Differentiate between standard costing budgetary control?

Answer 1

LESSON 6:

BUDGETARY CONTROL AND STANDARD COSTING

Learning Objectives

After studying this chapter you should be able to Understand

· Budgetary control

· Standard costing

Standard Costing

Introduction

From Management's point of view, "What a product should

have costed" is more important than."What it did cost".

Managers are constantly comparing their product cost with

"What it should have costed". Reasons for deviations are

rigorously analyzed and responsibilities are promptly fixed.

Thus, "what a product should have costed" is a question of

great concern to management for improvement of cost

performance. A scientific answer to this problem, i.e.,an answer

based on reasons and consequences, is developed by use of

standard costing. Standard Costing is a managerial device, to

determine efficiency and effectiveness of cost performance. First

of all, we briefly discuss different terms to be used in this

lesson.

Standard. It' is a predetermined measurable quantity set in

defined conditions.

Standard cost:- Standard cost is a scientifically predetermined

cost, which is arrived at assuming a particular level of efficiency

in utilization of material, labour, and indirect services. CIMA

defines standard cost as "a standard expressed in money. It is

built up from an assessment of the value of cost elements. Its

main uses are providing bases for performance measurement,

control by exception reporting, valuing stock and establishing

selling prices."

Standard cost is like a model, which provides basis of comparison

for actual cost. This comparison of actual cost with

standard cost reveals very useful information for cost vontrol.

Standard cost has also been referred to as cost plan for a single

unit. Cost plan will give element-wise outline of what the

product cost should be according to management's thinking.

This thinking is not merely an estimate or guess work. It is

based on certain assumed conditions of efficiency, economic

and other factors. Standard cost is primarily used for following:-

· Establishing budgets

· Controlling costs and motivating and measuring efficiencies.

· Promoting possible cost reduction.

· Simplifying cost procedures and expediting cost reports

· Assigning cost to materials, work-in-process and finished

goods inventories.

· Forms basis for establishing bids and contracts and for

setting selling prices.

Standard Costing. According to CIMA (London), "standard

costing is a control technique which compares standard costs

and revenues with actual results to obtain variances which are

used to stimulate improved Performance." Use of standard

costing is not confined to industries having repetitive processes

and homogeneous products only. This technique has established

the advantages of its use in industries having

non-repetitive processes like manufacture of automobile,

turbines, boilers and heavy electrical equipment.

Standarcd Costing and Estimated Cost:- following are the

points of difference between standard cost and estimated cost.

1. Scientific Determination:- standard cost is scientifically

determined. It means considerable amount of time and

energy is spent to decide how a task should be accomplished

and what resources it should consume. Estimated cost is not

scientifically determined. It is based on past data relating to

product, which is adjusted according to anticipated changes

in future.

2. Representation of Management's View: standard cost

represents management vies of efficient operation and

relevant expenditure. For this reason, standard cost ensures a

particular efficiency in utilization of material, labour and

indirect services. The idea of efficiency does not dominate

determination of estimated cost.

3. Different Aims: "What a product cost should be" and

"What a product cost will be" point towards the two

different attitudes, that dictate determination of standard

cost and estimated cost.

4. Usage of Control:- Standard cost primarily helps

management in controlling cost performance. For this

reason, precision efficiency and analysis become important

ingredients of standard cost determination.

Limitations of Historical Costing

1. Data does not provide yardstick of comparison for actual

cost.

2. Data is made available too late to correct inefficiencies that are

causing costs to go out of limits.

3. Data does not provide motivation to employees to strive for

accomplishment of there objectives.

4. Data provides insufficiently for budgeting, planning,

decision-making and price quotation.

These limitations of historical costing are primarily responsible

for advent and wide usage of standard costing.

Standard Costing and Budgetary Control

Budgetary control and standard costing are two different terms.

These techniques are complementary to each other. These are

interrelated techniques, but these techniques are not interdependent.

Standard costing is introduced primarily to ascertain

efficiency and effectiveness of cost performance. Budgetary

control is introduced to state in figures an approved plan of

22 11.269

© Copy Right: Rai University

ADVANCED MANAGEMENT ACCOUNTING

action relating to a particular period both standard costing and

budgetary control have to following common features:

1. Both have common object of improving managerial control.

2. Both techniques are based on the presumption that cost is

controllable.

3. In both the techniques results of comparison are analyzed

and reported to management.

Despite these common features these are two different techniques.

The points of difference are summarized as follows:-

1. Denote Different Ideas. Standard costing denotes a unit

idea. It outlines, what a unit should cost. Standard cost

provides a cost plan for a unit whereas budget denotes a

"total idea". The statement clearly explains the difference;

"Budgeted cost of material is Rs. 1,000/-, if 10,000 units are

produced at a standard cost of Re.1/-each".

2. Different aims- Budget seeks to lay down a monetary limit

of expenses, which should not be normally exceeded. If this

limit is exceeded the actual profit will fall short of budgeted

profit. Standard costing seeks to procure efficient utilization

of material, labour and indirect services

3. Different scope- Budgets are laid down for all functions of

an organisation like production, purchase, selling and

distribution and research and development. Standard costing

relates primarily to one function i.e., production. It mainly

deals with manufacturing cost only

4 Treatment of Income and Expenditure:- budget

preparation considers both income and expenditure, whereas

use of standard costing is mainly confined to expenditure

only.

5. Difference in Treatment of Variance:- in practical life,

budget are taken to be the monetary ceiling. Often efforts are

directed to see that budgets are not exceeded, because failure

to be in budgetary limit will call for detailed explanation to

higher management. In standard costing, variances are

subjected to microscopic view with reference to causes and

incidence. All distinct deviation are reported to higher

management

6. Different Function:- Budgetary control desrescribes a

monetary limit which, if adhered to will keep the business

out of financial crisis. Standard costing emphasizes a

particular efficiency in utilization of input resources. It may

highlight new areas for

Advantages of Standard Costing

1. Use of standard costing leads to optimum utilization of

men, material, and resource.

2. Its use provides a yardstick for comparison of actual cost

performance.

3. Only distinct deviation is reported to management. Thus, it

helps application of the principle of "management by

exception".

4. It is very useful to management in discharging functions, like

planning, control, and decision-making and price fixation.

5. It creates an atmosphere of cost consciousness.

6. It motivates workers to strive for accomplishment of

defined targets. It precipitates an attitude that is conducive to

efficiency.

7. It highlights areas, where probe promise improvement.

8. Its introduction leads to simplification of procedures and

standardization of products.

9. Its introduction enables the management to reduce time

required for preparation of reports for pricing, control or

quotation.

10.Its use enables to find out the cost of finished goods

immediately after completion.

11.If standard costing is used, stock ledgers can be kept in

terms of quantities only. This eliminates much clerical effort

in pricing, balancing and posting on stores ledger cards.

12.Its use may encourage action for cost reduction.

Limitations of Standard Costing: -

Standard costing is very good system, but it should be giving

regard to following limitation:

1. Establishment of standards may demand a lot of skill,

imagination and experience. If all factors are not in harmony,

desired result will not be forthcoming.

2. Variance analysis is useful, whereas deviation are linked with

responsibilities. Sometimes, it is difficult to fix responsibility,

because the result happens to be outcome of a number of

contributory factors.

3. Standards should correspond to current conditions for best

results. Current conditions change very rapidly. Revision of

standard is a costly exercise and leads to a lot of associated

problems. For this reason revision of standards may get

ignored. This delay may be disastrous for effectiveness of the

system.

4. It is difficult to use standard costing, when working

conditions do not permit standardization of material

contents, labor contents or the use of indirect services

relating to different jobs, processes and services.

5. Lack of interest by appropriate level of management renders

the use of standard costing ineffective.

6. Isolating the Controllable and uncontrollable elements of

variances is a very difficult exercise and this difficulty restricts

the application of standard costing.

7. Sometimes, use of standard costing creates adverse

psychological effects, if standards are set at a high level.

Preliminaries to Establishment of

Standards

Before standard cost for different elements of cost is determined,

management must take decisions about the following:

1. Length of period of use. First of all decision is to be

arrived at, relating to a period, for which standards will be

used. According to this decision, management will decide to

use current standard, basic standard or normal standard.

This decision is the starting point for establishment or

standards.

2. Types of standards to be used. It means that management

should decide how tight or looses standards ought to be.

© Copy Right: Rai University

11.269 23

ADVANCED MANAGEMENT ACCOUNTING

Policy of management will help to take this decision. If cost

reduction is the aim, a tight standard will be choice of

management. Similarly, if pricing decision and planning the

expenditure is the aim of management, standards

corresponding to the current conditions will be the choice of

management.

3. Review of existing procedures. The existing procedure

should be subjected to review, because some activities may

have to be routinised and wastages, rejections and losses may

have to be standardized. This review will call for a complete

study of technical and operational aspects of organization.

4. Classification of accounts. The existing accounts manual

in an organisation may not be sufficient to comply with the

requirements of cost collection, cost analysis and variance

reporting. For this reason, existing accounts manual may

have to be suitably adapted to meet the requirements. This

may call for a change in existing classification of heads of

accounts.

5. Review of existing coding system. The existing coding

system is subjected to review to adapt it to introduction of

standard costing. This change may demand orientation of

existing coding system.

Factors Interfering with the Successful

use of Standard Costing

Some of the factors, which tend to interfere with the successful

use of standard costing, are summarized below:

1. Some companies have well-developed standard cost plans for

product costing. Still they make little use of standard costing

for managerial purposes. One valve manufacturing concern

had been collecting labour cost variance by departments for

several years and yet they did not know what to do with

them. When a discussion of these variances took place with

the foreman of the department in which the variances

occurred, the cost accountant could not believe that he had

ignored these variances for control purposes

2. Some standards are out-of-date or unreliable. They are not,

therefore, taken seriously.

3. Reports are not made in terms which management

understands. Using technical cost accounting terminology

will not help executives having a production or sales

background.

4. Changing conditions made it necessary to revise standards

more often. Many firms do not do this.

5. Sometimes it is difficult for management to make effective

use of standards, since it is difficu1t to determine the sources

of variances. When these sources are eventually discovered so

much time has elapsed since they occurred that the

managerial effectiveness of control is lost.

Special use of Standard Costing

The use of standard costing is fast growing as an effective

technique of cost accountancy. Its special uses are discussed

under following headings:

1. Adds to managerial effectiveness and efficiency. It is not

enough for a manager to be effective. He has to be efficient as

well. Performance of a manager should be both effective

and efficient, i.e., desired objective should be accomplished

with minimum input resources. The use of standard costing

provides media to specify these objectives of effectiveness

and efficiency. It also provides framework to measure the

degree of attainment of effectiveness and efficiency.

2. Aids inventory costing. Valuation of inventory at standard

cost simplifies the pricing of inventory. It enables the

company to follow a consistent practice. All operating gains

and losses are charged off to accounting period in which they

arise. This enables executives to analyse the variances by type,

causes and locations. When standard costing is used, a unit

standard cost is available for inventory valuation and pricing

of store issues. It avoids the need to compute a new average

unit price with each input entry, as is the case, when perpetual

inventory records are kept at actual cost.

3. Help in product pricing. The knowledge of standard cost

of product can be useful as one of many factors to be taken

into account for pricing. The standard cost of a product is a

useful starting point in pricing. It provides a warning that

unless this amount and something more for profit is

recovered in the selling price, the product will not be really

profitable. The knowledge gained in setting standard cost

provides the entire cost picture of the product ranging from

its out -of-pocket cost to full costs. With all this

information, it becomes possible to ascertain the extent to

which an available price will cover out-of-pocket costs and

contribute to recovery of fixed costs. The standard cost

provides one of the many factors that should be considered

in pricing.

3. Reduces clerical record keeping and aids cost reduction.

Standard costs may result in reduction of clerical work. For

example, under actual cost system, each item of each material

requisition must be costed separately, when LIFO or FIFO

method is used. In a large company, this is an enormous

task, since thousands of requisitions may be issued. Under a

standard costing system, all the issues of a particular type

have to be multiplied once by the standard cost. Under

standard costing, only quantities have to be maintained on

stores records. This saving is, of course, partially offset by

the added cost of establishing and revising standards.

Budgetary Control

Introduction

For effective running of a business, management must know:

i. Where it intends to go, i.e., organizational objectives.

ii. How it intends to accomplish its objective.

iii. Whether individual plans fits in the overall organizational

objective.

iv. Whether operations conform to the plan of operations

relating to that period.

Budget control is the device that a company uses for all these

purposes.

Budget: a budget is a quantitative expression of plan of action

relating to the forthcoming budget period. It represents a

written operational plan of management for the budget period.

It is always expressed in terms of money and quantity. It is the

24 11.269

© Copy Right: Rai University

ADVANCED MANAGEMENT ACCOUNTING

policy to be followed during the budget period for attainment

of specified objectives.

The essential features of a budget are:.(a) financial and quantitative

statement of the action plan, (b) laid down prior to the

budget period during which it is followed (c) based on

management's policy (d)prepared for specified objective.

In the ClMA terminology, budget is defined as follows:--

"A plan expressed in money. It is prepared and approved prior

to the budget period and may show income, expenditure, and

the capital to be employed. May be drawn up showing incremental

effects on former budgeted or actual figures, or be

compiled by zero-based budgeting."

Budgetary Control and Budgeting. The terms budgetary

control and budgeting are often used interchangeably to refer to

a system of managerial control. Budgetary control implies the

use of a comprehensive system of budgeting to aid management

in carrying out its functions like planning, coordination

and control. It is a system, which uses budgets for planning and

controlling different activities of business. This system

involves:-

i. Division of organization on functional basis into different

sections (each section is technically known as a budget center)

ii. Preparation of separate budgets for each "budget center",

iii. Consolidation of all functional budgets to present overall

organizational objectives during THC forthcoming budget

period,

iv. Comparison of actual level of performance against budgets.

Comparison process is stretched far enough to declare either

attainment of objective or basis of revision of plan of

action and

v. Reporting the variances with proper analysis to provide basis

for future course of action.

In the CIMA (London) Terminology

"Budgetary control is the establishment of budgets relating to

responsibilities of executives to the requirement of a policy, and

the continuous comparison of actual with budgeted results

either to secure by individual action the objective of that policy

or to provide a basis for revision."

Budgeting is a way of managing business and industry. It

emphasizes that management should anticipate problems and

difficulties. Advance decision should be taken for the course of

activities during the forthcoming budget period. Budgetary

control denotes a formal system based on the concept of

budgeting.

Objectives of Budgetary Control

1. Planning. Planning is an important managerial function. It

helps to decide in advance what to do, how to do it, when to

do it and who is to do it. Planning, thus, helps the managers

to anticipate eventualities, prepare for contingencies for

achieving the ultimate goa1s. Budget preparation drives the

managers to plan ahead. Managers express their operational

plans for anticipated business conditions. Without a formal

procedure of budgetary control, many operating managers

will not find the time to plan ahead. Thus, budgeting is an

important sub-units in the attainment of overall

organizational objectives.

2. Communication. The employees of an organization should

know organizational aims, objectives of sub-units (budget

centres) and the part that they have to play for their

attainment. Budgets effectively communicate this

information to employees.

3. Coordination. To coordinate is to harmonize all the

activities of a company so as to facilitate its working and its

success. Coordination will lead to following results:

a. each department will work in harmony with others,

b. each department will know the specific role that it has to

play in the accomplishment of overall organisational

objectives, and.

c. the sequential arrangement of activities of different

departments is so governed that overlapping of activities

and wastage of time and labour is avoided.

A comprehensive system of budgeting helps to coordinate

different functional budgets. In other words, a budget will

preclude the production department from producing more

than the sales department can sell.

4. Motivation. If employee have actively participated in

budget preparation and if they are convinced that their

personal interests are closely associated with the success of

organizational plan, budget provide motivation in the form

of goals to be achieved. The budgets will motivate the

workers, depends purely on how the workers have been

mentally and physically involved with the process of

budgeting.

5. Control. Under the system of budgetary control, budget

forecast is thoroughly discussed and reviewed to be finally

approved as functional budgets. Thereafter a lot of cuts and

adjustments are made to make functional budgets fit in the

organizational objectives. Then budget formation is

followed by a feedback system to pinpoint the extent of

variation between actual level of performance and budgeted

level of performance. Thus, the inbuilt mechanism of the

routine of budgetary control is bound to precipitate to an

operational control

6. Approved Plan. A master budget provides an approved

summary of results to be expected from proposed plan of

operations. It concerns all functions of organization and

serves as a guide to executives and departmental heads

responsible for various departmental objectives.

Requirements of a Good Budgeting System

Following are the requirements of a good budgeting system:

i. Budgeting process should be backed and supported by the

chief executive of an organization.

ii. The organizational goal should be quantified and clearly

stated These goals should be within the framework of

organizations' strategic and long-range plans.

iii. The organizational goals must be divided in functional

goals.

© Copy Right: Rai University

11.269 25

ADVANCED MANAGEMENT ACCOUNTING

iv. The functional goals should not conflict with overall

organizational objectives.

v. All in the organization should mentally accept the exercise of

budget preparation.

vi. The persons responsible for execution of budget should

participate in budget preparation.'

vii.The budget should be realistic. It should represent goals that

are reasonably attainable.

viii.The budget, should cover all phases of the organization

ix. The budgeting should be a continuous exercise.

x. Periodic reports should be prepared promptly comparing

budget and actual results.

xi. Clear-cut organizational lines should be established with

appropriate delegation of responsibilities for effective

implementation.

Advantages of Budgetary Control

1. A budget programme forces the managers to plan ahead.

2. It forces early consideration of basic policies.

3. All members of top management participate in budget

committee. For this reason even planning at departmental

level gets benefit of experience of seasoned executives.

4. All functional heads are compelled to make plans in

harmony with the plans of other departments.

5. Management is forced to put down in cold figures, what it

means by satisfactory results.

6. It demands the most economical use of labour, materials,

facilities and capital.

7. It inculcates a habit of timely, careful, adequate consideration

of all factors before reaching important decisions.

8. The use of budgets removes clouds of uncertainties for

lower levels of management regarding basic policies and

objectives.

9. The use of budgets promotes understanding of the

problems of co-workers

10.It facilitates periodic self-analysis of the organization.

11.It aids in obtaining bank credit.

12.Management is forced to give timely and adequate attention

to the effect of changing business conditions.

Limitations of Budgetary Control

1. Estimates are used as basis for budget plan and estimates are

based, mostly on available facts and best managerial

judgment. Since a lot of human element is involved in

exercising managerial judgment, it is but natural to give

some allowance in interpretation and utilization of

estimated results. Budgeting based on inaccurate forecasts is

useless as a yardstick for measuring the actual performance.

2. The circumstances are constantly changing and, therefore,

budgets and budgetary techniques will not be useful, till they

are continually adapted.

3. In order that a system may be successful, adequate budget

education should be imparted at least through the formative

period. Sufficient training programmes should be arranged

to make employees give positive response to budgetary

activities.

4. Execution of budgetary control will not automatically occur.

A continuous budget consciousness throughout the

organization is needed for achievement of this objective.

5. Budgetary control cannot reduce the manageria1 function to

a formula. It is only a managerial tool which measures

effectiveness of managerial control.

6. The use of budget may lead to restricted use of resources.

Budgets are often taken as limits. Effort may, therefore, not

be made to exceed the performance beyond the budgeted

targets, even though it may be physically possible.

7. Frequent changes may be called for in budgets due to fast

changing industrial climate. It may be difficult for a company

to keep pace with these fast changes, because revision of

budget is an expensive exercise.

The following Question-answer format

Summarizes the Chapters Learning

Objectives

1. Explain the major features and advantages of a budget.

A budget expresses in quantitative terms, an organizations

objective and possible steps for achieving them. Thus, a

budget is tool that helps managers in both their planning

and control functions. The two major parts of a budget are

the operating budget and the financial budget. Advantages

of budget include formalisation of planning, providing a

framework for judging performance and aiding in

coordinating their efforts.

2. Anticipate possible human relations problem caused by

budgets.

The success of a budget depends heavily on employee

reaction to it. Negative attitude toward budget usually

prevent realization of many of the benefits of budgeting.

Such attitude are usually cused by managers who use budgets

to force behaviour or to punish employees. Budgets

generally are more useful when they are formulated with the

willing participation of all affected parties.

3. Understand the importance of budgetingof budgetingto

mangers.

The budgetary process compels managers to think and to

prepare for changing conditions. Budgets are aids in

planning, communicating, setting standards of prformance,

motivating personnel towards goals, measuring results and

directing attention to problem ares that need investigation.

Notes

Submitted by ,

╚►♥ѕαη∂єєρ♥◄╝