4. Rationale for budgets Flashcards
Define Budget and its difference to forecast
Quantified plan of action for accounting period
- Target and aim for period whereas forecast is an estimate of what’s likely to occur
PRIME
P: Planning - forcing management to plan
R: Responsibility - split up accountability
I: Integration and co-ordination - between departments
M: Motivate - to improve performance
E: Evaluation and control - compare actual performance to target
What is meant by the conflicting purposes of budgeting
Conflic in motivation and evaluation and control
eg. to motivate budgets should be challenging
which is not useful for evaluation and control
What are the steps in planning
- Determine objectives
- Plan: set budget
- Operate in line with objectives
- Control: compare actual to budget
Define planning according to CIMA
Establishment of objectives, formulation evaluation and seleciton of pollicies and tactics to achieve them
What are the types of planning
- Strategic planning: long term beyond budget period
- Budgetary/tactical planning: generally a year with detailed plans
- Operational planning: short term day to day basis of usage of resources
Define budget period
The period for whicha. budget is prepared and used -sub divided into control periods
What are the advantages of implementing budgets
- Forces organisation to plan
- Allocates responsibility
- Encourages cordination and integration
- Can motivate
- Provides targets to evaluate performance
What are the disadvantages of implementing budgets
- Can result in plan fixation and loss of flexibility
- Takes management time and costs
- Can be demotivating
- Variance analysis does not provide solutions
- Encourages spending of budget allowance to protect future periods
Which external factors can impact usefullness of budgets
-P: Political impact on sales
- Economic: currency fluctuations and exchange rates
- L: legal: taxes, employment regulations etc
Define Incremental budgeting
Where budget is based on the current years budget plus an extra amount for estimated growth or inflation
What are the advatages of incremental budgeting
- Simple and cheap
- Relatively quick to adminster
- Has proof of concept
What are the disadvantages of incremental budgeting
- Does nto identify inefficiencies
- Budgetary slack: deliberately overestimating costs or under estimating revenues
- Not suitable for changing environments
- Encourages managers to spend up to budget
- Does not produce challenging performance targets
Define Zero Based budgeting
Method of budgeting that requires each cost eleement to be specifically justified - as if undertaken for the first time
- To reduce waste and allocate resources more efficiently
What are intended activity referred to in zero based budgeting
Decision packages
What are the two types of decision packages
Mutally exclusive: contain alternative methods to getting same job done
Incremental packages: which divide one aspect of activity into different levels of effort
What is the three step approach to decision packages in zero based budgeting
Step 1: define the decision package (mutally exclusive or incremental package)
Step 2: Evaluate and rank activity
Step 3: Allocate resources
What are the advantages of Zero based budgeting
- Possible to identify an dremove inefficient or obsolete operations
- Requires close examination
- Results in more efficient allocation and challenges status quo
- Responds to cahnges in environment
- Good for short term
What are disadvantages of zero based accounting
- Lot of extra work
- Short term benefits will be emphasises
- makes impression that all decisions have to be made in the budget
- requires for management skills to create decision packages
- ranking process cna be difficult
Which scenarios willl ZBB work best and worst
- Does not work well for direct manufacturing costs
- Does work well in support expenses
- Does work well in service industries and not for profit organisations
What is a Rolling budget
Budget is continously updated by adding further accounting period
- Beneficial for periods of uncertainty
- Shorter periods between preparing budgets
What are the advantages of rolling budgets
- Uncertainty is reduced
- More realistic budgets
- Planning and control will be based on more recent plan
- Continuos and encourages planning horizon
What are disadvantages of rollinng budgets
- Effort and expense
- May demotivate managers due to regular revision
- More costs due to adminstration expense
What is activity based budgeting
Uses the costs determined using activity based costing as a basis for preparing budgets
