3.9 Budgets HL

Question 1

What is meant by a budget?

Answer 1

A budget is a financial plan of expected revenue and

expenditure for an organization, or a department within an organization, for a given time period.

Question 2

Outline four types of budgets.

Answer 2

• Flexible budgets enable a business to adapt to changes
in the business environment
• Incremental budgets add a certain percentage onto
the previous year’s budget, usually linked to the inflation
rate, due to increased costs of production. Expenditure
items are literally the same as before.
• Marketing budgets allow managers to plan their
marketing activities, such as the amount planned for
advertising, sponsorship, and sales promotion.
• Production budgets are plans for the level of output,
including forecasts for the cost of stocks that need to
be purchased.
• Sales budgets are forecasts of the planned volume of
sales and the value of sales revenue.

Question 3

State four reasons for producing budgets.

Answer 3

Planning
Guidance
Coordination
Control and Motivation

Question 4

What are the main considerations when setting budgets?

Answer 4

Available finance 
Historical data
Organisation objectives
Benchmarking 
Negotiations

Question 5

What are the main limitations of budgeting?

Answer 5

unforeseen changes
overestimate budgets to meet their targets easier
budgets can be set by senior managers who have no direct involvement in running of the department
less useful for businesses with seasonal fluctuations
rigid and poorly allocated budgets can harm quality
time-consuming
budget holders can compete to increase their own budgets
ignores qualitative factors
inflexible

Question 6

Distinguish between cost and profit centres.

Answer 6

A cost centre is a department or unit of a business that incurs costs but is not involved in making any profit.
A profit centre is a department or unit of a business that incurs both costs and revenues.

Question 7

What are the advantages and disadvantages of businesses using cost and profit centres?

Answer 7

ads:
managers can identify areas of weakness
smaller departments and teams tend to work better
no need to fuss about whether a cost is fixed/variable/indirect/direct
delegation can motivate people
performance can be used to encourage and reward teams

disads:
performance can change because of external factors
data collection must be accurate
managing cost and profit centres can add pressure
departments are less likely to consider social responsibilities and ethical objectives if they are run as profit centres
unnecessary competition may occur

Question 8

What is variance analysis and why is it an important management tool?

Answer 8

A variance exists if there is a difference between
the budgeted figure and the actual outcome.
–> Variance analysis helps managers to monitor and control budgets.

Question 9

What is budgetary control and why is it important to an organization?

Answer 9

Budgetary control is the corrective measures taken to ensure that actual performance equals the budgeted performance
–> coordinated and controlled budgeting leads to consistent and coordinated decision-making.

Question 10

Distinguish between favourable and adverse variances.

Answer 10

Favourable variances exist when the discrepancies are financially beneficial to the organization.
Adverse variances (or unfavourable variances) exist when the discrepancies are financially detrimental to the organization.