13 Budgeting and Budgetary Control

Question 1

What are some contemporary examples for budgeting and budgetary control

Answer 1

• Liz Truss mini budget
• From soaring mortgage costs to a sterling slump, the fiscal event set off a chain of chaos that led to PM’s downfall

Question 2

What is budgeting

Answer 2

• The quantitative expression of a proposed plan of action by management for a specified period
• May include both financial and nonfinancial data
• It contains an element of management commitment, that is, the managers agree to accept the responsibility for attaining the budgeted objectives
• Periodically, actual financial performance is compared to budget and variances are analyzed and explained

Question 3

What are the objectives of budgeting

Answer 3

• Budgets should reflect the long term objectives
• Then translated to ensure they are understandable at operational level
• Therefore, can influence behaviours of regional managers

Question 4

What must written plans specify

Answer 4

• Where the organization wishes to go
• How it intends to get there
• What results should be expected

Question 5

What is the purpose of the planning and budgeting process

Answer 5

• To enhance management control
• To achieve coordination (top-down, bottom-up, sideways)
• To establish “challenging-but-achievable” performance targets

Question 6

What is the budgeting and planning cycle

Answer 6

1. Strategic planning
2. Programming / Capital Budgeting
3. Operational budgeting

Question 7

What is strategic planning

Answer 7

• Relatively broad processes of thinking about the missions, goals, and strategies
• Normally a top-management process

Question 8

What is programming / capital budgeting

Answer 8

• Specification of specific action programs to be implemented over the next few years and specification of the resources each will consume.
• Long-term expenditure to cover long term investment projects that will deliver strategy
• Covered in business finance

Question 9

What is operational budgeting

Answer 9

• Short-term financial planning to manager operational activities
• Budgets match the organization’s responsibility structure
• This is management accounting in a simpler sense
• More detailed than capital budgeting
• 12 month sales FC

Question 10

What are the advantages of budgeting

Answer 10

• Budgets are meant to promote coordination and communication among subunits within the company
• Budgets are often used to assign responsibilities by allocating resources to managers.
• Budgeted amounts can be used as goals to motivate.
• Budgeted amounts can be used as targets by which performance is evaluated and rewarded.

Question 11

What is the budgeting cycle

Answer 11

• Before the start of the fiscal year
• Managers at all levels take into account past performance, market feedback, and anticipated future changes to initiate plans for the next period
  o Taking past performance and making an adjustment
• At the beginning of the year, senior managers give subordinate managers a frame of reference, a set of specific financial or nonfinancial expectations against which they will compare actual results
  o Distribute departmental responsibilities

Question 12

What is the time period for a budget

Answer 12

• Budgets typically have a set time period (month, quarter, year).
• This time period can itself be broken into subperiods
  o Annal budget broken into 4 quarters or 12 months
• The most frequently used budget period is one year.
• Businesses are increasingly using rolling budgets.
  o Next 12 months

Question 13

What are incremental budgets

Answer 13

• Base budget is the previous budget.
• Only incremental changes from the previous budget are examined in detail.

Question 14

What are zero base budgets

Answer 14

• Each line item is set at zero each year.
• Every line item must be justified and renewed each year.

Question 15

What is the mast budget

Answer 15

• Reflect managements operating and financial plans for the specific period
• Two main types
  o Operating budgets
  o Financial budgets
   These can be traced to the 4 types of responsibility centres
   Revenue, cost, profit, and investment

Question 16

What are operating budgets

Answer 16

Summarise the level of activities such as sales, purchasing, and production

Question 17

What are financial budgets

Answer 17

• Identify expected financial consequences of activities summarised in operating budget
• Profit, growth, market share

Question 18

What is budgetary control

Answer 18

• Budgetary control involves establishing budgets that relate the responsibilities of managers to the agreed objectives of the business.
• The continuous comparison of actual with budgeted results, so that the objectives are achieved.
• If actual outcome is adverse compared to budget expectation then corrective actions will be indicated, and future budgets can be set in the light of this learning experience.
  o Created to ensure delivery of long term goals

Question 19

What is variance analysis

Answer 19

• A variance is the difference between actual results and expected performance
• Management by exception is the practice of focusing management attention on areas that are not operating as expected and devoting less time to areas operating as expected.
  o Variance analysis should focus on the exception.
  o Can also be used to assess manager performance

Question 20

What is the procedure for completing variance analysis

Answer 20

• Ascertain the budget and phasing for each period
• Report the actual spending
• Determine the variance between budget and actual (and determine whether it is either favourable or adverse)
• Investigate why the variance occurred
• Take corrective action

Question 21

What are the questions to be asked when completing variance analysis

Answer 21

• Is the variance significant?
• Is it early or late in the year?
• Is it likely to be repeated?
• Can it be explained (and understood)?
• Is it controllable?

Question 22

What is a static budget variance

Answer 22

• The static budget is based on the level of output planned at the start of the budget period
• The static-budget variance is the difference between the actual result and the corresponding budgeted amount in the static budget
  o A favourable variance results when actual revenues exceed budgeted amounts or when actual costs are less than budgeted costs
  o An unfavourable variance results when actual revenues are less than budgeted amounts or when actual costs exceed budgeted costs

Question 23

What is Static Budget–Based Variance Analysis

Answer 23

When actual units sold are less than expected in the budget then
* Analysis of the variances with a static budget must recognise that actual costs will be expected to have a favourable variance and revenues an unfavourable variance
* If, as in the example, an actual cost higher than the budget, that is it has an unfavourable variance, then this should especially attract management’s attention. Fewer actual units sold than budgeted should lead to lower costs and a favourable variance

Question 24

What is a flexible budget

Answer 24

• Calculates budgeted revenues and budgeted costs based on the actual output in the budget period, that is what costs and revenues should be for the actual activity level
• Companies develop their flexible budgets in three steps:
  1. Identify the actual quantity of output
  2. Calculate the flexible budget for revenues based on budgeted selling price and actual quantity of output
  3. Calculate the flexible budget for costs based on budgeted variable cost per output unit, actual quantity of output, and budgeted fixed costs

Question 25

What is Flexible Budget–Based Variance Analysis

Answer 25

When the actual results are compared to the flexible budget for the period

Question 26

What are the types of variance

Answer 26

1. Sales variances: price and quantity of product/services sold
   2a. Material variances: price and quantity of materials used
   2b. Labour variances: wage rate and production efficiency
2. Overhead variances: spending and efficiency

Question 27

What is the formula for Sales-Volume Variance

Answer 27

Sales volume variance for operating income = Flexible budget variance - Static budget amount

or

Sales volume variance for operating income = (Budgeted contribution margin per unit) x (Actual units sold - Static budget units sold)

Question 28

What is the formula for price variance

Answer 28

Price variance = (Actual price of input - Budgeted price of input) x Actual quantity of input

Question 29

What is the formula for efficiency / Usage variance

Answer 29

Efficiency variance = (Actual quantity of input used - Budgeted quantity of input allowed for actual input) x Budgeted price of input

Question 30

What is the formula for Variable Overhead Flexible-Budget Variance

Answer 30

Variable overhead flexible budget variance = Actual costs incurred - Flexible budget amount

Reveals how much variable overhead costs differed from the flexible budget amount

Question 31

What is the formula for Variable Overhead Spending Variance

Answer 31

Variable Overhead Spending Variance = (Actual variable overhead cost per unit of cost allocation base - Budgeted variable overhead cost per unit of cost allocation base) x Actual quantity of variable overhead cost allocation base used

The variance captures both the unexpected changes in price as well as the efficiency of use of variable overhead items such as energy and indirect materials

Question 32

What is the formula for Variable Overhead Efficiency Variance

Answer 32

Variable Overhead Efficiency Variance = (Actual quantity of variable overhead cost allocation based used for actual output - Budgeted quantity of variable overhead cost allocation based allowed for actual output) x Budgeted variable overhead cost per unit of cost allocation base

The measure captures the actual use of the driver relative to the amount budgeted to be used for the actual output level

Question 33

What is the formula for Fixed Overhead Flexible-Budget Variance

Answer 33

Fixed Overhead Flexible-Budget Variance = Actual costs incurred - Flexible budget variance

It is the difference between actual fixed overhead costs and fixed overhead costs in the flexible budget (all given as totals)

Question 34

What does the Fixed Overhead Spending Variance show

Answer 34

• It informs managers of the difference between actual spending on fixed overhead and the planned amount of spending in the master budget
• It highlights to managers the sources of unexpected changes in resources expended to acquire capacity

Question 35

What is production volume variance

Answer 35

• Also known as denominator-level variance
• Arises only for fixed costs
• It is an indicator of the use of capacity
• A favourable variance indicates that overhead is overallocated; if unfavourable, the overhead is under allocated

Question 36

What is the formula for production volume variance

Answer 36

Production volume variance = Budgeted fixed overheads - Fixed overhead allocated for actual output units produced

Question 37

What can efficiency variances show

Answer 37

• Poor productivity
• Poor production planning
• Poor quality material that requires greater skill to work
• The availability of labour with the right skills

Question 38

What can price variances show

Answer 38

• Changes in supplier prices not yet reflected in the bill of materials
• A negotiated wage increase that has not been included in the labour routing
• Poor purchasing practices
• Unplanned overtime
• Inflation

Question 39

What are some criticisms of variance analysis

Answer 39

• Variance analysis
  o emphasises variable costs in a manufacturing environment
  o In the non-manufacturing sector, overheads form the dominant part of the cost of producing a service and so price and usage variance analysis has a limited role to play
• Reducing variances based on standard costs can be an overly restrictive approach in a TQM, JIT or continuous improvement environment
  o Tendency to aim at the more obvious cost reductions (cheaper labour and materials) rather than issues of quality, reliability, on-time-delivery, flexibility, etc.

Question 40

What is budgetary slack

Answer 40

• The effectiveness of budgets can be greatly undermined by efforts to make the resulting budgeted goals (especially profits) more easily attainable
• This is achieved when budgets are being formed by the practice of underestimating budgeted revenues, or overestimating budgeted expenses- creating budgetary slack
• Basically management making it easier for themselves

Question 41

What is “Beyond Budgeting” and how can it get the best from budgets

Answer 41

Goals
* Set relative goals for continuous improvement; not fixed performance contracts
Planning
* Make planning a continuous process; not a top-down annual event
Resources
* Make resources available as needed; not through annual budget allocations
Coordination
* Coordinate interactions dynamically; not through annual planning cycles
Controls
* Base controls on relative indicators and trends; not on variances against plan
Rewards
* Reward success based on relative performance; not on meeting fixed targets