2.2.4 Budgeting

Question 1

Budgeting

Answer 1

A financial plan/target for the future of costs and incomes for a particular aspect of a business that must be reached over a given period of time.

Question 2

Main types of budgets

Answer 2

1. Revenue (income) budget.
2. Cost (expenditure) budget.
3. Profit budget – based on the combined sales and cost budgets.

Question 3

Purpose of a budget

Answer 3

• Motivate staff.
• A means of controlling income and expenditure.
• To monitor performance.
• Provides direction and helps in the coordination of a business.
• Helps employees to focus on costs.
• Turn objectives into practical reality.
• Delegate without loss of control.

Question 4

Historical budgeting

Answer 4

Use last year’s figures as the basis for the budget.

Question 5

Advantages of historical budgeting

Answer 5

+ Realistic as its based on actual figures from previous time periods.

Question 6

Disadvantages of historical budgeting

Answer 6

• Circumstances may have changed.
• Departments can feel expectation to spend a certain amount of money regardless of what they really need.
• No incentives for developing new ideas or reducing costs.

Question 7

Zero budgeting

Answer 7

Budget and revenue costs are set to zero. Budget is based on new proposals for sales and costs.

Question 8

Advantages of zero budgeting

Answer 8

+ Eliminates unnecessary costs as all spending has to be justified.
+ Can take into account current and likely future conditions which may be more accurate.
+ Helps the business identify those departments which require large amounts of essential capital as well as those which require minimal expenditure.

Question 9

Disadvantages of zero budgeting

Answer 9

• Time consuming.
• Budgets can be very tight.

Question 10

Adverse variance

Answer 10

Worse than expected.
- Unexpected events leading to unbudgeted costs.
- Over-optimistic sales forecast.
- Over-spending by budget holders.
- Competitor actions mean selling prices are lower than expected.

Question 11

Favourable variance

Answer 11

Better than expected.
- Cautious sales and cost assumptions.
- Competitor weakness leading to higher sales.
- Better than expected productivity or efficiency.
- Selling prices raised higher than budget.

Question 12

Variance formula

Answer 12

Actual amount - Budgeted amount

Question 13

Limitations of budgets

Answer 13

• Difficult to forecast accurately.
• Difficult to monitor fairly.
• Unforeseen changes difficult to predict.
• Unachievable targets can have a negative impact on motivation.
• Budgets can take time and skill to set, monitor and review.
• Can encourage managers to focus on short-term rather than long-term.