Chapter 10 - Budgetary Control

Question 1

Budgets and Financial Plans

Answer 1

A budget is prepared in advance, so its essentially futuristic.
It’s a forecast expressed in monetary and quantitative terms of what is thought is likely to happen, based on historic information and projections from the future.

Question 2

Sales Budget

Answer 2

Forecast sales expressed in monetary terms (values) or units (volumes).

It determines the level of activity of the whole organisation, so it’s logical to start with this one.

Question 3

Production Budget

Answer 3

Will ensure the adequate output is produced to meet expected sales

Question 4

Raw Materials Budget

Answer 4

Is a subsidiary of the Production Budget.

Recognised the changes in production levels change the levels of other resources needed.

Question 5

Cash Budget

Answer 5

Sales generate cash; and production, raw materials, marketing require cash; so it’s vital the business knows how much is coming in and how much is going out.

It is also important to recognise when it’s flowing in and out, as the time of the receipts and payments is crucial.

Question 6

Reasons for budgetary control

Answer 6

the main concern is planning for the future activities of the business. Therefore the budget process sets out in a formal way the objectives to be achieved in the coming years.

It is also a measure of control, as it is sets out the expected costs of running a particular department, based on current costs with amendments for foreseeable eventualities. Therefore it can control that costs do not escalate.

Question 7

Further benefits for budgetary control

Answer 7

• helps set goals and targets
• motivator
• can work as an important means of communication
• need for department coordination, as most budgets are drawn up with information contained in another budget
• monitor what’s happening in the business

Question 8

Management by Exception

Answer 8

Budgetary control is an example of management by exception, which tries to focus on the areas that deviate from the original plan.
This optimises the use of management time.

Question 9

The content of budgets

Answer 9

Mainly provide monetary results, but there can be other quantitative terms.

Question 10

The Sales Budget

Answer 10

This is the budget on which all other operational budgets are based, as sales represent the level of activity that is expected for the business.

Question 11

The Sales Budget

Factors included

Answer 11

• current sales levels
• analysis of the trend over the recent years (increasing or decreasing sales), trend compared to others in the business
• consultation with the sales force
• the state of the order book for the year ahead
• national and local market conditions
• possible impact of newcomers to the market
• seasonal factors

Question 12

The Production Budget

Answer 12

The production manager will gear production to meet the expected demand and ensure a buffer to meet unexpected contingencies.
It is drawn up on the basis that the closing inventory at the end of the period must be a minimum of 20% of the next month’s budgeted sales.

Question 13

Preparation Methodology

Answer 13

Budgets are forecasts and constructed on the basis of known or current information.

Question 14

Budgeting Preparation Methodology

Factors that should be included

Answer 14

• sales volume
• current prices
• wages rates
• inventory - raw materials available and costs
• cost of bought-in services and overheads
• inflation rates
• government influences (tax, fuel costs, etc)
• business rates
• the strength of the business’ market
• competition

Question 15

Monitoring and control

Answer 15

Comparing the budget to the actual results will indicate how effective the budgeting process was, as there will inevitably be differences between the actual result and the original forecast.

Question 16

Variances

Answer 16

This is the difference between the budgeted and the actual figure.

There are 2 types of variance: favourable and adverse.

When the variance is significant the manager should investigate the reason for the difference, and correct with action that will take it back to control.

Question 17

Variances

Favourable

Answer 17

Example:
If Sales are actually higher than budgeted the variance is favourable.
If Costs are lower than budgeted the variance is favourable

Question 18

Variances

Adverse

Answer 18

Example:
If Sales are lower than budgeted the variance is adverse.
If Costs are higher than budgeted the variance is adverse

Question 19

Budgetary Control

Answer 19

A variance will be deemed significant when it is lower or higher than a specified amount; and it’s consequent investigation is called budgetary control.

Question 20

Cash Budget

Answer 20

Crucial for a business because it shows expected cash inflows and outflows. This allows expenditure to be allocated to the periods where there is cash inflow and avoid borrowing.

It draws up the information contained in all other budgets. It deals precisely when the cash came in and out, not when it is expected to be received and paid.

Question 21

Principles of cash budgeting

Answer 21

• Consider that time differences between sales and cash inflows; and purchases and cash outflows (because of credit terms to customers and from suppliers)
• non-trading transactions must be considered: capital expenditure and payment of finance costs
• depreciation and allowance for doubtful debts shouldn’t be included
• opening balances from payables, receivables, cash and bank are taken from the Statement of Financial Position