complex process of production.

5.       Relevant: - The information must be relevant to the management needs. This is very important to know the information needs of the management. for example if management interested in cost control then management shall require more and more information about cost structure and patterns.The details reporting of revenue and less reporting of cost shall not serve the purpose because management need more structured information about cost.

6.       User Friendly: - The information must be provided in form and format which can be easily understood. The user friendly information can be defined as self explanatory information . User friendly information does not require any involvement of the person who prepare information.

Types of Costing Techniques

Types of Costing

Costing is very important aspect of management accounting , in fact management accounting is based on different costing techniques and their further implication at different scenarios. Costing techniques provides a bases for management to perform management function. For example standard costing technique provides a bases for preparing budgets that is basically a controlling tool of organization resources.

Types of Costing

There are variety of costing techniques , however, we have mentioned the some important costing techniques.

1. Standard costing
2. Absorption Costing
3. Marginal Costing
4. Activity based Costing
5. Process Costing
6. Job order Costing
7. Batch Costing

Types of Cost

like costing techniques we use different cost concept in management accounting, we have given some important cost concept.

1. Opportunity cost
2. Relevant cost
3. Sunk Cost
4. Fixed Cost
5. Variable cost
6. Step cost
7. Committed cost

Types of Budgets

What are Budgets

The budget are basically future estimates of revenue or cost. budget is play very important rule in directing organization activity to achieve long term goals. Budget also serve the purpose of controlling the organization resources . Budgets can also be used for the purpose of performance measure of different manager and center.

Types of budgets

There are mainly the following types of budgets commonly prepared in the organization.

1. Fixed budget
2. Flexible budget
3. Zero based budget

1. Fixed Budget

A fixed budget does not change with level of activity. for example a construction manager has prepared a fixed budget for the construction of a bridge and site manager require to complete the construction work within this budget.

2. Flexible Budget

A flexible budget changes with level of activity i.e ( number of unit produced). for example for 10,000 unit the production cost was 18,000 and for 12,000 unit production cost was 20,000.

3. Zero Based Budget

Zero based budget are prepared from the scratch. This concept try to eliminate the wrong projection and encourages to prepare the budget on facts and not merely the changing the number in excel sheet. The biggest limitation of Zero based budget is time consuming.

Management Accounting

Management accounting basically is to support management to perform management function effectively i.e planning , controlling , Decision Making. Management accounting provide support to management for effective utilization of resources to maximize the organization profit. Management accounting have no structured formats like financial accounting and management may decide the formats which best suit to their requirements. Management accounting deals both with historical cost and future cost and especially for decision making the future cost is more relevant than historical cost.

There is no statutory requirement to prepare management account and mostly statutory requirement are for the preparation and presentation of Financial account. Management accounts are also not subject to audit, however, the auditor may look into management accounts to obtain evidence for financial accounts.

Management accounts are prepared as and when required by the management . some report may be required on daily bases and other may be required on monthly and quarterly bases. for example material consumption report may be required by production manager on daily or weekly bases and product wise sales report may be prepared for each month.
Example of Management Reports


There are variety of management reports, for example, sales by customer report, product wise sales , material consumed by each product, Labour consumed by each product, monthly budget, variance analyses, total machine hour utilization, Idle time, etc.

Limitations of Sensitivity Analyses

Limitations of Sensitivity Analyses

We know that sensitivity analyses is basically is predicting future value with the help of some variable. The different values of variable are put to estimate the impact on outcome.

Data Accuracy is vital :- the result are totally depends on quality of data , if the input is wrong output will be misinterpreted.

Special Skills :- The sensitivity analyses is a skillful job especially when the processes are being designed for data input to generate the relevant result. This require special skill over the computer software and relevant formulas .


Only Critical Variable Tested :- The sensitivity level normally critical variable are tested one by one and it is assumed that when the one variable tested other remains constant.

Process of forecasting Demand

Process of forecasting demand

There are three step is involved in forecasting demands

1. Demand depends on Microeconomics Growth :- The demand for product in most cases are directly related to microeconomics growth rate of the country. However, it is not necessary that growth rate of country must be reflected in the organization growth with same rate.

2. Industry Growth must be reflected in the growth of organization. for example a oil industry is growing with a substantial rate then it is expected that it will have positive impact on the growth of the organization.

3. Organization independent Growth objective :- we know that general growth rate and industry growth rate not necessary is to be reflected in the organization performances. The every organization has its own target and methods of achieving growth.

 The following are important aspect

1. What is current market share
2. What can attract new customer
3. What customer expectation from the market
4. how customer reacted previously

Methods of collecting Secondary data

Methods of collecting Secondary data

Secondary data is not specially collected for a purpose but it is already available and used for a specified purpose.

Advantages of Secondary Data

Time Saved

The first important advantage is time saved. The data collection is not an easy task and require a lot of time and planning. Therefore by applying secondary data a lot of time can be saved and this time can be utilized in more detail analyses of data and research work.

Cost Saved

The other advantage that data collection require a lot of work force especially when a large amount of data is to be collected . The work force is not only cost for data collection but it also involves like printing material for data collection and travel and accommodation cost.

Disadvantages of Secondary Data

Relevance 

The data is being used may not be relevant for your work if it is not collected for the same nature of work or research. 

Time Factor

Sometime the recent data is not available and using an old data for decision making process is not a rational approach. for example if the data available for number of people die from different disease for last decade has of no use of planning a health sector for this decade. you need last two or three years data for disease and sometime last year disease data.

Not Required

The secondary data has not been compiled as per your requirement therefore it may be a time consuming job to get the relevant data out of secondary  data.

Copy right Issues

The many organization does not allow the data for any other purpose and using the data may create legal consequences . The data is published by organization for general public knowledge and can not be used in specialized research or for commercial interest.



The main types of secondary data

1. Internally generated secondary data
2. Externally available Secondary Data

The internally generated data may include the following

• Inventory
• Product schedule
• Sales related information
• Marketing research data
• Management accounts
• Internal audit report
• Financial statements
• Organization policies

The sources of external Data

• New paper
• Professional magazines
• Research paper on internet
• Public libraries
• Government Publication
• State bank Publication

Methods of collecting primary data

Methods of collecting primary data

The following are important methods of collecting Data

1. Physical observation (Example counting people crossing bridge)
2. Interviews from the people
3. Questioner filling
4. Customer complain box
5. Pre test and Post test

Types of Inventory Re Order Systems

Types of Inventory Re Order Systems

The following are important type of inventory re- oder system

1. Periodical Review of inventory
2. Just in time system commonly know as JIT
3. Perpetual inventory re order method
4. Martial requirement planning

Periodical Review system :- The management fixed a level of inventory and that level is periodically review i.e ( weekly , monthly or quarterly ). The management re order the quantity to maintain that minimum level. This method is very simple . 

Just in time Method : The management order as required. This concept was introduced basically to control the holding cost of inventory . The holding inventory not only involves high cost but also involve high risk of damage by fire etc. 

This method reduces the holding cost of inventory substantially. The other advantages of jit system that it improves the management control over the inventory and theft and leakages and other manipulation in inventory is minimized. The JIT system also helps to control effectively spoilage or other deterioration.


Perpetual inventory  order system :- Under this system the inventory is being automatically updated and management re order the quantity when the system inform about the point at which inventory is to be re ordered. 

The great advantage of this system is that inventory level are updated in real time and the management has full information about inventory level. This arrangement improves management control over the important inventory items and their availability.

Martial requirement planning : under this system material is ordered as per the requirement of production department. The production schedule are prepared and on the bases of such schedule the material are ordered. This system is an extension of JIT system .

 In JIT system the immediate requirement determine the inventory re order quantity where in case martial requirement planing management prepare more detail plan of production and inventory level are maintain to support production process.

Advantages of perpetual Inventory System

Advantages of perpetual Inventory System

The perpetual inventory is basically a system which update the inventory record in real time. it means that inventory level changes with each purchase and sold transaction. The perpetual inventory system is gaining popularity with each day passing for the following advantages.

1. Easy to prepare the financial system without any delay. The stock form an important part of financial statements . The availability of stock figures from the books of accounts make the task of accountant very easy to prepare the financial statement.
2. Time Saved :- The inventory count in periodic system of inventory consumes a lot of time . The perpetual system saves the time as the inventory figure are already available and only needs to be confirmed by physical count.
3. Act as control Procedure :- This system is really helpful to identify any mistake or fraud in the inventory . the management can identify the mistake by the comparison of figures of physical count against figures of perpetual system.
4. Re order decision easier :- The stock level are available at all time so management can easily decide about the re order quantity.