Module III

Syllabus: Construction disputes and settlement: Types of disputes – Modes of settlement of disputes –
Arbitration- Arbitrator - Advantages and disadvantages of arbitration – Arbitration Award.
Construction cost and budget: Construction cost – Classification of construction cost – Unit rate costing of
resources- Budget – Types of budget – Project Master budget.

Construction disputes and settlement

When two individuals or parties worked together for a common goal, development of disputes is a natural
phenomenon. In construction industry disputes mainly arise between the client & the contractor. There are two
categories of disputes mainly contractor’s claims against the client and the clients claims against the contractor.

- Contractors claims against the client

1. Claim for extras due to delays caused by employer
2. Interest on delay payments
3. Interest on various claim amounts
- Clients claims against the contractor
1. Claims for delay by contractor in completing work
2. Claims for effective work done by contractor
3. For abandoned contracts, claims for expenditure by client for getting balanced work completed through
other agents.

Normally in construction contracts, provisions are included for settlement of disputes by arbitration. If this is not
there in the contract disputes between client and contractor are settled by negotiation. If negotiations do not settle the
disputes the parties have to approach competent civil courts. Settlement of disputes in construction contracts can be
briefly categorized as follows

1. Settlement by direct negotiation between the client and the contractor

This is the best and most recommended method of settlement of disputes and it is also in the interest of both the
parties. Even when there are arbitration clauses in contracts such clauses do not prevent the parties from amicably
settling the matters directly. The arbitration ceases to exist with respect to the disputes which are thus settled. Thus
even when the parties are unable to resolve all their disputes by such direct negotiations, still the number of disputes
to be settled by arbitration can be reduced to the barest minimum, which is in the interest of both the parties.
2. Settlement through arbitration
Arbitration is the settlement of a dispute by the decision, not of a regular and ordinary court of law, but of one
or more persons chosen by the parties themselves who are called arbitrators. Thus arbitration is a domestic court
where the arbitrator acts as a judge. The contractor cannot go to court of law unless he has gone through arbitration
for the redress of his grievances. Even if the contractor goes to court the engineer in charge should take the plea that
the contractor being a signatory to the agreement containing arbitration clause, any dispute cropping up with
execution of work has first to be settled by reference to arbitration clause. For arbitration appropriate procedure
should be adopted and explained as follows
i. Appointment of arbitrator
Disputes in civil engineering works come up between the contractor and the department usually the
executive engineer. According to the arbitration act the contractor who is the aggrieved party is referred as claimant
and the party against whom the aggrieved party is putting her claims is referred as respondent
The first act of the contractor is to submit his statement of facts. In it the details of grievances and claims
are mentioned against the executive engineer. This statement of facts must be submitted with in the period of
limitation (90 days)

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 Having received the request from the contractor for appointment of an arbitrator the department should
examine the facts and also ascertain whether the claims are time barred and falls within the preview of the
arbitration clause. After this superintending engineer sends his report to the chief engineer for his final orders. The
chief engineer then appoints an arbitrator within at least 30 days from the receipt of such request.
ii. Preparation and submission of a case for arbitration
After being appointed, the first job of the arbitrator is to call a meeting of the claimant and the respondent. In
the meeting claimant is asked to submit his statement of facts containing in details his grievances and claims against
the respondent within a specified date. This statement of facts must be accompanied with copies of all documents,
correspondence, agreement, bill drawings, vouchers etc which the claimant thinks necessary to justify his claims.
One copy of the statement of facts is also given to the respondent. Thereafter the arbitrator directs the respondent to
submit his counter statement of facts within a specified date.
The respondent has to take prompt action to prepare his defence duty supported by documentary evidence and
witnesses to the superintending engineer. One copy of reply is also forwarded to the department counsel. The copy
of the reply supported with documentary evidences is forwarded to the claimant and also to the arbitrator.
iii. Hearing of the case
After having received statement of facts from claimant and counter statement of facts from claimant and counter
statement of facts from the respondent duly supported with the documents as they deemed necessary the arbitrator
studies deeply. Then he fixes some data for both the parties to come before the arbitrator and plead their claims and
counter claims. During the course of pleading counsels both the parties can cross examine each other.
Arbitrator hears pleadings and arguments of both the parties scrutinizes and examines all documents and papers
produced in course of the sittings and then closes the case and publishes the award. As per clause the case has to be
completed within a period of four months from the date the arbitrator first enters into reference.
iv. Issue of award
After preparing the award the arbitrator signs it and gives notices in writing to the parties to sign it. The amount
of fees and charges payable in respect of the arbitration and award are charged. The award is prepared always on
non judicial stamped paper. The authority of an arbitrator ceases as soon as award is made. After this no action of
the parties by way of consent or otherwise would give the arbitrator to make a second award.
If some money is payable to party he should first supply to the arbitrator stamped paper of appropriate value as
may be asked by the arbitrator according to amount of the award as per rules of the state.
v. Filing of award
Once the award is written on the stamped paper it should be examined if it is acceptable to the party. Once the
award is accepted, immediate action should be taken to have the award made a rule of the court by taking necessary
steps before the court, by other party.
In case the reference was made by the court, the arbitrators or umpires should file the award in the court. In case
the reference is made by the parties out of the court, the arbitrators or umpires should give notice of the same to the
parties as soon as the award is made . they shall file the award in court if so requested to do by the parties. If the
arbitrators do not file the award in the court any of the parties may move the court requesting the arbitrators or
umpires to file the award in court. An application for this purpose should be made within 30 days from the date of
service of the notice of making of the award. An awardwill not be bad if it was made before but filed after the date
fixed by the court.
In arbitrations out of court the award need not be necessarily be filed in court to give validity to it.
3. Settlement through court action
Settlement through court of law is the last resort and this takes number of years and
can be frustrating. Courts usually would like the party concerned to exhaust all other administrative channels for
seeking redress ( eg direct negotiation and arbitration ) before hearing the case. Only if the contractor is extremely
confident of his case and honestly believes that he has been wronged at the negotiation and at the arbitration levels
must embark for court action. Court action will require engaging top legal minds who have some experience in
construction industry feuds and ensuring long legal battle- which will also require prolonged attention and physical

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presence of contractor’s top personnel, whose services will thus be diverted away from their usual business. This can
be extremely costly and demoralizing.
3. Computerised evidence
The use of CPM as a method of pinpointing delays is made use in providing computerized evidence for settling
disputes in many developed countries. The reliability and accuracy of the computerized results has given a faster
method of settling disputes.

ARBITRATION

Arbitration, a form of alternative dispute resolution (ADR), is a technique of settlement of dispute by the
decision not of a court of law but of one or more persons chosen by the parties themselves involved in the dispute.
The persons so chosen and given the right to give decisions are called arbitrators. Thus arbitration may be said to be
a domestic court where the arbitrators act as judges.

Other forms of ADR include mediation (a form of settlement negotiation facilitated by a neutral third party)
and non-binding resolution by experts. Arbitration is often used for the resolution of commercial disputes,
particularly in the context of international commercial transactions. The use of arbitration is also frequently
employed in consumer and employment matters, where arbitration may be mandated by the terms of employment or
commercial contracts.

Arbitration can be either voluntary or mandatory (although mandatory arbitration can only come from a
statute or from a contract that is voluntarily entered into, where the parties agree to hold all existing or future
disputes to arbitration, without necessarily knowing, specifically, what disputes will ever occur) and can be either
binding or non-binding. Non-binding arbitration is similar to mediation in that a decision cannot be imposed on the
parties. However, the principal distinction is that whereas a mediator will try to help the parties find a middle ground
on which to compromise, the (non-binding) arbitrator remains totally removed from the settlement process and will
only give a determination of liability and, if appropriate, an indication of the quantum of damages payable. By one
definition arbitration is binding and so non-binding arbitration is technically not arbitration.
Arbitration is a proceeding in which a dispute is resolved by an impartial adjudicator whose decision the
parties to the dispute have agreed, or legislation has decreed, will be final and binding. There are limited rights of
review and appeal of arbitration awards.

Need For Arbitration

In view of the all round development activities new construction projects are being taken up in the country
every day. Since most of the works are got done through contractors by inviting tenders, interpretations of project
document clauses that are bound to crop up is course of execution of the project. There may be so many other
reasons also because of which disputes are likely to come up every now and then between contracting party and
contractors. The only way of solving such disputes is through law courts or arbitration. The solution of such
disputes is very time consuming which may extend through years. It is seen that some disputes took more than 20
years in getting decision. In the interest of development of the nation departmental officers should make every effort
to appoint an arbitrator with mutual consent so that quicker disposal of such disputes is attained. Whenever case has
been referred to law courts the judges at various levels should on merit refer suitable cases for settlement through
arbitration. The sole purpose of arbitration is to get the cases disposed of at the earliest so that progress of important
and national development projects is not jeopardized.

Advantages of arbitration

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  Privacy
Arbitration is a private method of settling disputes. Unlike proceedings in the court, the general public are not
admitted to hearing, none of the documents will become public, & there will not be any reporting of the outcomes.
Companies which are involved in high-tech & other sensitive contracts frequently required arbitration process so as
to avoid confidential data becoming the subject of public debate in the court or matters of public report.
 Flexibility of procedure
There is a scope for having the arbitration procedure tailored to the requirements of the parties. Court process
tends to be procedurally complex hence it takes a lot of time before a case comes to trail. With arbitration, the case
can be deal with quite quickly & at a face of the parties and the arbitrator rather than at the pace of the public
judicial system which is frequently over worker
 Choice of arbitration
The parties can themselves decide who is the best qualified to hear the dispute. A case which goes to the court
will be heard by the judge who will invariably be a lawyer. An arbitration disputes may on the other hand be heard
by engineering or some other person with the specialist knowledge. The arbitration clause in the contract ought to
provide how the arbitrator is to be selected.
 The arbitration is often faster & cost effective
Arbitration can be cheaper or more flexible for business. In arbitrate proceedings the language of arbitration
may be chosen where as in judicial proceedings the official language of the country of the competent court will be
automatically control
 Because of the provisions of the New York convention, 1958, arbitration awards are generally easier to en
forced in other nation than the court judgement.
Disadvantages of arbitration

 Limited authority of arbitrators

 The recognition & enforcement of arbitration awards
 Sometimes arbitration becomes highly complex
 Arbitration may be subject to pressures from powerful law firms representing the stronger & wealthier
party.
 In some arbitration agreements, the parties are required to pay the arbitrator, which adds an additional layer
of legal cost that can be prohibitive especially in small consumer disputes.
 If the arbitration is mandatory & binding the parties waive their rights to acess the court & to have a judge
or jury to decide the case.

Modes of arbitrators
1) Arbitration without the intervention of a court
When both parties agreed to enter an arbitration to resolve their disputes & they have no difference to the subject matter
or to the procedure of arbitration, this mode shall apply.
2) Arbitration with the intervention of a court
When both the parties have the valid agreement for the arbitration but difference have arisen in the subject matter or
procedure of arbitration, a court having jurisdiction may be asked to intervine to settle the dispute in respect of the
subject matter or procedure. There after the arbitration shall proceed to resolve the main dispute
3) Arbitration in suits
In an ongoing law suit, when both parties have agreed they may settle the issue through an arbitration before the
judgement is pronounced. Court may give order in the selection of arbitrator & the time for award.
4) Statutory arbitration
Some statutes provides for the compulsory arbitration in disputes arising out of matters covered by them. Statues like the
cooperative societies act, the industrial dispute act & the land acquisition act requires compulsory arbitration

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Types of arbitration
o Judicial arbitration
It is usually not arbitration at all, but merely a court process which refers to itself as arbitration such as small claim
arbitration before the country court.
o High low arbitration ( bracketed arbitration )
It is arbitration where in the parties to the dispute agree in advance the limits within which the arbitral tribunal must
render its award. It is only generally useful where the liability is not in dispute, & the only issue b/w the party is the
amount of compensation. If the award is lower than the agreed minimum, then the dependent only need to pay the lower
limit, & if the award is higher the agreed maximum, the claimant will receive the upper limit. If the award falls within
the agreed range, when the parties are bound by the actual award amount
o Binding arbitration
It is a form of arbitration where the decision by the arbitrator is legally binding & enforceable, similar to a court
o Non binding arbitration
It is a process which is conducted as if it were a conventional arbitration, except that the award issued by the
tribunal is not binding on the parties & they retain their right to bring a claim before the court or to the other arbitration
tribunal
o Pendulum arbitration
It refers to a determination in industrial disputes where an arbitrator has to solve a claim b/w a trade union &
management by making a determination of which side has the more reasonable position. The arbitrator must choose
only in b/w the two options & cannot split the difference or to select an alternative position
Arbitrators

An arbitrator is a third party who reviews the evidence in the case and imposes a decision that is legally
binding on both sides and enforceable in the courts. Arbitration is often used for the resolution
of commercial disputes, particularly in the context of international commercial transactions.
Selection of Arbitrator

Selection of arbitrator is of importance and arbitrator should have the following qualifications

1. The Arbitrator should be a person who has expert knowledge in particular branch of profession and the
matter in dispute
2. He must be impartial and unbiased ie the Arbitrator shall be personally not related to any of the parties in
any way and he shall be free from ill feeling against any of the parties.
3. He must have unquestionable character, high integrity and unshakable faith in justice

Generally a person not below the rank of retired superintending engineer gets selection as an arbitrator. A
high court generally provides a panel of arbitrators and as such to be an arbitrator one should be included in the
panel.
Powers & Duties of an arbitrator

 To administer both to the parties & witness appearing

 State a special case for the opinion of the court or any question of law involved or state the award , wholly
or in part, in the form of a special case of such question for the opinion of the court
 To make the award conditional or in the alternative
 To correct any clerical mistakes in an award or error arising from an accidental slip or omition

Duties of Arbitrator

1. Duty to follow rules of natural justice:

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 An arbitrator must observe the rules of natural justice. He must act in a judicial manner. His enquiry should
not be slip-shod but full and complete. He must give due notices and maintain proper record of the proceedings. He
ought not to hear one side in the absence of the other side. Any departure from the rules of natural justice is sure to
vitiate the award.
2. Duty to act fairly to both parties:
The arbitrator must act fairly to both parties. He must not favour one party more than another, or do
anything for one party which he does not do for another.
3. Duty not to delegate:
An arbitrator must not delegate his duties to a third person, or to a co-arbitrator. Since one who has an
authority to do an act for another, must do it himself and cannot delegate to another. This rule is, however, subject to
the exception that an arbitrator may delegate to another the performance of an act of ministerial character only.
4. Duty to decide according to law:
It is duty of an arbitrator, in the absence of a provision to the contrary, to decide the question according to
legal rights of the parties and not according to what he may consider to be fair and reasonable under the
circumstances. If an arbitrator decides honestly, through wrongly, he is not guilty of misconduct. But deliberate
disregard of law in matters of arbitration is misconduct.
5. Duty not to exceed his authority:
An arbitrator cannot go beyond the scope of his authority. He derives his authority from the arbitration
agreement. He cannot take upon himself an authority which is not conferred by the submission. If the arbitrators go
beyond the scope of reference and decide a dispute not referred to them, the award is bad.
6. Duty to decide all matters referred:
It is the duty of the arbitrator to decide all the matter referred to him. Where he omits to decide some of the
important questions referred the award is bad. A partial award is invalid and should be remitted for reconsideration.
7. Duty to act together:
When there are several arbitrators, all must act together. The presence of all the arbitrators at all the
meetings is essential to the validity of the award. Omission on the part of the arbitrators to act together amounts to
misconduct.
8. Duty not to accept hospitality:
An arbitrator should not accept hospitality from one of the parties, if the invitation is given with the
intention of inducing him to act unfairly. But merely dining or lunching with one of the parties and his witness in the
absence of other will not invalidate an award.

Construction cost & budget

Construction costs form part of the overall costs incurred during the development of a built asset such as
a building. Very broadly, construction costs will be those costs incurred by the actual construction
works themselves, and on some projects may be determined by the value of the contract with the main contractor.
However, the construction contract may include costs that might not in themselves be considered
literal construction costs (hard costs), such as fees, profits, overheads, and so on. Many projects will also
include costs that it is not possible to determine when the construction contract is awarded (such as prime cost
sums and provisional sums), and there may be construction works that are awarded by the client outside of the main
contract (such as fitting out the interior, minor alterations to the completed works, installation of equipment, and so

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on). As a result, what is considered the actual 'construction cost' of a project must be clearly defined and may not
be finally determined until well after the actual construction works have been completed. This is true, even if
a contract is described as having a 'fixed price' or 'guaranteed maximum price

Classification of construction Cost

Here are five types of costs in a typical project:
 Fixed
 Variable
 Direct
 Indirect
 Sunk

Fixed Costs
Fixed costs are those that do not change throughout the life-cycle of a project.For example, if you are constructing a
road, the excavators and bulldozers are fixed costs. For software development projects, the physical development
space and development computers are fixed costs to the project.
Variable Costs
Variable costs, as the name suggests, are costs that change during the project life-cycle. Construction projects
usually have a long duration and can easily span several years.
For example, in 1987, the Channel (Euro) Tunnel project begun. The objective of this project was to construct an
undersea high-speed train tunnel that would connect Great Britain to France. The project was completed over a
period of 3-4 years and at a cost of about 13 billion U.S. dollars. The project employed over 15,000 people and had
mammoth cost overruns.This project required tremendous risk management skills. During the construction of this
project there were several variable costs, such as fuel costs and labor rates.
Direct Costs
Direct costs are expenses that come out of the project budget directly. For example, if you have outsourced some of
your development work, the developers are expected to put in a specific amount of time, which is then billed for.
The developer salaries are direct costs.
Indirect Costs
Indirect costs are those that are shared across multiple projects. Indirect costs are sometimes also referred to as
Oversight costs. For example, in software development projects, it is common for a project manager or an architect
to be partially allocated across several projects. Hence, the cost of the project manager or architect will be shared
among the projects they are allocated to. Project managers are usually an indirect cost to the project. This is because
their work is to supervise.
Sunk costs
A sunk cost also known as stranded cost is an expense that has already occurred and can’t be changed or avoided. In
other words, it’s a cost that has already been paid and can’t be refunded or reduced. It is in the past and has no
bearing on any future decision making processes. Just like the name implies, sunk costs are gone and can’t be
recovered. Accountants focus on this fact when making business decisions because cost that occurred in the past
should not affect the actions in the future.
For example if a company spends some money for training its employees to use a new software system. The
software turns out to be heavily confusing and unreliable. The senior management team wants to discontinue the use
of new software system. Then the cost spent to train employees is sunk cost and should not be considered in the
decision of discontinuing the new system.

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Construction cost

Cost of land & Development Rights-

 Cost of Land
 Registration charges
 Stamp duty
 Cost of development rights Etc.

Borrowing Cost -
 Incurred for the specific project
 Incurred for common etc.

Construction and Development Cost -

 Incurred for the specific project
 Incurred for common or general etc.

Construction & Development Cost Specific to the Project -

 Land cost
 Site labour cost
 Cost of material
 Depreciation of plant and equipment used in the site
 Cost of moving plant- when one material or equipment move one project to another site of
project.
 Cost of hiring plant & machinery
 Cost of design
 Guarantee and warranty cost etc.

Construction Cost Common in Nature and Attributable to the Projects-

 Insurance
 Cost of technical assistance not directly related to the specific project
 Construction and development overheads
 Borrowing cost

Cost Not Considered as Construction Cost-

 General administration cost
 Selling cost
 Research and development cost
 Depreciation of idle plant and equipment
 Cost of unconsumed material
 Advance payment to sub contractor
 Cost of material which is delivered to the site for future activity.

Classification of costs:
Cost classification is the process of grouping costs according to their common features or
characteristics. Classification of costs is necessary for detailed recording and accurate cost ascertainment.
Cost can be classified according to,
1. Elements 2. Functions 3. Behaviour

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Classification on the basis of element of cost:
On the basis of element of cost can be classified into following types,

1. Direct materials-
Direct materials are those materials which enter into part of the product, the cost of which from part of the
prime cost. Direct materials are also called process materials or prime cost materials. It includes all materials
specially purchased for a particular process, job or production order. Ex-The clay in bricks, the wood in furniture,
the leather in shoes etc.

2. Indirect materials –
Indirect materials are those which cannot be traced as a part of the product. But they are necessary for the
production process. Indirect materials are also known as on cost materials or expense materials. Ex- Fuel, lubricating
oil etc required for operating and maintaining plant and machinery Small tools for general use

3. Direct wages –
Direct wages are the cost of remuneration, such as wages, salaries, commissions; bonus etc direct wages
refers to the cost of wages paid to operatives who help in altering the construction, composition, conformation or
condition of the product manufactured by a concern. Ex- wages paid to drivers it is also called as direct labor or
productive labor or process labor.

4. Indirect wages –
Indirect wages represent the cost of labor employed in the works or factory which is ancillary to
production. In short, wages which cannot be directly identified with a job, process or operation are generally treated
as indirect wages.
Ex- a. General indirect labour such as inspectors, supervisors etc
b. Micsellaneous allowances to labour.

5. Direct Expenses –
Direct expenses are those which are neither direct material cost nor direct wages but directly identifiable
with a job process or operation. Direct expenses are also known as chargeable expenses, prime cost expenses,
productive expenses etc
Ex- a. Hire charge of a special concrete mixer required for civil engineering job.
b. Cost of special pattern, drawing or layout.

6. Indirect expenses –
Indirect expenses which cannot be charged to a product directly and which are neither indirect material cost
nor indirect wages are regarded as indirect expenses.
Ex- a. Rent, rates and taxes
b. Insurance
c. Canteen expenses

Classification on the basis of Functions:

On the basis of functions of manufacturing concerns the costs can be classified to the following types

1. Product cost –
This is the cost of sequence of operations which begins with supplying materials, labour and services and
ends with primary packing of the product. Therefore production represents prime cost + absorbed production over
head

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2. Variable cost-
It is the cost which tends to follow (in the short term) the level of activity, this cost will tend to vary
directly with output. Variable costs are also known as direct costs.
Ex- a. Direct materials
b. Direct labor
c. Direct expenses

3. Administration cost-
It refers to the cost of management and of secretarial accounting and administrative service, which cannot
be directly related to production, marketing, research or development functions of the enterprise. In short
administration expenses are in the nature of indirect expenses and include the following,
Ex- a. Salaries of office staff, accountants directors etc
b. Maintenance of factory estate etc

4. Marketing cost-
The cost incurred in researching the potential markets and promoting products in suitable attractive forms
and at acceptable prices. It includes the selling cost, publicity cost, distribution cost etc

Classification on the basis of Behavior wise:

1. Fixed cost –
It is defined as the cost which accures in relation to the passage of time and which within certain output and
turnover limits, tends to be unaffected by fluctuations in the levels of activity (output or turnover). Other terms
used include period cost and policy cost.
Ex- a. Rent and rates of the factory building
b. Depreciation of building
c. Insurance

2. Mixed cost-
These contain both fixed and variable characteristics over various relevant ranges of operation.
These are 2 types,
1. Semi-variable cost- The fixed part of a semi-variable cost usually represents a
minimum fee for making a particular item/service available. The variable portion is the cost
charges for actually using the service. Ex-Truck rentals, equipment rentals and Utilities

2.Step cost -The fixed part of step costs changes abruptly at various levels of activity
because these costs are acquired in indivisible portions. A step cost is similar to a fixed cost within
a very small relevant range.
Ex-a. salary to supervisor
b. Inspection cost

Budget
A budget is a financial plan for a defined period, often one year. It may also include
planned sales volumes and revenues, resource quantities , costs and expenses, assets, liabilities and cash flows.
Companies, governments, families and other organizations use it to express strategic plans of activities or events in
measurable terms. A budget is the sum of money allocated for a particular purpose and the summary of intended

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expenditures along with proposals for how to meet them. It may include a budget surplus, providing money for use
at a future time, or a deficit in which expenses exceed income
Budgets are also very important in individual life, as it is important in business firms.
The following are the essential of budget:
(a) It is prepared in advance and is based on future plan of action.
(b) It relates to a future period and is based on objectives to be attained.
(c) It is a statement expressed in monetary or physical unit prepared for the formulation of policy.

Types of budget:-
1. Functional basis of budgets.
a. Sales budget:
Sales budget is the primary budget. It is the most important budget to prepare and the other budgets are
prepared on the basis of sales budget. In this budget the in charge or expert forecast the future expected sales of the
firm. The sales manager is responsible for the accuracy of the budget. The sales budgets may prepare on basis of
product, type of customers, salesman, locality etc. for the preparation of sales budget the following things should be
take under care like past sales, sales man estimates, plant capacity, raw material, orders in hand, seasonal
fluctuations, competition etc.
b. Production budget:
After preparing sales budget the next budget will be production budget. In this budget works manager
prepare schedule of production by breaking large production in small units to fulfill the target production. A
properly operated budgets leads to inventory control, improved maintenance of production schedules and production
targets. Suppose, if the estimated opening stock is 5000 units and estimated sales are 25000 units and closing stock
of the product is 3000 units the estimated production will be 25000 + 3000 – 5000 =23000 units (sales + closing
stock – opening stock).
c. Material budget:
In the production budget material is the first requirement to be considered. Materials are basically divided
into two categories as direct and indirect material. It includes the preparation of estimates of different types of the
raw material needed for various products and purchasing raw material in required number at a required time. There
are few factors which should be taken under care like requirement of raw material; company’s stocking policies,
price trend, and cost of raw material.
d. Labour budget:
labour is an important factor in every production organization. Labour plays an important role in converting
raw material into finished product. The labour requirement budgets prepared on basis of production budget. Labour
may be of two types direct and indirect labour. In this budget company has to budget the required number of hours
and the expected pay scales of the employees. This budget gives information about personnel specifications for the
job for which workers are to be recruited, the degree of skill and experience required and rates of pay.

e. Manufacturing Overhead budgets:

This budget gives the works overhead expenses to be incurred in a budget period to achieve the production
target. The cost of indirect material, indirect labour etc can be calculated with the help of this budget. For making
proper control it can be divided into departmental overhead budget. Variable expenses are estimated on the basis of
the budgeted output because these expenses are bound to change with the change in output.

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 f. Administration Expenses budget:
The budget covers the expenses incurred in framing policies, directing the organization and controlling the
business operations. In budget an estimate of expenses is prepared regarding central office and of management
salaries. The budget may be prepared at department level for effectiveness in budgeting system. The budget can be
prepared with the past experience and anticipated changes.
G. Selling and Distribution budgets:
This expense is related to the selling and distribution of material. In this budget experts have to plan for the
expected selling and distribution expenses of the firm. Certain items of selling and distribution costs as cost of
transportation, salesman salaries etc.
h. Cash budget:
This budget is prepared to predict the inflow and outflow of cash during the budget period. In cash receipt
we consider cash sales, credit collection and other receipts in cash payments we consider cash payments, tax
payable, dividend payable etc. Without cash organizations cannot work so prediction about cash is very important. A
cash budget makes provision for a minimum cash balance which will be available at all times.

2. On the basis of flexibility

a. Fixed budget:
This is the rigid budget and it is drawn on the assumption that there will be no change in the budgeted time
period. A fixed budget will be helpful only when actual level of activity is equal to budgeted level of activities.
According to charted institute of management accountants.” A fixed budget is defined as a budget designed to
remain unchanged irrespective of activity actually attained.
b. Flexible budget:
It is also called as variable budget. A flexible budget gives different budgeted costs for different budgeted
costs for different levels of activities. This budget is applicable in where activity levels vary from period to period.
Where the business is new and it is difficult to predict. Where industry is influenced by change in fashion. Where
there are changes in sales.
3. On the basis of period:
a. Long time budgets:
Long-term budgets are prepared for those organizations, which deal in regular product line. Here
organizations are not supposed to change their proceedings in short time periods.
b. Short time budgets:
Short-term budgets are prepared for small time periods which work for seasonal product line. Here
products may change in near future.
Types of Budget
Budgets help businesses track and manage their resources. Businesses use a variety of budgets to measure their
spending and develop effective strategies for maximizing their assets and revenues. The following types of budgets
are commonly used by businesses:

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1. Master Budget
A master budget is an aggregate of a company's individual budgets designed to present a complete picture of its
financial activity and health. The master budget combines factors like sales, operating expenses, assets, and income
streams to allow companies to establish goals and evaluate their overall performance, as well as that of individual
cost centers within the organization. Master budgets are often used in larger companies to keep all individual
managers aligned.

2.OperatingBudget
An operating budget is a forecast and analysis of projected income and expenses over the course of a specified time
period. To create an accurate picture, operating budgets must account for factors such as sales, production, labour
costs, materials costs, overhead, manufacturing costs, and administrative expenses. Operating budgets are generally
created on a weekly, monthly, or yearly basis. A manager might compare these reports month after month to see if a
company is overspending on supplies.

3.CashFlowBudget
A cash flow budget is a means of projecting how and when cash comes in and flows out of a business within a
specified time period. It can be useful in helping a company determine whether it's managing its cash wisely. Cash
flow budgets consider factors such as accounts payable and accounts receivable to assess whether a company has
ample cash on hand to continue operating, the extent to which it is using its cash productively, and its likelihood of
generating cash in the near future. A construction company, for example, might use its cash flow budget to
determine whether it can start a new building project before getting paid for the work it has in progress.

4.FinancialBudget
A financial budget presents a company's strategy for managing its assets, cash flow, income, and expenses. A
financial budget is used to establish a picture of a company's financial health and present a comprehensive overview
of its spending relative to revenues from core operations. A software company, for instance, might use its financial
budget to determine its value in the context of a public stock offering or merger.

5.StaticBudget
A static budget is a fixed budget that remains unaltered regardless of changes in factors such as sales volume or
revenue. A plumbing supply company, for example, might have a static budget in place each year for warehousing
and storage, regardless of how much inventory it moves in and out due to increased or decreased sales

Project master budget

A master budget is the financial document used for projecting the income and expenses of a company, as
opposed to a division, product, or other area of a business. From the master budget, a small-business owner can
develop a variety of reports to help set specific goals for the business. The major components of a master budget
include income and expenses, overhead and production costs, and the monthly, annual, average, and projection
totals.
Income
One of the two main components of a master budget is income. This includes not only your sales, but also any
interest, dividends, royalties or other capital gains you earn. If you won’t be using these latter forms of income to
run your company, leave them off your master budget, making it an operating budget focused on income from sales.
Some master budgets include a bad debt entry, calculating it using a percentage of the sales income.

Expenses
The other main component of a master budget is expenses. Many small-business owners create sub-components of
their master budget expenses to help calculate spending areas they can cut during slow times, or to help calculate

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production and overhead costs. After you’ve listed all of your expected expenses for the year, label each as a fixed
or variable cost. A fixed cost is one you can’t easily change from month to month, such as your rent, insurance
premium, loan payment or copier lease. You will be more likely to be able to cut variable expenses if you’re short
on cash, because many of these are discretionary. Designate recurring variable expenses you can’t easily cut, such as
utilities, phone bills or labor, differently than variable expenses you can’t modify, so you can quickly find places to
cut when the need arises. To create a flexible budget, use formulas that change your discretionary spending based on
your income.

Overhead and Production

Once you complete a master budget, break out your production and overhead costs to help with pricing your product
or service. Identify costs directly tied to making each unit or delivering each service. Depending on the type of
business, these costs might include machinery, materials, extra energy, or labor. Mark these as production costs.
Identify non-production costs, such as marketing, phones, office supplies, and general and administrative costs, and
mark these as overhead expenses.

Totals
A common component of a master budget is the "Total" function, which shows you how you are doing each month
and for the year. You can total your income and expenses by month to show your net income or loss each month.
You can also total your income and expense by category to see how a particular area of your company is
performing. Using totals to track your monthly income and expenses will help you manage your cash flow better if
you prepare a separate budget that shows when bills are due and when income is expected, rather than using
monthly averages. For example, instead of dividing your insurance premium costs by 12 and putting the average in
each month’s expenses, enter insurance premium payments only in the months they are due.

Projections
A helpful component of many budgets is the projection total column, which shows you how you’ll end the year if
you continue performing at your current levels of income and spending. These can be skewed if you have large
expense or income amounts early in the year. Looking at your performance for a particular month usually isn’t a
realistic indicator of your overall performance, because you will have more bills come due in some months. Periods
of higher bills can include the beginning of the year when fees are due, dates when quarterly insurance premiums or
taxes are due, or times when you have seasonal sales peaks and valleys. Averaging your monthly income and
expenses can help you project your annual performance if you don’t have seasonal swings and your expenses are
fairly steady.

Other Budgets and Report

Some businesses create the master budget in conjunction with other budgets, such as sales, marketing, general and
administrative, production, labour, materials, and overhead. This allows each department to amend its numbers,
updating the master budget when they do, which alerts management to any problems or opportunities that occur
when departments or functions change their performance.

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