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HEC: MCA > 3. Budgeting > Flashcards

3. Budgeting Flashcards

1
Q

What are budgets?

A
  • “A quantitative expression of a proposed plan of action by management for a future time period”

Detailed plan for the acquisition and use of financial and other resources over a specified period of time (typically 1 year)

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2
Q

What are the two overarching roles of budgeting?

A
  1. Planning (and coordination)
  • Making sure that different parts of the company are aligned in terms of their activities
  • Work with “one set of numbers” across the company
  1. Control
  • Target setting & motivation
    Performance evaluations
  • Setting clear performance expectations (that are in line with organization’s objectives)
  • Signaling to employees that top management knows where it is going, that the organization has a plan
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3
Q

What are the 5 roles of budgets?

A
  1. Planning (map intended future)
  2. Motivation (targets and incentives)
  3. Authorization (limits/targets)
  4. Communication (ensure coordination)
  5. Evaluation (benchmark for appraisal)
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4
Q

What are some different types of budgets?

A
  • Fixed budget
  • Flexed budget
  • Continuous/rolling budget
  • Zero-based budget
  • Project programming budgeting systems
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5
Q

What are the components of the master budget?

A
  • Operating budget: Plans for all operational phases (purchasing, production, sales, personnel, marketing) –> Budgeted IS
  • Financial budget: Identifies the sources and uses of funds for operations and CAPEX –> budgeted BS
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6
Q

What is the starting point of the budgeting process?

A

Starting point of budgeting process is specifying firm strategic goals

  • Long range planning identifies the required actions over a 5-7 years long period to attain the firm’s strategic goals and objectives
  • Firm expresses its mid-term strategic goals and objectives in a capital budget and master budget (typically 12-month period)
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7
Q

What is a master budget?

A

A “grand plan of action” that brings longer-term goals together with short-term actions for an upcoming period

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8
Q

What are the steps/budgets in the operating budgets of the comprehensive master budget?

A
  1. Sales budget
  2. Production budgets
  3. DM, DL and overhead budgets
  4. Budgeted IS
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9
Q

What is the three-step process of preparing individual budgets?

A
  1. Define the “bottom-line” information contained in the budget
  • For example, sales in the sales budget
  1. Determine what this information is a function of
  • For example, in the sales budget, sales are a function of budgeted unit sales and budgeted selling price per unit
  1. Present information in a user-friendly way
  • Understand that personnel beyond the sales department will use this information
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10
Q

How is expected sales volume determined?

A
  • Look at data from prior/similar period
  • Compare data to industry and competition
  • Talk to customers, sales reps
  • Identify market trends, business trends
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11
Q

What does sales budgets do and what are they used for?

A
  • Determines your total expected sales revenue during a specified period
  • Used to help prepare production budgets
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12
Q

What qualitative factors might influence a sales budget?

A
  • Degree of market competition
  • State of the economy (domestic and overseas)
  • Level of advertising / other marketing factors
  • Quality of sales team
  • Historic sales / pattern of cyclical or seasonal influences
  • Developments in new technology/innovation
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13
Q

What does production budgets do and what are they used for?

A
  • Determines your total expected units to be produced to meet inventory/sales plan
  • Used to help prepare production sub-budgets
  • To make managerial decisions: how much raw materials to purchase (purchase budget), how many workers are needed (DL budget), what other production costs are expected (OH budget), how much equipment is needed, what size facility is needed
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14
Q

What are factors to consider when determining desired ending inventory?

A

Minimize the amount of obsolescence, storage/warehousing costs, while being able to meet customer demand and not create product stockouts

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15
Q

What does a purchases budget show?

A
  • Determines your total expected raw materials (DM purchases) to be purchased to meet inventory/production plan
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16
Q

What are the 8 steps of the comprehensive budgeting cycle?

A
  1. Translate long term strategic goals/objectives into annual operating plan. Communicate budget policy/guidelines
  2. Prepare sales budget
  3. Prepare other operational budgets (usually production, then purchasing, then other input factors like labor and indirect costs)
  4. Prepare financial budgets (e.g. the cash budget)
  5. Negotiate budgets with organizational members
  6. Coordinate & review budgets
  7. Final agreement of budgets
  8. Ongoing review of budget to actual performance
17
Q

What are some behavioural issues in budgeting?

A
  • Goal incongruence when the goals/budget of the firm doesn’t align with the goals of the employees (Easy budgets fail to encourage employees to give best effort while difficult budgets may discourage managers. Budgeted performance linked to compensation may lead to “gaming”)
  • Budgetary slack is the ‘cushion’ managers intentionally build into budgets to help ensure success in meeting the budget (they request less budget than needed)
  • Budgetary spend is an issue when managers feel that if they don’t use all the resources they receive, their future budget may be cut (potentially unnecessary spend)
  • Involve employees in budgeting process to foster goal congruence
18
Q

What does the last step in the comprehensive budgeting process tell us (ongoing review)?

A

Informs the company about budgetary planning and financial control (what needs to be done to improve current/future performance. Budgetary processes compare actual costs with budgeted costs by computing variances

  • Budgeted costs in the (comprehensive) master budget are drawn up using standard cost data
  • Therefore, standards are an important input to the budgeting process

–>A standard costing system is a fundamental requirement for budgetary planning and financial control

19
Q

What is standard costing?

A
  • Standard costing reflects “ideal” or “currently attainable” (DL, DM, indirect OH) costs that should be incurred under efficient operating conditions
  • Standard costs can be identified through work studies (time and motion or market analysis) or through adjusting past period historical data
20
Q

What are standard costs based on?

A

On carefully predetermined amounts representing an expected level of performance.

  • Standard costs are used for planning labor and material requirements → allows for planning appraisals
  • Standard costs are benchmarks for measuring performance → useful in identifying cost inefficiencies
21
Q

What is variance analysis?

A

Comparison and investigation of difference between actual cost and standard cost

22
Q

What is the problem with comparing the master (standard) budget to the actual results?

A

Very high level, aggregated data. Not very useful in identifying the cause of the firm’s unfavourable/favorable performance

23
Q

What is a flexible budget and what does it enable?

A
  • Flexible budget is created by scaling the standard prices and costs to the actual volumes
  • Allows us the break down the overall variances into various components to get at the root cause of the performance variation
24
Q

What variance do we get if we compare the figures in the Master budget and the flexible budget?

A

(Sales) Volume Variance: the difference between line items is due to changes in the volume of activity

25
Q

What variance do we get if we compare the figures in the Actual results and the flexible budget?

A

Flexible Budget Variances: The difference between line items is due to several types of changes:

  • Sales Price variance
  • Spending Variance
  • Rate/price (cost) variance
  • Efficiency Variance
26
Q

What is the formula for Price/rate variance (of variable costs)?

A

Price/Rate Variance = AQ*(AC-SC)

Actual input quantity * (actual cost per input unit - Standard cost per input unit)

27
Q

What is the formula for Efficiency/Usage variance (of variable costs)?

A

Efficiency/usage variance = SC*(AQ - SQ)

Standard cost per input unit * (Actual input quantity - Standard input quantity required to produce actual output)

SQ = SHOULD have been used to produce the output

28
Q

What are explanations of materials variances?

A
  1. Price variances:
  • Purchase of materials of a different grade
  • Quantity discounts
  • Freight/delivery expediting (rush orders)
  1. Usage variances:
  • Purchase of non-standard quality materials
  • Poorly trained or poorly supervised workers
  • Poorly maintained machinery
29
Q

What are explanations of labor variances?

A
  1. Price variances
  • Labor substitution
  • Out-of-date contracts
  1. Efficiency variances
  • Poor quality materials used in production
  • Poorly trained or supervised workers
  • Poorly maintained machinery
30
Q

What are the 5 steps of the summary of the variance analysis process?

A
  1. Predetermination of standard costs, incorporation into the budget process, and production of the master budget
  2. Recording of actual results at the end of the budget period
  3. Comparison of actual and standard (budgeted) amounts. “Flexing” the master budget to produce a flexible budget
  4. Variance analysis, including calculation of sales price, spending and variable cost variances
  5. Interpretation of variances (online class F) and subsequent reporting to management, appropriate action taken
31
Q

When should investigation of variances be undertaken?

A

If a variance is significant, which can for example be decided by a relatively simple rule of thumb, for example threshold: “5% of budgeted cost or €10,000, which ever is the lower threshold”

  • Includes both relative and absolute elements
32
Q

In addition to the significance of a variance, the decision to investigate also need to consider:

A

The nature of the standard (budgeted) cost

  • If the standard cost is an “ideal” (optimum, as per scientific management), then unfavorable variances are to be expected: Ideal standards will almost always generate unfavorable variances (May not investigate just because unfavorable variance, since this is almost always the case here)
  • If the standard cost was considered “expected” or “attainable” in which case the variances might the expected to vary around the ‘mean’
33
Q

Why does actual performance differ from standard performance?

A
  • Measurement errors: errors in measuring the actual outcomes
  • Out of date (or just not very good) standards (perhaps due to changes in the production functions)
  • Out of control operations (efficient or inefficient operations)
  • Random or uncontrollable factors (chance fluctuations for which no cause can be found)
  • Poor communication of standards
34
Q

What are to think about when interpreting variances?

A
  1. Consider trend of variances over time; this implies mapping, perhaps graphically, the pattern of the variances across several time periods
  • Are the, e.g. monthly, variances increasing in size?
  • Are they distributed around (unfavorable/favorable) the budget estimates? Or are they in one direction?
  1. Statistical sampling can help to estimate whether estimates are randomly distributed around the mean or ‘biased’. Budgeted costs are, of course estimates (‘on average’) and therefore actual costs would be expected to be normally distributed around an estimate
  2. Finally, the decision to investigate ought to factor in whether the cost of investigating outweighs the anticipated benefit (expensive to investigate all variances)
35
Q

What is a critical issue to remember about variances?

A

Variances are very rarely independent of each other:

  • For example: if there is a sales volume variance that is unfavorable, this might be the result of a favorable sales price variance.
  • i.e. because the sales price was higher than expected (for whatever reason), the company sold fewer items → unfavorable sales volume

HEC: MCA (4 decks)

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