10. Budgetary Flashcards
What is fixed budget
Master budget - Set prior to control period
- Not changed in response to changes
- Acts as a benchmark in performance evaluation
What are the features of fixed budget
- Used in planning stage to define broad objectives
Fixed: - Budget prepared on basis of estimated volume of production and estimated volume of sales but no changes are made for a different volume of production
- When actual volumes of production and sales are achieved- fixed budget is not adjusted
What is a flexible budget
Budget designed to change as volume of activity changes by recognising different cost behaviour patterns
How are flexible budegts useful
Planning stage - for what if analysis to show different results from prossible activity levels
What is difference between flexible budget and flexed bduget
Flexible: designed at planning stage with varying levels
Flexed budget: revised budget that reflects actual activity levels achieved in budget period
What are the steps to prepare flexed/flexible budgets
1: Determine cost behaviour patterns - decide costs are fixed, variable or semi variable
2. Calculate budget cost allowance for each cost item
How are costs split based on cost behaviour in step 1
- Fixed costs: remain constant as activity levels change
- Non fixed costs: divide each cost figure by the related activity level
If cost is linear variable cost: cost per unit will remain constant
If cost is semi variable, the unit rate will reduce as activity levels incrase
How are semi variable costs split into fixed and variable componenets
Hihg low methods or scattergraph method
How do you calculate budget cost allowance
= Budgeted fixed cost + (number of units x variable cost per unit)
How useful are flexible budgets in modern environment
Majority of costs are now fixed as:
- Wage costs are fixed due to basic wage and guaranteed hours
- Fixed plant costs are a high proportion of costs
- So flexible budgets are less useful
What is budget centre
A section of entitiy for which control may be exercised through budgets prepared
What features does a well organised system of control have
- Hierarchy of budget centres
- Clearly identified responsibilities for achieveing tagrets
- Responsibilities for revenues, costs and capital purchase employed
Define responsibility accounting
A system of accounting that segregates revenue and costs into areas of personal responsibility to monitor and assess the performance of each part of an organisation
- Associates costs with managers
- Distinguishes between controllable and uncontrollable costs
What are examples of responsibility structures
- Cost centre- cost decisions - standard variances
- Revenue centre - revenue decisions
- Profit centre- decisions over costs and revenues
- Investment centre- decisions over costs, revenues and assets
What is the controllability principle
- Managers should only be held accountable for costs/revenues for which they have control so they remain
-Motivated - Can take action
Define controllable cost
A cost which can be controlled by a cost/profit/investment centre manager
- Can be changed within a given period ( motsly variable)
What are examples of how controllable costs can change
- Controlllable by senior managers but not junior
- Controllable in one department but not another
- Controllable in long term not short
How does controllability link to fixed costs
- Committed fixed costs: not controllable in short term but are in long term eg. depreciation, rent
- Discretionary cost: cost within a particular period is determined by and altered by budget holder eg. advertising, R&D
What is meant by dual responsibility
Particular cost might be slit between multiple managers
eg. raw material cost between purchasing and production
- reporting system must allocate responsibility appropriately
What is feedback control
- Comparing actual historical results against a standard or plan and taking control action where there is a variance
What are examples of feedback control
- Variance analysis
- Positive feedback : actual is better than expected, control action to encourage deviation
- Negative feedback: actual is worse than expected, control action to get back to plan
What is feedforward control
- System operates by comparing planned results against a current revised forecast of what results will be
- Control action is triggered by differences between anticipated and planned results
What are limitations of feedback/forward control
- Allows errors to occur due to lag in event and corrective action
- If time delay is large, feedforward control is preferred
- Often both systems are used
What are reasons for negative reactions of budgetary control
- Managers who set the budget are not the ones that are responsible for achieving them
- Lack og goal congruence: goals of organisation may not coincide with personal aspirations of managers
- Control is applied at different stages by different people
What are the two methods of participation in budget settign
Top down budgeting: when budget targets are set by seniors and cascaded downwards to departments
- Bottom down budeting: when budget process starts at relatively low level of management and submitted upwards for consolidation
What are advantages of top down budgeting
- LIkely to be quick
- Avoid budgetary slack and budgetary bids
- Utilise senior management awareness of resource availability
What are the advantages of bottom up budgeting
- They reflect views and expectations of operational managers with local knowledge
- Morale and motivation improved through participation
- Increased liklihood of achieving targets
What is negotiated budgeting
Final budget is likley to be reached after negotiation between senior and junior management
- Budgeting is a bargaining process
Define budgetary slack
When managers may build in slack into their budgets to protect themselves against anticipated future cost cutting programmes so variances will be favourable
What are poor attitudes to setting budgets
- Not enough time
- Formal budget is too restrictive
- Argue to base it of previous outcomes
What are poor attitudes when putting plans into action
- Put just enough effort to achieve rather than beat targets
- Formal budget enfource rigidity and are not flexible
- Short term planning and less focus on logner term
- Minimal co-operation and communication between managers
- Managers use up full budget even if not needed - ‘lose it or use it mentality’
What are poor attitudes of use fo control information
- Low priority of finance for operational managers
- See control information as criticism
- Budgets can be seen as pressure devices
- Might not understand information
- False sense of objectives
- Flaws in system of recording actual costs
- Timliness of informaiton
- Demotivation due to uncontrollable costs/variances
What are the drwabacks of using pay as a motivator
- Formal reward and performance evaluation systems can encourage dysfunctional behaviour
- Can be too challenging and might demotivate
What is short termism
Excessive focus on short term at the expense of long term performance
What are methods to encourage a long term view
- Having realistic short term targets
- Provide sufficient management informaiton
- Evaluate managers’ performance in terms of contribution to both objectives
- Linking managers’ rewards to share price
- Set non financial targets
What are some non financial factors which can reflect a company’s performance
Quality
Customer service
What are ethical implications of budgeting
- Competitive market: pressure to make profits can lead to unethical decisions
- Government agency: budgets may be set for political gain
- Subsidiary: internal politics mean some budgets for subsidiaries are more challenging than others - tax rates and policy differences
Define budget cost allowance
The budgeted cost expected for the actual level of activity achieved during the period
