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Lesson-21 Fixed and Flexible Budgets Learning Objectives To know about fixed budgets To know about flexible budgets

gets To understand how to prepare fixed budgets To understand how to prepare flexible budgets

Fixed and Flexible Budgets Any budget in any functional area of an operation can be established as a fixed budget or a flexible budget. A fixed budget is established for a specific level of activity and is not adjusted to the actual level of activity attained at the time of comparison between the budgeted and actual results. Naturally, a fixed budget is established only for a short period of time where the budgeted level of activity is expected to be attained to the maximum possible extent. It is more suitable for fixed expenses, i.e. the expenses which have no relation with the level of activity. This budget does not indicate that it cannot be changed at all. It can be revised if the actual level of activity is likely to differ widely from the budgeted level of activity. A fixed budget cannot be used as an effective tool of cost control while computing the variations between the budgeted result and the actual result. The variance cannot be explained properly. Also, it is not possible to say whether the variance is due to the changes in the level of activity or due to the efficiency or inefficiency of the executive responsible for the execution of the budget. A flexible budget is designed to change with the fluctuations in the level of activity and provides a basis of comparison for any level of activity actually attained. A flexible budget is more elastic and practical. It can be properly used as an effective tool for the evaluation of performance and cost control. It explains the variations between the budgeted and actual results. It also states the variations which are due to changes in the level of activity (which is beyond the control of operating executive) and which are due to the operational efficiency or inefficiency (for which the operating executive is responsible.) For the purpose of establishment of flexible budgets, it is necessary to classify the costs as fixed costs, variable costs and semi-variable costs. The fixed costs remain same at all levels of activity whereas the variable costs change directly in proportion to the level of activity. As far as the semi-variable costs are concerned, each item of cost is examined and classified into its fixed and variable elements and a trend is established regarding the nature and behavior of each item of cost.

Illustrations 1. The manager of repairs and maintenance department has submitted the following budget estimates. These will be used while constructing a flexible budget to be used during the coming budget year. Details of Cost Planned at 6000 Direct Repairs Hours 30,000 40,200 13,200 Planned at 9000 Direct Repair Hours 30,000 60,300 16,800

Employees salaries Indirect repair materials Miscellaneous costs

(a) Prepare a flexible budget for the department upto an activity level of 10,000 repair hours (use increment of 1000). (b) What would be the budget allowance at 8,500 repair hours? Solution Employees salaries Indirect repair materials Miscellaneous costs Working Notes Following are the observations made from the analysis of above-mentioned costs: (a) Employee salaries are fixed costs as they remain constant for both 6000 repair hours and 9000 repair hours. (b) Indirect repair material is variable cost as it varies proportionately from 6000 hours to 9000 hours. This cost neither remained constant nor increased proportionately at the activity level of 6000 hours to 9000 hours. The cost increased by Rs. 3,600 for the increase of 3000 hours. This means that the variable portion of this cost is Rs. 1.20 per hour. Hence, out of total miscellaneous cost of Rs. 13,200 for 6000 hours, Rs. 7,200 is the variable portion and balance Rs. 6,000 is the fixed portion. 2. Vivek Elementary School has a total of 150 students consisting of 5 sections with 30 students per section. The school plans for a picnic around the city during the weekend to places such as zoo, amusement park, planetarium etc. A private transport operator has come forward to lease out buses for the picnic. Each bus has a maximum capacity of 50 seats (excluding two seats reserved for the teacher accompanying the students). The school will employ two teachers for each bus paying them an allowance of Rs. 50 per teacher. It will also lease out the required number of buses. The following are the other cost estimates: 8500 Hours 30,000 56,950 16,200 1,03,150 10000 Hours 30,000 67,000 18,000 1,15,000

Cost per student Breakfast Lunch Tea Entrance fee at zoo Rent Special permit fee Block entrance fee of the planetarium Prizes to the students for games 5 10 3

Rs.

2 650 per bus 50 per bus 250 250

No costs are incurred in respect of the accompanying teachers (except the allowance of Rs. 50 per teacher). (i) Prepare a flexible budget estimating the total cost for the levels of 30, 60, 90, 120 and 150 students. Each item of cost is to be indicated separately. (ii) Compare the average cost per student of these levels. (iii) What are your conclusions regarding the breakeven level of students if the school proposes to collect Rs. 45 per student? Solution No. of Students a. b. Variable cost Semi-fixed costs Rent of the bus Permit fees Allowances to teachers c. Fixed costs Entrance fees Prizes to students Total costs Average cost per student 250 250 1900 63.33 250 250 3300 55.00 250 50 3900 43.33 250 250 5300 44.17 250 250 5900 39.33 650 50 100 1300 100 200 1300 100 200 1950 150 300 1950 150 300 30 600 60 1200 90 1800 120 2400 150 3000

3. Prepare a flexible budget for overheads on the basis of data given below. Ascertain the overheads rates at 50%, 60% and 70% capacity. Variable overheads Indirect material At 60% capacity Rs. 6,000

Indirect labor Semi-variable overheads Electricity (40% fixed, 60% variable) Repairs and maintenance (80% fixed, 20% variable) Fixed overheads Depreciation Insurance Salaries Total overheads Estimated direct labor hours Solution Calculation of Overheads Rates 50% Capacity Rs. Variable overheads Indirect material Indirect labor Semi-variable overheads Electricity Repairs and maintenance Fixed overheads Depreciation Insurance Salaries Total overheads Estimated direct Labor hours Overhead rate (Labor hour rate) Re 0.55 1,55,000 16,500 4,500 15,000 85,900 27,000 2,900 5,000 15,000

18,000

30,000 3,000 16,500 4,500 15,000 93,000 1,86,000

60% Capacity Rs. 6,000 18,000 30,000 3,000 16,500 4,500 15,000 93,000 I 1, 86,000 Re 0.50

70% Capacity Rs. 7,000 21,000 33,000 3,100 16,500 4,500 15,000 1,00,100 2,17,000

Re 0.46

4. A factory can produce 60,000 units per annum at its 100% capacity. The estimated

costs of production are as below: Direct materials Direct labor Indirect expenses Fixed Variable Semi-variable Rs. 1,50,000 per annum Rs. 5 per unit Rs. 50,000 per annum upto 50% capacity and extra expenses of Rs. 10,000 for every 20% increase in capacity or part thereof Rs. 3 per unit Rs. 2 per unit

The factory produces only against orders. If the production program of the factory is as indicated below and the management desires to ensure a profit of Rs. 1,00,000 for the year, work out the average selling price at which each unit should be quoted. For three months of the year-- 50% capacity Remaining nine months of the year-- 80% capacity Solution Calculation of Total Cost 50% capacity Number of units produced Direct material-- Rs. Direct labor-- Rs. Variable expenses-- Rs. Fixed expenses-- Rs. Semi-variable expenses-- Rs. Total cost 7,500 22,500 15,000 37,500 37,500 12,500 1, 25,000 80% capacity 36,000 1,08,000 72,000 1,80,000 1, 12,500 32,500 5,05,000 Total capacity 43,500 1,30,500 87,000 2,17,500 1,50,000 45,000 6,30,000

Thus, the total cost during the year is likely to be Rs. 6,30,000. If it is desired to earn a profit of Rs. 1,00,000, the total amount to be covered by the units to be sold will have to be Rs. 7,30,000 (Rs. 6,30,000 + Rs. 1,00,000). As the total units produced are estimated to be 43,500, the above amount will have to be covered by 43,500 units. Hence, the average selling price per unit will be = Rs. 7,30,000 43,500 = Rs. 16.78 per unit (approx.)

Working Notes (i) (ii) It is assumed that whatever units are produced can be sold. It is also assumed that the production and the incidence of all the indirect expenses are equally spread during the year.

5. From the following details, prepare a flexible budget for three months ending on 30th September showing the estimated sales, sales cost and profit for 60%, 80% and 100% capacity. Assume that all items produced are sold. Fixed expenses Management salaries Rent and taxes Depreciation on machinery Sundry office cost Semi-variable expenses At 50% capacity Plant maintenance Indirect labor Salesmens salary and expenses Sundry expenses Variable expenses At 50% capacity Materials Labor Sales mens commission 12,00,000 12,80,000 1,90,000 26,70,000 Rs. 1,25,000 4,95,000 1,45,000 1,30,000 8,95,000 Rs. 4,20,000 2,80,000 3,50,000 4,45,000 14,95,000

Semi-variable expenses remain constant between 41% and 70% activity, increase by 10% of the above figures between 71 % and 80% activity, and increase by 15% of the above figures between 81 % and 100% activity. Fixed expenses remain constant whatever may be the level of activity. Sales are Rs. 51,00,000 at 60% activity, Rs. 68,00,000 at 80% activity and Rs. 85,00,000 at 100% activity. Solution Flexible Budget 60% capacity 80% capacity 100% capacity

Rs. (A) Sales (B) Sales cost (1) Fixed expenses Management salaries Rent and taxes Depreciation on machinery Sundry office cost 4,20,000 2,80,000 3,50,000 4,45,000 14,95,000 60% capacity Rs. (2) Semi-variable expenses Plant maintenance Indirect labor Salesmens salary and expenses (3) Variable expenses Material Labor Salesmans commission 14,40,000 15,36,000 2,28,000 32,04,000 Total sales cost 1 + 2 + 3 (C) Profit A B Numericals on Flexible Budget 55,94,000 4,94,000 1,25,000 4,95,000 1,45,000 8,95,000 51,00,000

Rs. 68,00,000

Rs. 85,00,000

4,20,000 2,80,000 3,50,000 4,45,000 14,95,000 80% capacity Rs.

4,20,000 2,80,000 3,50,000 4,45,000 14,95,000 100% capacity Rs.

1,37,500 5,44,500 1, 59,500 9,84,500 19,20,000 20,48,000 3,04,000 42,72,000 67,51,500 48,500

1, 43,750 5,69,250 1,66,750 10,29,250 24,00,000 25,60,000 3,80,000 53,40,000 78,64,250 6,35,750

1. A company produces a standard product. The estimated cost per unit is given below: Raw materials Rs. 10

Direct wages Direct expenses Variable overhead

8 2 5

Fixed overheads are estimated to be Rs. 70,000 and selling price per unit is Rs. 40. Prepare a flexible budget at 50%, 70% and 90% level of activity. Assume that output at 100% level of activity is 10,000 units. 2. The following expenses relate to a cost center operating at 80% of normal capacity. Sales are Rs. 1,20,000. Draw up flexible administration, selling and distribution costs. Budget is operating at 90%, 100% and 110% of normal capacity. Administration costs Office salaries General expenses Depreciation Rates and taxes Selling costs Salaries Traveling expenses Sales office expenses General expenses Distribution costs Wages Rent Other expenses Rs. 3, 000 0.5% of sales 2% of sales 4 % of sales 1.5% of sales 1 % of sales 1 % of sales Rs. 3,000 1.5% of sales Rs. 1,500 Rs. 1,750

3. The expenses budgeted for the production of 10,000 units in a factory are furnished below: Per unit Materials Labor Variable overheads Fixed overheads (Rs. 1,00,000) Variable expenses (Direct) Selling expenses (10% fixed) Distribution expenses (20% fixed) Administrative expenses (Rs. 50,000) Total cost of sale per unit Rs. 70.25 20.10 5 13.75

(to make and sell) Prepare a budget for the production of: (i) 8,000 units (ii) 6,000 units Assume that administrative expenses are rigid for all levels of production. 4. Following are the details for the year 1985: Sales 20,000 units @ Rs. 3 per unit Raw material Direct labor cost Variable overheads Fixed overheads The management expects the following estimates in 1986. a) b) c) d) e) Sales to increase to 30,000 units, selling price to remain unchanged Raw materials prices to increase by 10% Wage rate to increase by 10% Labor productivity to improves by 5% Fixed overheads to increase by Rs. 2,000 Rs. 60,000 26,500 5,000 8,000 10,000

155

You are required to prepare the budget for 1986. 5. Production costs of a factory for a year are as follows: Direct wages Direct materials Production overheads: Fixed Variable Rs. 90,000 Rs. 1,20,000 Rs. 40,000 Rs. 60,000

During the forthcoming year, the following are anticipated: The average rate for direct labor remuneration will fall from 90 paise to 75 paise per hour Production efficiency will be reduced by 5% Price per unit of direct material and other materials and services which comprise overheads will remain unchanged Direct labor hours will increase by 33 1/3

Prepare the budget and compute factory overhead rate, the overheads being absorbed on direct wages.

6. ABC Ltd. manufacturing a single product is facing a severe competition in selling at Rs. 50 per unit. The company is operating at 60% level of activity at which sales level are Rs. 12,00,000. Variable costs are Rs. 30 per unit. Semi-variable costs may be considered as fixed at Rs. 90,000 in case output is nil and variable element is Rs. 250 for each additional 1% level of activity. Fixed costs are Rs. 1,50,000 at the present level of activity, but at the level of activity of 80% or above these costs are expected to increase by Rs. 5,000. To cope up with the competition, the management of the company is considering a proposal to reduce the selling price by 5%. (a) Prepare a statement showing the operating profit at levels of activity of 60%, 70% and 80%, assuming that the selling price remains at Rs. 50 per unit. (b) If selling price is reduced by 5%, show the number of units which will be required to be sold to maintain the present profits. 7. A company producing electronic watches estimates the following factory overheads costs for producing 5,000 units: Indirect materials Indirect labor Inspection cost Heat, light and power Expendable tools Supervision costs Equipment depreciation Factory rent Rs. 16,000 Rs. 30,000 Rs. 16,000 Rs. 8,000 Rs. 8,000 Rs. 8,000 Rs. 4,000 Rs. 4,000

Indirect labor, indirect material and expendable tools are entirely variable. Heat, light and power and inspection costs are variable to the extent of 50% and 40% respectively. Other costs are fixed costs for a month. Prepare a flexible budget for the overheads for the production of 4,000 and 6,000 units per month. Also find out the average factory overheads per unit for these two production levels. 8. Anil and Avinash Enterprises is currently working at 50% capacity and produces 10,000 units. Estimate the profits of the company when it works at 60% and 70% capacity. At 60% capacity, the raw materials cost increases by 2% and the selling price falls by 3%. At 70% capacity, the raw materials cost increases by 4% and selling price falls by 5%. At 50% capacity, the product costs Rs. 180 per unit and is sold for Rs. 200 per unit. The unit cost of Rs. 180 is made up as below:

Materials cost Wages Factory overheads Administration overheads

Rs. 100 Rs. 30 Rs. 20 (40% fixed) Rs. 30 (50% fixed)

9. ABC Ltd. manufactures a single product for which market demand exists for additional quantity. The present sales of Rs. 60,000 per month utilizes only 60% capacity of the plant. The sales manager assures that with a reduction of 10% in the price, he would be in a position to increase the sales by about 25% to 30%. The following data is available: (a) Selling price (b) Variable cost (c) Semi-variable cost (d) Fixed cost Rs. 10 per unit Rs. 3 per unit Rs. 6000 per unit Rs. 0.50 per unit Rs. 20,000 at present level, estimated to be Rs. 24,000 at 80% output

You are required to submit the following statements to the board: The operating profits at 60%, 70% and 80% levels at current selling price and at proposed selling price The percentage increase in the present output which will be required to maintain the present profit margin at the proposed selling price

10. A manufacturing company has an installed capacity of 1,20,000 units per annum. The cost structure of products manufactured is given below: Variable cost (per unit) Materials Labor Overheads Fixed overheads Semi-variable overheads Rs. 8 Rs. 8 (subject to a minimum of Rs. 56,000 per month) Rs. 3 Rs. 1,04,000 per annum Rs. 48,000 per annum at 60% capacity which increases by Rs. 6000 per annum for the increase of every 10% of the capacity utilization or any part thereof

The capacity utilization for the next year is estimated at 60% for 2 months, 75% for 6 months and 80% for the remaining year. If the company is planning to have a profit of 25% on the selling price, calculate the estimated selling price for each unit of production. Assume that there is no opening or closing stock. 11. The monthly budget for manufacturing overhead of a company at two levels of

capacity is as follows: Capacity Budgeted production (units) Wages Consumable stores Maintenance Power and fuel Depreciation Insurance 60% 600 (Rs) 1,200 900 1,100 1,600 4,000 1,000 9,800 100% 1000 (Rs) 2,000 1,500 1,500 2,000 4,000 1,000 12,000

(a) Indicate which of the items are fixed, variable and semi-variable. (b) Prepare a budget for 80% capacity. (c) Find out the total cost, both fixed and variable, per unit of output at 60%, 80% and 100% capacity. 12. From the following data, prepare a flexible budget for the production of 40,000 units, 60,000 units and 75,000 units, distinctly showing variable and fixed costs as well as total costs. Also indicate the element-wise cost per unit. Budgeted Output and Budgeted Cost per unit Budgeted Output 100,000 units Per unit cost Rs. Direct material Direct labor Direct variable expenses Manufacturing variable overheads Fixed production overheads Administration overheads (fixed) Selling overheads Distribution overheads 90 45 10 40 5 5 10 (10% fixed) 15 (20% fixed)

13. The budget manager of Progressive Electrical Limited is preparing a flexible budget for the accounting year commencing on 1st April 1995. The company produces only one product called Kaypee. Direct material costs Rs. 7 per unit. Direct labor average is Rs. 2.50 per hour and requires 1.60 hours to produce one unit of Kaypee. Salesmen are paid a commission of Re 1 for every unit sold. Fixed, selling and administration expenses amount to Rs. 85,000 per year.

Manufacturing overheads under specified conditions of volume have been estimated as below: Volume of Production (units) Indirect materials Indirect labor Inspection Supervision Depreciation Engineering services Total manufacturing overheads 1,20,000 Rs. 1,50,000 Rs.

2,64,000 3,30,000 1,50,000 1,87,500 90,000 1,12,500 1,98,000 2,34,000 90,000 90,000 94,000 94,000 -----------------------------------------9,70,000 11,50,000

Normal capacity of production of the company is 1,25.000 units. Prepare a budget of total cost at 1,40,000 units of output. 14. Excellent Manufacturers can produce 4000 units of a certain product at 100% capacity. The following information is obtained from their books: June 94 Units produced Repairs and maintenance Power Shop labor Consumable stores Salaries Inspection Depreciation 2,800 Rs. 500 1,800 700 1,400 1,000 200 1,400 July 94 3,600 Rs. 560 2,000 900 1,800 1,000 240 1,400

The rate of production is 10 units per hour. Direct materials cost is Re 1 and direct wages per hour is Rs. 4. (a) Compute the cost of production at 100%, 80% and 60% capacity showing the variable, fixed and semi-fixed items under the flexible budget. (b) Find out the overhead absorption rate per unit at 80% capacity. 15. The following data is available for a manufacturing company for a yearly period: Fixed expenses Rs. in lakhs

Wages and salaries Rent, rates and taxes Depreciation Sundry administrative expenses Semi-variable expenses (at 50% capacity) Maintenance and repairs Indirect labor Sales department salaries Sundry administrative salaries Variable expenses (at 50% capacity) Material Labor Other expenses

9.5 6.6 7.4 6.5

3.5 7.9 3.8 2.8

21.7 20.4 7.9 -----98.0

Assume that fixed expenses remain constant at all levels of production and semi-variable expenses remain constant between 45% and 65% of capacity, increasing by 10% between 65% and 80% capacity and by 20% between 80% and 100% capacity. The sales at various levels are as follows: Rs. in lakhs 50% capacity 60% capacity 75% capacity 90% capacity 100% capacity 100 120 150 180 200

Prepare a flexible budget for the year at 60% and 90% capacities and estimate the profits at these levels of output. 16. A factory is currently running at 50% capacity and produces 5,000 units at a cost of Rs. 90/- per unit as per details below: Material Labor Factory overheads Administrative overheads The current selling price is Rs. 100 per unit. Rs. 50 15 15 (Rs. 6 fixed) 10 (Rs. 5 fixed)

At 60% working, material cost per unit increases by 2% and selling price per unit falls by 2%. At 80% working, material cost per unit increases by 5% and selling price per unit falls by 5%. Estimate the profits of the factory at 60% and 80% working and give your comments.