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Accounting Units 3 & 4 > Budgets > Flashcards

Flashcards in Budgets Deck (30):
1

Budgeting

The process of preparing reports that estimate or predict the financial consequences of likely future transactions. Business owners must attempt to predict what will happen in the future, so that they can plan ahead and be prepared for what is likely to occur.

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Budget

an accounting report that predicts/estimates the financial consequences of future events

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3 budgeted reports

Cash flow statement
Income statement
Balance sheet

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Compare and contrast budgeted reports and historical/current reports

Budgeted reports differ from the actual or historical, reports we have prepared so far in two key ways. Budgets report future events rather than historical events. They focus on what will happen rather than what has already happened. As a consequence, budgets use estimates or predictions rather than actual, verifiable data. Both use the same headings, and include the same items.

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Purpose of budgeting

Assists planning
Aids decision making

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Budgets assist planning

Budgeting assists planning by predicting what is likely to occur in the future. This allows the owner to prepare so that possible problems may be managed, and possible opportunities may be taken.

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Budgets assists making

Budgeting aids decision-making by providing a standard against which actual performance can be measured. This allows the owner to identify areas in which performance is unsatisfactory, so that remedial action can be taken. This can include the calculation of budgeted ratios and other indicators of performance.

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The budgeting process

budgeting should be a continuous process; budgets should be compared against actual reports to allow problems to be identified, decisions should be made based on that assessment, and then new budgets should be prepared for the next period.

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Budgeting and going concern

A budget has limited value if it is not used to make decisions to improve business performance in the future. In addition, it makes little sense to develop a budget for one period without preparing another budget for the next period. Under the Going Concern principle, businesses are assumed to be continuous, so the budgeting process should be continuous too.

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Cash flow in order to survive

In order to survive a small business must have sufficient cash to meet its obligations. These obligations will include making Payments to Creditors, paying expenses (such as wages, rent and aclvertising), meeting loan repayments and providing drawings for the owner. In order to do this, the business must generate sufficient cash inflows, chiefly through its Cash Sales and Receipts from Debtors.

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Budgeted cash flow statement

The budgeted cash flow statement attempts to predict all future cash inflows and cash outflows, and thus the estimated bank balance at the end of the budgeted period, to assist the owner in assessing the firm's ability to meet its obligations over the budget period.

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Advantages of consecutive budgeting

In general, more frequent budgets will be more accurate, and therefore more useful as benchmarks for comparison. In addition, they will allow for the earlier detection of problems, so that corrective action can be taken in a more timely fashion, and can perhaps stop a small problem from becoming large.

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Budgeted cash flow statement assists planning

Prepare for an expected cash surplus or cash deficit. Should the budget predict an overall Net Decrease, the owner might make a cash capital contribution or reduce drawings. Should the budget predict an overall Net Increase the owner might purchase more NCAs or increase repayments. A business with a bank overdraft may choose to do nothing and let the expected cash surplus bring its bank balance above $0.

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Budgeted cash flow aids decision making

In addition, the Budgeted Cash Flow Statement aids decision-making because it sets a standard (benchmark) for the assessment of the firm's actual cash performance. By comparing budgeted and actual cash flows, the owner can identify problems areas and then act to correct the situation. They could assess effectiveness of advertising, debtor/ creditor collection, level of cash drawings etc.

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Budgeted income statement

Given that the main objective of a trading business is to earn a profit, the owner should plan ahead for how to achieve this goal. In addition, the firm must have some type of benchmark against which it can assess its trading (profit) performance. Both of these aims are met by the preparation of a predict revenues and expenses for the budget period.

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Cash v profit

Whereas the Budgeted Cash Flow Statement reports expected cash inflows and cash outflows over the budget period, the Budgeted Income Statement reports expected revenues earned and expected expenses incurred over the budget period. As some cash items are not revenues or expenses, they will be omitted from the Budgeted Income Statement such as GST and contributions/drawings.

However the Budgeted Income Statement will include some revenues and expenses that are not reported as cash flows such as stock gain/ loss and depreciation.

Finally, some of the items will affect both budgets but the amounts may differ such as credit sales/receipts from debtors and cost of sales/payments for stock.

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Budgeted income statement assists planning

The Budgeted Income Statement aids p|anning because it indicates the future requirements of the firm relating to issues such as staffing which may require hiring or firing; stock levels; or advertising campaigns.

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Budgeted income statement aids decision making

As a decision-making tool the Budgeted Income Statement provides a standard against which trading performance can be measured allowing problems to be identified and corrective action taken. This benchmark can also act as a target or goal to motivate staff and management. Specifically the owner could assess level of sales, advertising effectiveness, mark up and expense control.

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Budgeted balance sheet

An accounting report that predicts assets liabilities and owner's equity at some point in the future.

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Budgeted balance sheet assists planning

The Budgeted Balance Sheet can be used as a planning document. By detailing the expected carrying value of non-current assets at some time in the future, it helps the owner prepare for their replacement. When used in conjunction with the Budgeted Cash Flow Statement, it can also be used to plan for the repayment of loans, and to set the level for drawings for the coming period.

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Budgeted balance sheet aids decision making

In addition, it can assist decision-making by setting a benchmark for indicators that assess liquidity and stability. Specifically, it will allow the owner to calculate the Budgeted
Working Capital Ratio, which can be used to assess liquidity; and the Debt Ratio, which can be used to assess stability.

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Variance reports

A variance report compares actual and budgeted figures, highlighting any significant differences so that problems can be identified and corrected. It is prepared once the figures are available, but before the next budget. By comparing actual and budgeted figures, significant differences (and problems in particular) can be identified, allowing the owner to make decisions to improve the firm's performance.

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2 variance reports

Cash budget variance report
Income statement variance report

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Cash budget variance report

A compares actual and budgeted cash flows. In appearance it is very similar to a Budgeted Cash Flow Statement, but is has additional columns for actual figures and the calculation of the variance.

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Variance

A is simply the difference between the budgeted figure and the actual figure. Whether it is favourable or unfavourable depends in the Cash Budget Variance Report, on its effect on cash. A variance is favourable (F) if it means cash will be higher than expected in the budget; a variance is unfavourable (U) if it means cash will be lower than expected in the budget.

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Cash budget variance report assists planning

It is possible that the variances revealed in the Cash Budget Variance Report are caused simply by poor budgeting. However, this does not mean the report is useless; it should
be used in p/anning the next budget so that it is more accurate.

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Cash budget variance report aids decision making

The unfavourable variances should be investigated, and their cause identified. This will allow the owner to take corrective action. When using the report in this way, it is also important to consider the links between items. For instance, an unfavourable variance in Advertising may actually generate a favourable variance in Cash Sales, but a corresponding unfavourable variance in Wages.

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Income statement variance reports

Variances in this report are classified as favourable or unfavourable depending on their effect on profit. In the Income Statement Variance Report, a variance is favourable CF) if it means profit will be higher than expected in the budget; a variance is unfavourable CU) if it means profit will be lower than expected in the budget.

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Uses of the income statement variance report

Assist planning and to aid decision-making.

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Problems with annual budgets

Will not provide necessary details to indicate seasonal or monthly trends or to identify problems early to ensure that corrective action can take place in a timely manner.