Review questions - session 2 Flashcards
R1. Describe the interplay between a budget and a strategic plan.
Planning for the next year is called budgeting and a budget is the financial expression of a proposed plan of action. The budget as well as the mid-term and the long-term plan are quantitative plans, i.e. financial expressions of future performance. A strategic plan is a rather qualitative plan i.e. a verbal expression of the proposed future of the company. Thus, the strategic plan is the path to reach the goal(s) of the company. A strategic plan may or may not have a defined time horizon.
While strategies often include rather soft promises with no concrete time limit, a budget substantiates the strategic plan and serves as fine-tuning of the strategy.
R2. What are the five elements of the budgeting cycle?
- Developing the budget: planning performance of the organization
- Implementing the budget: in operations
- Measuring actuals and investigating variations: from plans and benchmarks
- Taking corrective action: if necessary
- Modifying future plans: considering market feedback, changed conditions and own experience
R3. What are the main advantages of preparing and using budgets?
- Budgets serve as a planning tool
- Budgets translate strategy into financials
- Budgets promote coordination
- Budgets promote communication
- Budgets provide a basis for performance evaluation
R4. What is the function of a master budget?
A master budget is a comprehensive expression of management’s operating and financial plans for a future time period, usually one year.
Budgets are commonly developed for individual divisions or parts of a company and can then be aggregated into a master budget. A group or a holding consisting of several (international) subsidiaries will aggregate the individual budgets delivered bottom-up to finally derive a master budget.
R5. What is the difference between an operating and a financial budget?
Any individual budget prepared for an entity, a division, or business unit consists of an operating budget and a financial budget.
- Operating budgets cover the operating activities: the day-to-day business activities of producing and selling goods and providing services.
- Operating budget consists of plans for any selling, manufacturing, purchasing, labor management, R&D, marketing, distribution, customer service, and administrative activities during the planning period.
- Operating budget is used to coordinate the activities in these business functions, aiming at providing a competitive product or service to the customer.
- Operating budget will result in a budgeted income statement, displaying planned revenues and operating costs during the period.
- Financial budget complements the operating budget.
- It focuses on how the operations and planned capital expenditures will affect cash and how the operating activities are going to be funded during the period.
- Financial budget is used to show and evaluate the financial consequences of a proposed operational decision. Of course, the operating budget and the financial budget are technically linked to each other.
- Financial budget consists of a cash budget, a budgeted cash flow statement and a budgeted balance sheet.
R6. Briefly outline the components of an operating budget.
- Revenue budget
- Production budget
- Direct materials budget
- Direct labor budget
- Manufacturing overhead budget
- Manufacturing costs per unit
- Cost of goods sold budget
- Non-manufacturing costs budgets
- Budgeted income statement
R7. Describe the purpose of a cash budget.
A cash budget shows the expected cash receipts and cash disbursements. Its purpose is to indicate the periods of perspective cash shortages and excesses.
R8. What is the difference between a budgeted income statement and a cash budget?
First and foremost, the cash budget does not include revenues and costs but cash inflows and cash outflows. While they are sometimes the same, in many cases, revenues are different from cash inflows and costs are not necessarily equal to cash outflows.
Moreover, the income statement ends with operating profit. The financial as well as the investing aspects are not considered.
R9. Describe the additional elements of the statement of budgeted cash flows. What further information does it provide in comparison to the cash budget?
Unlike the cash budget, the budgeted cash flow statement provides additional sections. It divides cash flows into three sections:
1. Cashflows from operating activities, including collections from customers and cash spendings for manufacturing (like wages), for administration, and other operating functions.
2. Cash flows from financing activities, including cash transactions with owners (like dividends) and with creditors (like interest or new borrowings).
3. Cashflows from investing activities, including purchases and sales of long-term assets(like machines or property).
In contrast with the cash budget, it provides more information about the origins of the cash flows and thereby allows for more analysis. By grouping cash flows into operating, investing, and financing, we get additional insights into the activities of the company.
R10. What is meant by “aspiration budget”? Explain why it achieves the highest employee motivation.
The aspiration budget describes the budget level that motivates the highest possible performance. It lies exactly at the point where the actual performance line doesn’t increase any further if managers further increase the budget difficulty. Setting the budget purposely at a level which is hardly achievable (the aspiration budget) will trigger the highest performance. However, setting the budget at this point leads to an adverse budget variance, i.e., the actual performance falls short of the budget.
R11. Differentiate between top-down and bottom-up budgeting. Mention the advantages and disadvantages of each approach.
Top-down budgeting:
- participants: senior management only
- centralization: centralized
- main advantages:
1. strategic goals are incorporated in budget
2. quicker to set up
- main disadvantages:
1. Budgets ex. catherdra may not be accepted by operating managers and employees
2. No specialized/first-hand market knowledge incorporated
Bottom-up budgeting:
- participants: line and operating managers only
- centralization: decentralized
- main advantages:
1. Ensures line managers’ commitment to meeting the budget
2. Specialized/first-hand market knowledge is incorporated
- main disadvantages:
1. No alignment with strategic goals
2. Subjet to manipulations (e.g. budgetary slack)
R12. What are the consequences of “budgetary slacks” for organizations? What can be done to avoid these?
The budgetary slack is widely feared by accountants and top management. Line managers intentionally underestimate revenues and profits or overestimate costs in order to make budgets more easily achievable. Budgetary slack leads to a major problem for an organization. Deliberately underestimating sales numbers and overestimating costs leads to an inefficient allocation of resources and forgoing of profits.
A general method for mitigating budgetary slack is to get involved in the budgeting process as deeply as possible. Controllers and managers may challenge the inputs and also consider external market data. A sales manager who budgets his own sales target can be questioned by industry benchmarks.
