Lecture 9 - Budgeting and Planning

Question 1

What is the budget cycle?

Answer 1

Question 2

6 criticism of annual budgets

Answer 2

1. Preparing budgets is time consuming and may not be worth the cost
2. The lack of flexibility inherent in budgeting does not fit well with a constantly changing environment
3. Budget slack: Budgets can be manipulated and provide incentives for the wrong/self-interested behaviour of managers
4. Budgetary reporting is not meaningful to front-line managers
5. Budgeting eliminates the drive for constant improvement
6. The budget is not aligned with strategy (Libby and Lindsay 2010)

Question 3

What is the problem with zero based budgeting?

Answer 3

Budget over 12 months, justify each expenditure each time.

Move away incremental buffers.

Tool to cut costs, rather than a good mechanism.

Question 4

What are key budget inputs required?

Answer 4

1. Sales (talk to marketing staff, expectation of improvement)
2. Production requirements
   
   1. Each individual plant
   2. Inventory levels
   3. “learning” effect à get better, more efficient.
3. Expense budgets

Connected budgets (production, sales and expenses)

Target setting (sales units, production volumes)

Identify standard inputs/costs

What is the behavioural impact on achievement of budget targets? Over or under achieve.

Question 5

What is the purpose of a flexible budget?

Answer 5

Flexible budget = what our static budget would look like if we developed it using actual quantity of output produced.

I.e. comparing actual results against our budgeted assumptions (standards)

• Allows us to get a sense of how different our actual and budgeted costs are after ‘equalizing’ the production volume.

Equalise for production and sales.

Question 6

What is standard costing?

Answer 6

Standards are benchmarks or ‘norms’ for setting targets and measuring performance.

Two types exist:

• Quantity
  
  • How much input is used?
  • E.g. 500cm of cotton used to make a shirt, or 2 labour hours
• Price
  
  • Specify how much should be paid

E.g. 1sm of cotton is $5, employee is paid $18 an hour.

Question 7

What is the flexible budget variance?

Answer 7

1. Price variance
   
   1. The difference between actual price of inputs and standard price.
   2. I.e. what price did we get for our inputs compared to what we predicted?
   3. Measures:
      
      1. Materials price variance
      2. Labour price/rate variance
      3. VMOH rate/spending variance
2. Quantity variance (efficiency variance)
   
   1. The difference between actual quantity of inputs and standard quantity of inputs.
   2. i.e. how much input was required compared to what we predicted?
   3. Measures:
      
      1. Materials efficiency variance
      2. Labour efficiency variance
      3. VMOH efficiency variance

Question 8

What can we use variance analysis for?

Answer 8

Organisational learning

Question 9

Management by exception vs continuous improvement.

When is each approach appropriate?

Answer 9

Management by exception

• Only intervenes if variances are beyond a threshold
• Management would investigate further/spend time on something if it is outside the acceptable upper and lower range. This is because management is time poor and is unable to investigate all variances.
• E.g. An ‘$X’ threshold of U variances.

It is appropriate for business in a steady state, and have a good understanding of what the appropriate standard should be (thus can accurately set thresholds)

Continuous improvement

• Regardless of threshold, always seeking to improve.

Appropriate when firms are:

• Management is time rich
• When firm operates in a quite volatile environment
• When firm is new and management is unable to gauge the correct standards.

Or new circumstances arise for the business (e.g. deregulation, which would influence management’s standards in unforeseen ways)

Question 10

Rationalising variances

Direct materials price and efficiency

Direct labour price and efficiency

Answer 10

• Overtime

Direct material - price

• Is the standard wrong?
• Price negotiation
• Quality of the materials
• Internal or external shocks (e.g. natural disaster in major forest areas).
  
  • Emergency change of supplier
• The way it was purchased? – Bulk (discount), regular

Direct materials – efficiency:

• Workers more efficient (skill)
• More machinery
• More planning
• Economies of scale?

Direct labour – price:

• Higher skilled?
• Poor negotiation
• Overtime
• Labour shortages

Direct labour – efficiency:

Less efficient at higher output levels (demotivated or tierd)

Question 11

What can variances be used for?

Answer 11

1. Evaluate performance/reward
   
   1. Is the variance outside or inside person’s control
2. Dysfunctional behaviour; Overemphasis on any single performance measure
   
   1. E.g. sole focus on price variance to evaluate performance of purchasing manager may lead to quality compromises.
3. Organisational learning:

Identify root cause of variance.

Question 12

What actions might a firm take in response to an unfavourable materials efficiency variance?

Answer 12

• Redesign products
• Redesign processes
• Change suppliers
• Workforce training
• Change the assignment of staff to tasks
• Better scheduling of materials delivery

Question 13

How do external events impact our ability to achieve the target?

Answer 13

Disasters that were unexpected.

Often harm our ability to meet target.

Question 14

How should you go about establishing standards?

Question 15

What are the long term implications of short term decisions?

Answer 15

I.e. cut marketing costs or maintanance costs –> can have implications in teh future.

Question 16

What are benefits of creating budgets?

Answer 16

1. Plan availability of resources
2. Facilitate product development and innovation decisions
3. Facilitate target setting across the organisation
4. Provide a mechanism for comparison with actual performance (the control function) includes the use of flexible budgeting

Facilitates a consideration of market influences