Comprehensive Cost Management, Budgeting, and Variance Analysis

This report delves into the critical aspects of cost management, essential for organizational decision-making and profit maximization. It begins with a thorough classification of costs, distinguishing between direct and indirect costs, and explores various costing methods such as job order, process, batch, contract, and service costing, including hybrid approaches. The report then delves into the calculation of costs using FIFO, LIFO, and weighted average methods. A significant portion is dedicated to preparing and analyzing cost reports, identifying variances, and commenting on performance, including the use of performance indicators. Furthermore, the report examines the purpose and nature of budgeting, appropriate budgeting methods like incremental and zero-based budgeting, and the preparation of production, purchase, and cash budgets. It concludes with variance calculations, identifying potential causes for variances, and recommendations for corrective actions, along with a reconciliation of budgeted and actual results, culminating in reports to management.

Contents
INTRODUCTION:......................................................................................................................................2
1.1 Classification of Costs:..........................................................................................................................3
1.2 Costing Methods:...................................................................................................................................4
1.2.1 Job Order Costing:..........................................................................................................................4
1.2.2 Process Costing:..............................................................................................................................5
1.2.3 Batch Costing:...............................................................................................................................5
1.2.4 Contract costing:.............................................................................................................................6
1.2.5 Service costing:...............................................................................................................................6
1.2.6 Hybrid or Mixed Methods:..............................................................................................................6
1.3 Calculation of Costs..............................................................................................................................7
1.3. FIFO:.................................................................................................................................................7
1.3.2 LIFO.................................................................................................................................................7
1.3.3 Weighted Average Cost (AVCO)......................................................................................................7
Analysis of Cost Data Using Appropriate Method....................................................................................8
2.1 Preparation and Analysis of Cost Report.............................................................................................8
Comments on Performance:....................................................................................................................9
2.2 Use of Performance Indicators:.............................................................................................................9
2.3 Suggest improvements to reduce costs, enhance value and quality:..................................................10
3.1 Purpose and Nature of Budgeting Process:..........................................................................................11
3.1.1 Purposes of Budgeting:.................................................................................................................11
3.1.2: Nature of the Budgeting Process:................................................................................................11
3.2: Appropriate Budgeting Methods and Their needs in the Organization:.............................................11
3.2.1 Incremental Budgeting:................................................................................................................12
3.2.2 Zero Based Budgets:.....................................................................................................................12
3.2.3 Top- down Budgeting:..................................................................................................................12
3.2.4 Bottom-up Budgeting:..................................................................................................................12
3.3 PREPERATION OF BUDGET.........................................................................................................12
3.3.1 Preparation of Production Budget:................................................................................................12
3.3.2 Preparation of Purchase Budget:..................................................................................................13

3.3.3 Preparation of Cash Budget:.........................................................................................................13
Variance Calculation, Possible Causes and Recommendation of Corrective:............................................15
4.1 Calculation of Variance and Possible Causes......................................................................................15
4.2 Causes and Corrective Actions:...........................................................................................................17
4.3 Reconciliation of Budget and Actual Result:.......................................................................................17
4.4 Reports to Management about the Findings:........................................................................................18
CONCLUSION:............................................................................................................................................18
INTRODUCTION:
Cost management is a very important part of management for decision making in any
organization that are reduction or manufacturing based. Identification of cost, allocation of cost,
analyzing cost and controlling cost are most important aspects of cost management. Without
proper cost management, an organization cannot survive for long to achieve its goals and

maximization of profit. On the other hand, for proper cost management knowing the nature and
behavior of different costs is vital.AS cost is directly related to the financial bottom line target
achievement of an organization, it indispensable for management to minimize cost by proper
allocation and controlling of cost. Preparation of budget, maintaining proper records of actual
outcome achieved, comparing the actual outcome with the targeted one( calculation of variance)
are some major tools of controlling cost and optimization of benefit.
Task 1:
1.1 Classification of Costs:
The following table contains the classification of the costs mentioned in the requirement 1.1.
Before detailed classification it is pertinent to mention that direct cost or indirect cost of
producing a goods or performing a service are determined based on whether those costs are
inextricable or directly influential on the quality and quantity of the goods or services.
S.L
No.
Name of the Cost Description of the Cost Classification of
the Cost
1. Wage of the Electrician Wage of electrician is directly
related to the ob and completion of
the job is highly dependent on the
performance of the electrician.
That is why, it is the direct labor
cost of the job.
Direct Cost
2. Depreciation of the tools used
by ht electricians
Depreciation of the tools used by
the electrician are incurred
whenever it is used for the job
purpose It is directly related to the
performance of the job.
Direct Cost
3. Salary of the Sparky Ltd’s
Accountant
Sparky has to give salary to its
accountants on the basis of the
terms of the employment. Whether
any job is performed or not( in the
short run), the salary of the
accountants shall have to be paid.
Salary of the accountants doesn’t
affect the performance of any job.
Rather it is an administrative cost.
Indirect cost.
4. Cost of cable and other
material used on the job
Cost of cable and other materials
used on the job are in inextricable
part of the performance of an
Direct cost

electrician’s job. This cost directly
influences the job performance
and its quality as well as quantity.
These are the direct material cost
of the job.
5. Rent of the premises for
inventory store.
Rent of premises used to store
inventory are not related to
performance of any job. These are
rather periodic cost and can be
termed as administrative cost. This
cost is neither associated with
performance of job nor does it
affect the quality or quantity of job
performed.
Indirect Cost.
1.2 Costing Methods:
Costing methods refers to the methods of accumulation of costs. Cost accumulation on the other
hand are use accounting techniques and processes to maintain proper database and recording of
cost incurred by a business during production and ordinary courses of operation whether it is
direct or periodic. Most popular and widely used costing methods are Job Costing, Process
Costing, Service Costing, Contract Costing, and batch costing. Cost accumulation stands to
means the ways by which costs are gathered and identified and allocated with specific
customers, jobs, batches, orders, departments and processes. The center of attention for cost
accumulation can be individual customers, batches of products that may involve several
customers, the products produced within individual segments during a period, or the products
produced by the entire plant during a period. The costing or cost accumulation method/ methods
are influenced by the type of production operation where costs are maintained and associated
with a particular cost center.

1.2.1 Job Order Costing:
In job order costing, costs are accumulated by jobs, orders, contracts, or lots. The key is that the
work is done to the customer's specifications. As a result, each job tends to be different. For
example, job order costing is used for construction projects, government contracts, shipbuilding,
automobile repair, job printing, textbooks, toys, wood furniture, office machines, caskets,
machine tools, and luggage. Accumulation of the costs of professional services (e.g., lawyers,
doctors and CPA's) also fall into this category.
1.2.2 Process Costing:
In process costing, costs are accumulated by departments, operations, or processes. The work
performed on each unit is standardized or uniform where a continuous mass production or
assembly operation is involved. For example, process costing is used by companies that produce
appliances, alcoholic beverages, tires, sugar, breakfast cereals, leather, paint, coal, textiles,
lumber, candy, coke, plastics, rubber, cigarettes, shoes, typewriters, cement, gasoline, steel, baby
foods, flour, glass, men's suits, pharmaceuticals and automobiles. Process costing is also used in
meat packing and for public utility services such as water, gas and electricity.
1.2.3 Batch Costing:
In Batch Costing products are produces in batches in large quantity. Each batch is assigned a
batch number so that the batches can be identified and traced easily for the purpose of cost
accumulation. Later on, the batch cost can be averaged by the number of product produced.
Batch cost includes both periodic and product cost or fixed and variable cost. Anytime, per unit
cost of production can be determined by dividing the total cost of a batch by the number of units
produced in that batch.

1.2.4 Contract costing:
A contract refers to a big job usually. In contract costing methods, cost are identified and
allocated to a specific contract or a customer for whom a contract is performed. It helps the
organization to assess the potential customers especially in big jobs. For, example, a company
may bid to sale an Air Craft. There may have several customers willing to by its product. In this
case, contract costing allows the company to determine the cost of performing the contract for
the each customer and profitability analysis of each may help the company to make a proper
decision.
1.2.5 Service costing:
Service costing, from the name it can be easily traced that, is the accumulation of service cost. It
is applicable for only service providing organizations rather than business of goods. The another
name of service costing is operation costing that maintains that cost providing service for a
particular time or period or operation a particular service oriented business. Examples are
Transportation, Hotels, Mobile phone companies, etc.
1.2.6 Hybrid or Mixed Methods:
Hybrid or mixed systems are used in situations where more than one cost accumulation method
is required. For example, in some cases process costing is used for direct materials and job order
costing is used for conversion costs, (i.e., direct labor and factory overhead). In other cases, job
order costing might be used for direct materials, and process costing for conversion costs. The
different departments or operations within a company might require different cost accumulation
methods. For this reason, hybrid or mixed cost accumulation methods are sometime referred to
as operational costing methods.

1.3 Calculation of Costs
1.3. FIFO:
Date Purchase Sales Balance
Unit Rate Amount Unit Rate Amount Unit Rate Amount
Janu. 1 5 50 250 5 50 250
Janu. 5 2 50 100 3 50 150
Janu. 10 1 50 50 2 50 100
Janu. 15 5 70 350 7
2 @50,
5 @70 450
Janu. 25 3
2 @50, 1
@70 4 70 280
1.3.2 LIFO
Date Purchase Sales Balance
Unit Rate Amount Unit Rate Amount Unit Rate Amount
Janu. 1 5 50 250 5 50 250
Janu. 5 2 50 100 3 50 150
Janu. 10 1 50 50 2 50 100
Janu. 15 5 70 350 7
2 @50, 5
@70 450
Janu. 25 3 70 4
2@50, 2
@70 240
1.3.3 Weighted Average Cost (AVCO)
Date Purchase Sales Balance
Unit Rate Amount Unit Rate
Amou
nt Unit Rate Amount
Janu. 1 5 50 250 5 50 250
Janu. 5 2 50 100 3 50 150
Janu. 10 1 50 50 2 50 100
Janu. 15 5 70 350 7
2 @50, 5
@70 450
Janu. 25 3 192.8571429 4
192.85714
29
771.428
5716

Analysis of Cost Data Using Appropriate Method
Using any of the above mentioned techniques, the company can maintain its costing records.
FIFO and Weighted Average costing method are nowadays accepted by accounting standards.
LIFO can also be used for internal purposes. The use of each of the cost flow technique has
several implication for companies cost, profitability, and taxation during a particular period that
is geared by the changes in price level of the products.
TASK 2
2.1 Preparation and Analysis of Cost Report
2.1 Preparation and Analysis of the Cost Report('000)
Particulars
Tentative/
Budgeted
amount
Out Come
Achieved/Act
ual
Varianc
e in
Numbe
r
Variance
Type
Unit 3 2.8 0.2
Unfavorab
le
Direct Material 30 28 2 favorable
Direct Labor 24 26 -2
Unfavorab
le
Factory
Overhead 18 18 0 0
Operating
Overhead 9 10.5 -1.5
Unfavorab
le
Marketing
overhead 3 2.5 0.5
Unfavorab
le
Total Cost 84 85 -1
Unfavorab
le
Comments on Performance:
From the table above, depicted variances and their comments, it is observed that total variance of
cost performance is Unfavorable. This Unfavorable to performance is achieved because among

the five categories of cost, the company has achieved favorable variance only in direct materials;
other four cost categories have unfavorable outcomes. The company has achieved a favorable
outcome in direct material cost that means it has achieved cost efficiency in using or purchasing
it required raw materials. But, in other cost category it has negative variance due to either
inefficiency of management or unavoidable circumstances. This huge unfavorable variance may
cause a great financial loss for the company. Management should focus highly with in depth
analysis of budget and actual market to acquire a positive outcome and sustain the healthy
performance of the company.
2.2 Use of Performance Indicators:
Performance indicators are variables used to measure and assess the performance of a company.
A performance e is simply the outcome achieved. It can be expressed both in absolute value or
percentage form. Use of performance indicators helps the organization to identify the factors that
are differently affecting the performance of the organization and to control those factors to
achieve a better outcome. Performance indicator highly aids the achievement of targets and goals
along with control over and efficiency in cost and circumstances surrounding them. Some of the
major performance indicators used by business entities nowadays are given below:
a) Bottom Line:
Bottom line or net profit of company is the widely used performance indicators to
measure and assess the performance of a company. It is affected by the cost and
revenue figures of a firm directly. Operating profit, profit before tax, gross profit is
something that should be individually developed and controlled to acquire a healthy
bottom line of the organization.
b) Sales Increase:
Increase in sales is another vital performance indicator for a business. It is easy to
conclude that, the higher the sales revenue, the higher will be the profit of a business,.
But caution should be there that, mare increase in sales with considering how much it
is contributing to the margin of business may become very dangerous for an
organization to sustain. For example, a business may try to increase sales volume at a
very competitive price to retain customers at very competitive price. This may lead to
huge financial loss for the company.
c) Customer Satisfaction:
Customer satisfaction is a relatively quantitative measurement of performance and
much more important than any other factor in present very competitive business
environment for the survival of a company. A satisfied customer is a resource for a
company who himself contributes to the business by not only purchasing the product
but also promoting the product in the market.
d) Cost Reduction:
Today’s business environment is very competitive and volatile. Businesses have to
perform in a very unpredictable environment. To sustain in this competitive
environment and survive in the face of unpredictable rapidly changing environment,
cutting cost is very important. Reducing the process tie of production, delay in supply

and procurement, increasing efficiency of the workers and employees, closer source
of raw materials with improves quality are some major ways of cost reduction.
2.3 Suggest improvements to reduce costs, enhance value and quality:
Here are the some ways the company can follow to reduce the cost, increase profit and
enhancing value of the firm:
1. Procure raw material with improved quality and from more convenient sources.
2. Ensure more variable that fixed type operating expenses.
3. Increase efficiency of operating and management people.
4. Employ more efficient workers.
5. Use of improved technology in the production process.
6. Scrutinizing cost, identifying controllable cost and minimizing those as far as
possible.
7. Identify unwanted costs and eliminate those.
8. Fasten the production and operating processes.
9. Fasten the business cycle.
10. Ensure more loyal employees and commitment to the firm who can also contribute to
the promotion of the firm.
11. Ensure more customer satisfaction and internal marketing.
TASK #3:
3.1 Purpose and Nature of Budgeting Process:
3.1.1 Purposes of Budgeting:
If we want define budget in a very simple way, it is just the estimation of probable inflows and outflow in
the form of revenue and expenses. The main purpose of budgeting is to know the tentative cost prior and
take corrective action after the actual situation is incurred. It helps the assessment of management
performance. Some important purposes of budget are as follows:
a) Identify the sources of revenue and inflows.
b) Identify the uses and outflows of resources.
c) To run the business properly with effectiveness and efficiency.
d) To
e) To identify the sources and uses that required more attention.
f) To identify those activities that are not contributing to the business to a desired level
and take corrective actions
g) To eliminate unwanted expenses.
h) To compare what is achieved with what is desired to evaluate performance.

i) To set organization goals and targets.
j) To perform the activities in a timely manner.
k) To reduce cost without compromising the quality and earning a higher profit margin.
l) To assess the clients/ customers, suppliers, lender, investors, borrower and statutory
levies.
3.1.2: Nature of the Budgeting Process:
Preparation of a budget always depends on the target and goals of an organization. It is always based on
the past performance of the business. Specific increments or decrement are assumed and some fixed ratios
are used to reach the budgeted amount based on the past performance. For example, if the companies
target is to maintain an Asset turnover ratio at 2 and its current level of asset is 2 million, then its
budgeted sales will b e 4 million( Asset*Asset Turnover ratio). Therefore, making a budget is a simple
process. But precaution should be taken to avoid overambitious expectation in making budget and
probable future business environment should also be taken into consideration.
3.2: Appropriate Budgeting Methods and Their needs in the Organization:
There are different types of budgeting methods that an organization can use based on its goals,
objectives, targets and nature of business. Different organization may require different budgeting methods
as their activities are different. Even in a very single organization, different budgeting may be used based
on the needs of management. Here we describe some commonly used budget methods and their needs in
the organization.
3.2.1 Incremental Budgeting:
Incremental budgets are made solely based on the current period budgets where some additions are made.
These additions are made based on the expectation regarding the inflation or increase in sales. So,
incremental budget also considers the macro-economic features also.
3.2.2 Zero Based Budgets:
Zero based budgeting eliminates the problems of incremental budgeting. IT starts with a zero base. To
clarify more, there remains no balance from the previous year and all the earning are expensed with
remaining zero balance.
3.2.3 Top- down Budgeting:
This type of budgeting gives more attention to the higher level tasks. Lower level tasks get relatively poor
attention. At first the budget for the higher level task is produced and after that the lower level task’s
budget is prepared. This is also called imposed budgeting.
3.2.4 Bottom-up Budgeting:
This is an opposite method of top-down budgeting methods. It at first prepares the budget for the
activities required for the implementation of a planning. As it focuses more on the fictional level of the
activities, it is more goal achievement oriented in nature.

3.3 PREPERATION OF BUDGET:
3.3.1 Preparation of Production Budget:
Particulars
(Units) Months(Amount in thousands) Total
July ‘16 August ‘16 September ‘16
Sales 100 85 100 285
Add: Expected
ending
Inventory 20 25 30 75
Total
Required
Units of
Finished
Goods 120 110 130 360
Less:
Inventory in
Hand 10 20 25 55
Production
Budget 110 90 105 305
3.3.2 Preparation of Purchase Budget:
Particulars
(Units) Months(Amount in thousands) Total
July ‘16 August ‘16 September’ 16
Expected
Production 110 90 105 305
Raw Material
Required per
unit 3 3 3 9
Total Required
Units of inputs 330 270 315 915
Add: Ending
Inventory of
materials 40 35 45 120
Total RM
required 370 305 360 1035
less: Opening
Inventory 30 40 50 120
Required R.M
purchased 340 265 310 915

3.3.3 Preparation of Cash Budget:
Particulars
(Units) Months(Amount in thousands) Total
July August September
Opening Cash in
Hand 80 40 80 200
Add: Target
Collection 150 180 135 465
A. Available Cash 230 220 215 665
Less: Projected
Distribution
Payment to
Suppliers 110 95 135 340
Payment to
Labor 50 30 60 140
Payment to VOH 30 15 20 65
Total Payment 190 140 215 545
Ending Cash
Balance 40 80 0 120
Desired Ending
Balance 120 60 50 230
Surplus(Deficient
) -80 20 -50 -110
Workings:
W1: Sales Budget
Particulars
(Units) Months(Amount in thousands) Total
July ' 16 August'16 September'16
Budgeted sale 100 85 100 285
Total sales
Revenue(5/unit) 500 425 500 1425

W2: Collection Budget
Particulars
(Units) Months(Amount in thousands) Total
July ' 16 August'16 September'16
Collection
from June
Sales 100 60 65 225
Collection
from July
Sales 50 80 25 155
Collection
from August
sales 40 30 70
Collection
from
September
sales 0 0 15 15
Total 150 180 135 465
W3: Payment to Supplier Budget:
Particulars
(Units) Months(Amount in thousands) Total
July ' 16 August'16 September'16
Payment June
Purchase 40 35 15 90
payment for
July purchase 70 30 10 110
payment
August
purchase 30 10 40
payment for
September
purchase 0 0 0
Total 110 95 35 240

TASK #4:
Variance Calculation, Possible Causes and Recommendation of
Corrective:
4.1 Calculation of Variance and Possible Causes
Following table contains flexible budget for the company to identify the level of variance occurred in
actual performance compared to the budgeted amounts:
Particulars
Static
Budget Flexible Budget Variance
Sales(Unit 3000 2500 500
Sales Revenue( @ 4
per unit) 12000 10000 2000
Less: 0
Material Cost @ 0.8
per unit 2400 2000 400
Direct Labor @ 0.9
per unit 2700 2250 450
Over head Cost @
1.2 per unit 3600 3000 600
Total Cost 8700 7250 1450
Net Profit 3300 2750 550
Master Budget Variance = (Actual Net Income- Master Budget Net Income)
= 3000-3300
= - 330(Favorable)
Sales Volume Variance of Operating Income = (Flexible Budget operating income- static budget
operating income)
=2750-3300
=-550(Unfavorable)
Flexible Budget Variance = (Actual Operating income- Flexible Operating income
=3000-2750

=250(favorable)
Selling Price Variance= Actual saes revenue- flexible budget sales revenue
=9900-10000
=100(unfavorable)
Material Quantity Variance= ( Actual Unit Useed- Standard Unit allowed)
= (1200-3300*0.3)*4
= 840 (Favorable)
Labor rate variance = ((Actual hourly wage rate- standard hourly wage rate)* actual hour worked
= (6.5-7)*400
=200(Unfavorable)
Labor Efficiency Variance = (direct labor hour used-standard direct labor hour allowed)* standard labor
rate per unit
= (400-(3300*5)/60)*7
=875(Favorable)
4.2 Causes and Corrective Actions:
Master Budget Variance:
This type of variance occurred as the actual sales volume is lower than the master budget sales volume.
Company should take initiate to increase the this actual sales level so that it can avoid master budhet
variance that is currently unfavorable.
Sales Volume Variance: Sales volume variance is unfavorable as the actual unit sold is lower than the
budgeted unit for sale. It is a very strong indicator of a business performance. Company should either
increase its actual sales level or it can correct its budget it that is overstated.
Flexible Budget Variance: As the actual selling price has fallen below the budget selling price, we see
an unfavorable variance of flexible budget. Company should go for more stringent and rigid analysis of
the market price level and future business environment.
Selling Price Variance: Selling price variance is the difference between actual selling price prevalent in
the market and what budget. Here for this company it is unfavorable variance. This company should take
necessary actions to increase the market price or if the budget is overstated.
Material Variance: Material variance is the difference between actual material price and standard price
allowed. When the actual material price is more than the standard rate price it becomes unfavorable.

Company can take action to acquire material from low price suppliers or can keep enough stock during
the time when the price is lower.
Labor Variance: Labor variance is the difference between actual labor cost and budget abort cost. It also
occurs when the actual labor required is more than the estimated requirement. It occurs in both way i.e.
quantity of labor and quality of labor along with the prevalent and esteemed price of wage.
4.3 Reconciliation of Budget and Actual Result:
Particulars Variance in Amount Variance in Amount
Budgeted Net Profit 3300
Sales Volume profit
Variance
550(Unfavorable )
Standard Profit from
Actual Sales Amount
2750
Selling Price Variance 100 (Unfavorable)
Material Price Variance 840(Favorable)
Labor Rate variance 20(Unfavorable)
Labor efficiency
Variance
875(Favorable)
Net Variance 1045
4.4 Reports to Management about the Findings:
The overall condition of the company looks favorable and shows that it is performing well.
Sales department has incurred a negative variance. May be it could not acquire the required
market, increase the price, retain the old and attract new customers or simply could not sale at
the desired level for the prevalence of unavoidable circumstances. The sales department should
be hold responsible for this negative variance incurred and it should take all the possible actions
to better the situation. Labor rate variance also should be controlled again increase in the rate or
budget should be rechecked to identify any discrepancies. Labor efficiency should be increased
to the highest level possible. Selling price fall is out of the control of the management. But it can
be cautious enough to predict the probable fall I n the selling price due to different causes and
can adjust the budget accordingly. From this analysis, we can decide that management should
focus more on the activities of sales department. Human resource department and its
management are performing satisfactory enough.

CONCLUSION:
So far we have discussedabout different types of cost, cost classifications, methods of costing/
cost accumulation and their implication on managerial decision making. We have also discussed
about budget, its type and how budget affects the management and decision of the business.
Budget help the organization to run properly and comparison of actual performance with the
targeted one leads the organiosation a sustainable development through taking corrective curses
of actions. We have also shown how to calculate different kinds of variances that help the
business to take proper action towards reducing the negative outcomes. Last but not least, cost
and management accounting are very inextricably related to each other. Without proper
management of cost a business cannot sustain its going concern status as it directly hits the
performance of the organization. So, management should be much more aware about controlling
and management of costs than any other matter.

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