Budget and Budgeting, Cost and Costing - Essay Example

The master budget is then compiled from the budget for limiting factors and other derived budgets. At the end of the period, the actual numbers are compared with the budget, and the organizational goals are reviewed. There are two common approaches to budgeting. In the bottom-up approach, the individual operating units or departments within the organization prepare their budgets. These budgets are then integrated to form the master budget keeping in mind the organizational constraints. In the top-down approach to budgeting, a central committee prepares the budget based on organizational objectives and drives it down the organization.

There are various types of budgets. A fixed budget is prepared to assume a constant level of activity and is useful for roles such as administration, HR, and marketing. A flexible budget is prepared to account for varying levels of activity or production in the organization. An incremental budget is based on previous periods taking into account external factors such as inflation and efficiency gains. A Zero based budget is started with a clean slate i.e. there are no inputs from the past.

A fresh cost-benefit analysis is done for each item. There are some inherent problems with budgets. The output of the budgets is as good as the input data. Budgets motivate people to achieve targets and have a short-term view rather than take action for the long-term development of the firm. Annual budgeting cycles are very inflexible and promote departmental initiatives only. These cycles don’t take into account unexpected expenditures, sudden demand, supplier problems, and resource constraints.

Several pay and non-pay controls are used for budgetary control. Payroll gives easily available and acceptable information while non-pay controls ensure greater flexibility. Variance is used to find the difference between actual and budgeted numbers. A positive variance indicates better performance and vice-versa. Costs and Costing Costs can be defined as the expenses incurred on an activity. Costs can be classified in different ways. Direct costs are the costs incurred on material, labor, and expenses that are incurred on the production of a product or service within an organizational unit for which the manager owns the responsibility.

Indirect costs are the costs that cannot be easily identified or related to a product or an activity and are incurred elsewhere in the organization. Fixed costs are the costs that are constant for a given volume of service units. Variable costs are the costs that vary directly with the volume of service units. Mixed costs contain both fixed and variable components of cost. Step fixed costs are the ones that remain constant over a range of activities but increase incrementally with an increase in activity.

Marginal cost is the change in cost when the volume of service units changes by one unit. A service unit is a measurement of the product or service produced by a firm. Relevant range is defined as the range of upper and lower levels of activity within which the variable cost per unit is constant and the fixed cost remains fixed in total. Marginal Cost Analysis is done to study the impact of the production of one more or one less unit on the total cost. This analysis helps in evaluating the viability of increasing production and capacity.

For example, the cost incurred by adding one more patient to a hospital can be calculated using this analysis. The cost per patient in a hospital cannot be uniquely evaluated because several factors come into play. When the inventory of hospital beds is full, the fixed cost is divided over a large number of patients hence reducing the total cost per patient. However, in case a large number of beds are empty, the cost per patient increases. There is always a trade-off between the cost of collecting information and its accuracy.

Generally, if the cost of collecting information is too high, the accuracy is compromised and an estimate is made. For example, the average cost per patient is calculated by using a proper costing method. In this method the resource consumption for a cost center is evaluated, then direct costs are allocated to this cost center and the costs are finally allocated from the cost center to the revenue center and the service units. Diagnosis-related groups are used to classify similar patients or provide similar care, understand resource consumption, and decide cost allocation.

Activity Based Costing is based on the fact that costs are incurred because of certain activities which are called cost drivers. This costing method follows a cause-and-effect methodology to allocate costs.