6: Budgeting

Question 1

What is budgeting?

Answer 1

A quantitative expression of a plan of action, in advance of the period to which it relates

A financial plan!

Gives an idea of the costs and revenue that are expected to be incurred or earned

Question 2

What types of budgets are there?

Answer 2

Departmental budgets

Functional budgets

Profit or loss account

Cash budgets

Master budget

Question 3

What are the 8 purposes of budgeting?

Answer 3

Planning for the future

Controlling costs

Co-ordination

Communication

Motivation

Evaluation

Authorisation

Resource allocation

Question 4

What is a budget committee?

Answer 4

Responsible for communicating policy guidelines to those who prepare budgets, and for setting/approving budgets

Normally made up of CEO, budget officer, departmental heads

Question 5

What is a budget manual?

Answer 5

Sets out instructions relating to the preparation and use of budgets

Details of the responsibilities if those involved in the budgeting process, including an organisation chart, list of budget holders

Question 6

What is the principal budget factor?

Answer 6

The factor that will limit the activity of an organisation in a given period

The budget for that factor must be produced first

Question 7

Four final steps in budget preparation?

Answer 7

Initial budgets are prepared - budget slack is built in

Initial budgets are reviewed - integrated into the complete budget system

Master budget is prepared - shown to top management for final approval

Comparison between budgets and actual results - variances

Question 8

What are the steps in budget preparation?

Answer 8

Sales (or Principal Budget Factor!)

Production Budget
- Raw materials
- Labour
- Factory overhead

CoS budget
Selling and dist expenses budget
General and admin budget

Master budget
- P&L
- Cash
- Balance sheet
- capital expenditure budget

Question 9

How to calculate the sales budget?

Answer 9

Sales volume x selling price

Question 10

What is the calculation for production budget?

Answer 10

Sales budget
Closing Inventory
(Opening Inventory)
—————————
Good production
Faulty production
—————————
Total production

Question 11

How to calculate the material usage budget?

Answer 11

Production budget in kg (closing inventory) x standard material usage per unit

Question 12

How to calculate material purchases budget?

Answer 12

Usage budget
Closing Inventory
(Opening Inventory)
————————
@ Standard cost of materials
————————
Budgeted materials cost

Question 13

How to determine labour budget?

Answer 13

Total labour hours x labour rate per hour

Answer should be in £

Question 14

What is the master budget?

Answer 14

The budget into which all subsidiary budgets are consolidated

Profit or loss
Balance sheet
Cash flow

Question 15

What are the elements of a budgeted balance sheet?

Answer 15

Non-current assets
Current assets
Current liabilities
Net current assets
Net assets
Owner’s capital

Question 16

What is sensitivity analysis?

Answer 16

Identifiy which budget assumptions have the greatest impact on the budget

And which need to be considered most carefully

Question 17

What is a cost equation, how is it used, and what one is used most?

Answer 17

Derived from historical cost data

Once a cost equation has been established, can be used to estimate future costs

Same formula as linear functions:

y = a + bx

Question 18

Break down the equation of a straight line?

Answer 18

Y = a + bx

A - fixed cost per period (intercept)

B - variable cost per unit (gradient)

X - activity level (independent variable)

Y - cost, total and fixed (dependent variable)

Question 19

What are the two ways of analysing semi-variable costs into their fixed and variable elements?

Answer 19

High-low method

Linear regression

Question 20

The four steps of calculating the high low method?

Answer 20

1. Determine the highest and lowest activity levels and their associated costs
2. Find the variable cost per unit

Increase in cost / increase in activity

3. Find the fixed cost

One semi-variable cost - (variable cost PU x activity level)

4. Calculate any expected costs

Fixed costs + (variable costs PU x activity level)

Question 21

Disadvantage of the high-low method?

Answer 21

Only takes into account two sets of data, which is not wholly representative

Question 22

What is linear regression, and what are the ads and dis?

Answer 22

Uses mathematical equations

Superior to high low method because it takes all data sets into account

Ads:
- all data points taken into account

Dis:
- assumes that historical behaviour of data goes into foreseeable future
- predictions only reliable it there is significant correlation

Question 23

What is correlation, and how is it measured?

Answer 23

Strength of a connection between two variables

Two variables are correlated if a change in one variable brings about a change in another

Measured by drawing a scatter graph and drawing a line of best fit

Question 24

What are the three outcomes of degrees of correlation?

Answer 24

Perfect - all values would lie on a straight line. Linear relationship

Partial - no exact linear relationship, but variables tend to be associated with other

Uncorrelated - no correlation

Question 25

Difference between positive and negative correlation?

Answer 25

Positive - high values with one variable are associated with high variable of the other - or vice versa Negative - high values of one variable associated with low values of other

Question 26

What is the correlation coefficient?

Answer 26

Alternative to drawing graph to determine if two variables are correlated Strength of a linear relationship between two variables -1 perfect negative 0 no correlation 1 perfect positive

Question 27

What is the coefficient of determination?

Answer 27

Square of correlation coeffecient How much of the variation in the DEPENDENT variable is ‘explained’ or linked by variation in the independent variable Closer to 1, stronger the correlation is Remaining amount in random fluctuations

Question 28

Two limitations of correlation?

Answer 28

Correlations could be misleading on sample data - sampling error - why correlation must be accompanied by a significance test to assess its reliability Correlation and casualty are not the same thing - correlation does not imply that one variable causes the other

Question 29

What is a time series analysis?

Answer 29

Uses moving averages to create a trend line over time When adjusted for seasonal variations can be used to make predictions for the future

Question 30

What three kinds of variations needs to be considered in a Time Series Analysis?

Answer 30

Cyclical variations - economic cycles of booms and slumps Season variation - regular variations around the trend over a fixed time period, usually a year Residual variations - irregular, random fluctuations

Question 31

What are three ways to calculate the trend for a time variance analysis?

Answer 31

High low Linear regression Moving averages Trend can be extrapolated once its been found!

Question 32

How to calculate moving averages?

Answer 32

Used to smooth out the variations 1. Choose a correct cycle length 2. Calculate the total for the first cycle 3. Calculate the average by dividing the total by the no. of periods in the cycle 4. Repeat for the next cycle, and so on

Question 33

How are seasonal variations calculated?

Answer 33

How much the data varies from the trend line Seasonal variance is the difference between the trend line value and the actual historical value Trend can be extrapolated and variations can be applied

Question 34

What are the two methods for calculating seasonal variations?

Answer 34

Additive model: Trend line value + seasonal variation Absolute number Multiplicative model: Trend line value / seasonal variation x 100 Percentage change

Question 35

Three limitations of time series analysis?

Answer 35

Assumption that what happening in the past is a reasonable guide to the future Assumption straight line trend exists Assumption that seasonable variations are constant

Question 36

What are the two types of budget in terms of participative?

Answer 36

Top down budget - set without the budget holder being allowed to participative - imposed budget, or non-participative Bottom up budget - budget holders have the opportunity to participate - participative budgeting

Question 37

Advantages of participative budgets?

Answer 37

Increased motivation Contains better information Increases managers understanding and committment Better communication Senior managers can concentrate on strategy

Question 38

Disadvantages of participative budgets?

Answer 38

Senior managers resent loss of control Bad decisions from inexperienced managers Budgets not in line with objectives Preparation is slower an disputes can arise Figures may be subject to bias as they add budget slack Create create environments that preclude participation

Question 39

3 extra budget types?

Answer 39

Continuous/rolling budget - prepared a year ahead and updated regularly by adding a further accounting period - will always reflect the budget a year in advance Incremental budget - uses the previous period’s budget as a starting point, then adds ‘increments’ as it sees necessary Zero-based budget - starts the budgeting process from zero because it takes nothing for granted

Question 40

What is beyond budgeting?

Answer 40

Idea that companies need to move beyond budgeting because of inherent flaws in budgeting - used in orgs that face enviro changes - greater use of rolling budgets and non-financial targets - targets are based on externally-observed benchmarks - innovation is encouraged and rewarded - budgets is set locally - inspire workers though bold and noble causes