Budgeted cost is an estimate of the expenses that a company expects to spend going ahead. Or, we can say it is the expenses that management estimates to pay based on forecasted revenue and sales. To meet the budgeted cost, a company usually sets aside funds in advance or makes arrangements for a suitable credit facility.
A point to note is that the budgeted cost could be for the full business, a particular project, or a product. For example, the estimated cost for a project would include all the expenses needed to complete the project. These expenses could be raw materials, salaries of the participants’ and more. It also consists of both fixed and variable costs, though they are budgeted differently.
For instance, if a company expects to increase production by 10%, then it would estimate the variable costs to rise by 10% as well. However, there may or may not be a need to raise the fixed cost to adjust for the increase in production.
Budgeted Cost – How to Create?
There are two main steps to create a budgeted cost:
Estimating Future Revenues
Under this, the company estimates the revenues and then the expenses to earn those revenues. The company uses the numbers of the current year or maybe previous years to determine the future. For example, if a company believes that its sales would be 20% more next year, then it would take the sales of the current year and add 20% to that.
Decide Associated Expenses
After estimating the revenue, the management needs to figure out the expenses that it would need to incur to achieve the revenues. These expenses that the company estimates are the budgeted costs.
There is no guarantee that the expenses that management estimates will be the same as the actual expenses. They can be very different from the actual costs depending on external and internal factors. For instance, management expects the raw material cost to be about 10% of the total cost. But, because of a significant rise in oil prices, the actual cost of raw materials was about 18% of the total cost. Though this variation won’t affect the accounting of the expenses, it may result in management changing the way it forecasts expenses.
Actual vs. Budgeted vs. Standard Costs
The actual cost is the amount that a company pays to meet the expenses for the current year, or of the previous years. Mostly these are the costs that go into accounting to determine the profit or loss for a business.
Standard costs are generally applicable in the case of manufacturing activities. These are the established or the general costs, meaning the company knows beforehand how much it would have to spend per unit. We can also say that it is the advance estimate of the actual costs. For instance, in a manufacturing organization, the standard cost for the next year for direct materials, including the standard rate per unit and the standard quantity of raw material per unit.
Budgeted costs, as said above, are the total estimates of the expenses that an organization expects to meet in the near future. Unlike the standard cost that relates to the cost per unit, the budgeted cost means the total cost for a certain level of activity.
Budgeted Cost of Work Scheduled (BCWS)
BCWS is a vital project management measure. It helps the management to understand the cost of a project at any time. In simple terms, we can say it is the estimated cost of a project up to a specific date.
Let’s take a simple example to understand BCWS better. Assume a project’s budgeted cost is $200,000, and it would take one year to complete. If, after six months, the management wants to know how the project is going, then BCWS could help.
The project was for one year, so after six months, one can expect the completion of 50% work. So, the Budgeted Cost of Work Scheduled in this case will be $100,000. We can compare this with the actual spending on the project after six months to check the performance.
Similarly, there is another concept, and it is, BCWP (Budgeted Cost of Work Performed). It is nothing but the budgeted cost of the work done or completed at the time of the reporting date. For instance, in the above case if 40% of the work is completed after six months, then the BCWP will be 40% of the total budgeted cost, or $80,000.