7.3 Approaches to budgeting Flashcards
1
Q
A periodic budget shows
A
The costs and revenue for one period of time and is updated on a periodic basis, eg for a year updated every 12 months
2
Q
A rolling budget (aka continuous budget) is
A
Continuously updated by adding a further accounting period (month or qtr) when the earliest accounting period has expired
3
Q
Reasons for rolling budgets
A
- To deal with the problem of uncertainty where accurate forecasts can’t be made (fast moving environments subject to rapid financial change, eg exchange rate)
- Or for areas of bus that need tight control (eg: for cash budgeting org could produce rolling budgets / revised forecasts for cash flow)
4
Q
Advantages of rolling budgets
A
- They reduce uncertainty in budgeting
- They can be used for cash management
- They force managers to look ahead continuously
- When conditions are subject to change, comparing actual results with a rolling budget is more realistic than comparing actual results with a fixed annual budget
5
Q
Disadvantages of rolling budgets
A
- Preparing new budgets regularly is time consuming
- It can be difficult to communicate frequent budget changes
6
Q
Incremental budgeting is the
A
- Traditional approach to budgeting and involves taking the previous years budget and adding on a % to allow for inflation, other cost increases and adjustments for specific items (eg extra machine)
- Fairly small changes are made to current years budget (eg: adjustments for planned increase or decrease in sales volume)
- A check is then done to ensure that the budget produced meets the performance targets of the org (eg: operating costs to sales ratio less than 60%)
7
Q
Advantages of incremental budgeting
A
- Simple, low-cost budgeting system
- Quick to administer
- Suitable in stable environments
- Most practical for certain items of cost where next years budget can reliably be based on current years cost (eg telephone expenses)
8
Q
Disadvantages of incremental budgeting
A
- Backward looking in nature since next years budget is based on what happened in the past, therefore unsuited to changing environments
- Assumes all current activities should be continued at the current level of operations and with the same allocation of resources, this builds on previous inefficiencies and doesn’t look to reduce waste
- Encourages over-spending, managers know if they fail to spend their budget is is likely to be reduced next period so spend their whole budget regardless of whether justified
- Targets are often unchallenging, based on past performance, which doesn’t encourage managers to look for ways to improve
- Consideration is not given to the justification of each activity, it is simply done because it was done previous year
9
Q
Zero based budgeting (ZBB) is a method of budgeting whereby
A
- All activities and costs are re-evaluated each time a budget is formulated and budgeted from scratch (zero base)
- For every activity managers look at its costs and purpose and consider if there are alternative ways of doing it
- Inessential activities and costs are identified and removed from next years budget
- Each functional budget starts with the assumptions that the function does not exist and is at zero cost
- Increments of costs are compared with increments of benefits culminating in the planned maximum benefit for a given budgeted cost
10
Q
Zero based budgeting is suitable for
A
- Allocating resources in areas where spend is discretionary (eg: R&D, advertising and training)
- Public sector org (eg: local authorities)
- New functions (new department or service)
11
Q
Advantages of ZBB
A
- It creates an org environment where change is accepted, enabling org to be more responsive to changes in bus environment
- It promotes a better focus on org goals, it moves budgeting away from number crunching towards analysis and decision making
- It forces managers to examine activities, identifying inefficient or obsolete operations and wasteful spending
- It establishes a measure of performance for each decision package which can be used to monitor actual performance and compare actual with budget
- It involves managers and many of the employees in the budgeting process, which allows their views to be considered
- It is forward looking, focusing on future rather than past
12
Q
Disadvantages of ZBB
A
- It is time consuming and costly, unlikely to be able to be done yearly
- There is a temptation to concentrate on short term cost savings (eg R&D, staff training) at expense of longer term benefits
- Might require training for management in budgeting skills
- The budgeting process may become too rigid and the org may not be able to react to unforeseen opportunities or threats
- The ranking process can be difficult since widely differing activities cannot be compared on quantitative measures alone
- It is less useful when budgeting for standard costs, where costs and efficiency levels should already be well-controlled
13
Q
Activity based budgeting (ABB) is a method of
A
- Budgeting based on an activity framework and utilising cost driver data in the budget-setting and variance feedback processes
- Uses costs determined by ABC to prepare budgets for each activity
14
Q
The basic approach of ABB is to budget the costs for each cost pool or activity as follows
A
- The cost driver for each activity is identified - A forecast is made of the number of units of the cost driver
- Given this estimate the activity cost is estimated. Where appropriate a cost per unit of activity known as the cost driver rate is calculated
- General overhead costs are budgeted separately
15
Q
Advantages of ABB
A
- It draws attention to the costs of overhead activities (important where overheads are large proportion of costs)
- It recognises the activities which drive costs (if managers can control these drivers then costs will be better managed and controlled)
- It can provide useful info for a TQM programme, by relating the cost of an activity to the level of service provided
