B:Budgeting Flashcards
What is a budget?
a quantitative or financial plan relating to the future
- can be for whole company, depts, resources
- usually for one year or less
What are the 6 purposes of a budget?
(1) planning
(2) control and evaluation
(3) co-ordination
(4) communication
(5) motivation
(6) authorisation
PMACCC
How do budgets compel planning?
- forces FORWARD looking approach
- adds PRESSURE in terms of targets
- encourages managers to ANTICIPATE problems and make decisions based on reasoned judgements
- planners would regard budgeting as an important technique for where LT strategies are converted to ST ACTION plans
How do budgets aid control and evaluation?
- provides plan and COMPARISON
- anomalies can be further investigated and CORRECTED
- management evaluation based on ACHIEVEMENTS
- budget might be only quantitative REFERENCE point for measurement
How do budgets help co-ordination?
- serve as vehicle through which the actions of the different parts of an org can be brought together and RECONCILED into one plan
- give managers GUIDANCE
- helps different activities of the business and to ensure that they are in HARMONY with each other
How do budgets help with communication?
- communicate targets to managers
- top mgmt communicated expectations to lower-level mgmt so everyone can organise activities and attain targets
How do budgets help with motivation?
- influence managerial behaviour
- motivate managers to perform in line with objectives
How do budget help with authorisation?
act as a form of authorisation for expenditure, hiring of staff and pursuit of the plans CONTAINED in the budget
Advantages of budgeting?
- ensure org’s actions match GOALS and they are communicated throughout org
- forces mgmt to consider FUTURE and how internal/external environment might change
- orgs are better placed to COPE with change and budget can help SIGNAL issues
- force management to consider cost & profitability of products, departments, functions etc
- can force mgmt to consider the VALUE ADDED by products, depts and functions
- improve DECISIONS on resource, cash allocation, financing and investment
- having budgets facilitates PERFORMANCE EVALUATION in areas such as the use of variance analysis
Disadvantages of budgeting?
- can be TIME CONSUMING and distract management from business’ core operations
- predicting future is subjective and relies on the ability of the preparer to make ACCURATE predictions
- can create CONFLICTS and barriers between budget holders rather than knowledge sharing and coordination
- can encourage SHORT-TERMISM where important expenditure is forgone due to meeting targets
- focuses on FINANCIAL outcomes rather than other measures of success e.g customer satisfaction, quality et
- can encourage managers to spend what is in the budget even if it is not necessary to prevent REDUCTIONS next time around
- can deter INNOVATION as staff become focused on meeting targets rather than responding to change by exceeding them
What are some areas of diversity that cause complexity in budgeting?
currency
legal framework
customer tastes and competitor actions
political climate
What should a budget period never be too short or long?
too short: regular planning and evaluation wastes time
too long: things will change and budget is less relevant
What is a principal budget factor/limiting budget factor?
a key resource that is in short supply thus affecting the planning decisions
-starting point for all other budgets
What does the sales budget consider?
budget for future sales
- expressed in revenue terms and units of sale
- might combine several sales regions
What does the master budget consist of?
5) budgeted statement of profit
6) cash budget & capital expenditure budget
7) SOFP
When will the purchase cost of direct materials differ form the material usage budget?
if there is a planned increase/decrease in direct materials inventory
How is direct labour cost of production calculated if variable and if fixed?
- variable:calculated by units x budgeted cost p.u.
- fixed:can be calculated by estimating payroll cost
How is production overhead budgeted using absorption costing?
overheads are allocated and apportioned
-budgeted absorption rates are determined
What is a cash forecast?
an estimate of cash receipts and payments for a future period under existing conditions
What is a cash budget?
commitment to a plan for cash receipts and payments for a future period after taking any action necessary to bring the forecast into line with the overall business plan
Why do cash receipts differ from sales and cost of sales in the SPL?
- not all cash receipts/payments affect the SPL e.g new shares
- some SPL are derived from accounting conventions not cash flows e.g depreciation
- timing of cash receipts and payments does not coincide with the SPL e.g AR
- irrecoverable debts will never be received in cash and an allowance for these debts man not be received at all so must adjust for these in cash budget
What is a sensitivity analysis?
revising the budget on the basis of a series of varied assumptions
-ONE changed at a time to determine overall impact
What is a stress test?
examines how a budget would perform or function under severe or unexpected pressure
Why is there a need for stress testing?
- help spot strategic issues
- allows risks to be quantified
- may be imposed on the business by lenders
- test for effects of infrequent expenditure e.g recruitment
- not only for survival of org, but identifies warning signs and spot improvements needed
- proactive instead of reactive to stresses
- help identify correlations between events
What does stress testing software involve?
use computer-generated simulation models that test hypothetical scenarios
- major organisations developed their own software and systems which tailors test to situations
- smaller orgs should use Excel
Where could information on expected future sales levels come from?
- general economic data:info on changes, growth, changes in consumer spending
- public announcements:competitors, customers announcing plans which impact prices and sales
- historic sales trends: to identify patterns and changes in existing buyers habits and tastes
- market research:all of the above can be verified through independent market research
- business unit consultation: when budgets are set centrally, regular communication with managers and business unit may provide insights into local conditions
What is big data?
- large volume of data
- structured or unstructured
- available daily and to everyone
- digital form
What are some sources of big data?
- media/social media e.g likes, retweets
- the web
- machine generated e.g Alexa, IoT
- databases
What are some benefits of big data analytics for budgeting?
- can reduce UNCERTAINTY in sales forecast and cost estimation
- help firms REACT quicker than rivals through better trend tracking
- can allow more PROACTIVE approach
- TRACKING consumer feedback and tastes to help remove non-value adding systems
- CRM can be improved resulting in better REPEAT businesses and customer loyalty
- can examine and ANALYSE to streamline and simplify resulting in cost reductions/efficiencies
- employees can be provided with better INFOand make better local and operational decisions
- customers NEEDS are more readily identifies meaning innovation is better
- performance can be tracked against WIDER criteria
What are some issues with big data analytics must overcome?
4Vs:
volume: too much data to analyse
variety: data comes in various forms
velocity: create and changed at a great speed
veracity: accuracy and validity of data
What are some problems in performing big data analytics:
- data available to competitors too so advantage short lived
- significant tech investment to store, organise and manage
- distorted with data outliers
How are data outliers dealt with?
could contain valuable information
- investigated separately from data
- common in big data
- use trimming approach:ignore high and low values and use middle
What is a rolling budget? (continuous budget)
continuously updated by adding a further accounting period when earliest period has expired
-for a fixed period, not always p.a
Why are rolling budgets used?
-deal with problem of uncertainty when greater accuracy and reliability are required
What are some advantages of rolling budgets?
- reduce UNCERTAINTY in budgeting
- can be used for cash management
- force managers to look ahead continuously, no free riding
- during change, comparing actuals to rolling is more realistic than actuals with fixed (static) budget
- business pace is not static so budgets shouldn’t be
What are some disadvantages to rolling budgets?
- preparing new budgets regularly is time consuming
- can be difficult to communicate frequent budget changes
What are the 3 alternative approaches to creating a budget?
Incremental
Zero based
Activity Based
What is Incremental Budgeting?
take previous year’s budget and add % to allow for inflation and other cost increases and adjustments
- small changes made
- check to ensure it meets performance targets
What are some advantages of incremental budgeting?
- simple
- cheap
- suitable in stable environments
- most practical
What are some disadvantages of incremental budgeting?
- backward looking
- builds on previous inefficiencies
- doesn’t remove waste/inefficiencies
- unsuited to changing environments
- targets too easy, unchallenging
- activities not justified
- encourages over-spending
What is zero-based budgeting?
-assume each functional budget is 0
-increments of cost are compared with benefits, culminating in planned maximum benefit for a given budgeted cost
-radical alternative to incremental:solution to issues
=>based on budgets prepared by managers
How is ZBB implemented?
- Establish activities and objectives
a. Decision units, costs and objectives - Establish decision package
a. Different ways to achieve objective
b. Different costs from non-finance teams
c. Can be mutually exclusive i.e different ways to achieve objective or incremental i.e different levels of service - CBA analysis on packages and rank
a. Which ones align with customer satisfaction, high quality
b. Ranked in order of preference - Allocate resources
What are the advantages of ZBB?
- creates an environment that accepts change
- better focus on goals
- forward looking
- improves resource utilisation
- better performance measures
- focuses managers to examine activities
What are the disadvantages of ZBB?
- time consuming
- expensive
- encourages short-termism
- management may lose focus on the true cost drivers
- managers require new budgeting skills
- can result in arbitrary decision
Why are the ZBB and ABB better than incremental costing when it comes to overheads?
- direct costs are relatively straightforward
- adding increment does not take overheads into account
- ZBB and ABB bring greater discipline to the process of budgeting for overhead activities and costs
What is activity-based budgeting?
method of budgeting based on an activity framework and utilising cost driver data in the budget-setting and variance feedback processes
-based on budgeting for activities
What is the ABB approach?
1) cost driver identifies and forecast made of number of units
2) given the estimate of activity level for the cost driver, activity cost is estimated and cost driver rate is calculated
What are the advantages of ABB?
- useful when overheads are significant
- better cost control
- management focus on monitoring and controlling OH easily
- useful for TQM environments by relating cost to level of service
What are the disadvantages of ABB?
- expensive to implement
- only suited to ABC users
What is Beyond Budgeting?
idea that firms need to move beyond budgeting because fo the inherent flaws in budgeting especially when used to set contracts
- argued that rolling forecasts and market related targets can replace traditional budgeting
- commonly used in fast changing environments
What are the common features of Beyond Budgeting systems?
- use of rolling budgets based quarterly/monthly instead of annually
- wider range of performance measures such as satisfaction, innovation
- targets set based on external ‘benchmarks’
- greater focus on determining and explaining what might happen in the future rather than looking at past
- innovation is encouraged and rewarded
- budgets set at local level rather than centrally
What are some advantages to Beyond Budgeting?
- planning is CONTINUOUS and the organisation is more likely to be proactive rather than reactive to changes
- targets become more CHALLENGING and more market focused thus challenging staff
- the organisation becomes more INNOVATIVE and continuously improves
- managers involved in decision making thus MOTIVATING
- managers can take decisions much more quickly
- created information systems which provide fast and open info throughout the org
What are some disadvantages to Beyond Budgeting?
- planning, coordination and performance evaluation become more complicated as do reward systems
- if targets seen as unachievable, effort reduced
- goals less clear and not communicated through firm
- firms who move beyond budgeting structure can face resistance from other employees where traditional budgeting is more deeply ingrained
- may be difficult/impractical for firm to adopt the culture of decentralisation
- more up to date, accurate info is costly
What type of budgeting is best suited to the following scenarios?
- inefficient operation
- highly direct labour intensive process
- efficiently operating firm
- different types of output using different combinations
- ZBB
- not ABB as it has relatively low overheads
- incremental
- ABB
What are 3 forecasting models?
- high-low method
- linear regression analysis
- techniques of time series analysis
What is the high-low method?
breaking semi-variable costs into variable and fixed
What are the 3 steps to the high-low method?
- Determine the variable costs
- VC per unit = increase in cost/ increase in activity - Find the fixed cost
- Calculate the expected cost
Limitations of high/low method?
- only takes extreme observations into account
- risky to forecast out of range as may become non-lineark
What does a linear regression estimate and assume?
estimates and assumes a linear relationship between variables
What is the regression calculation for a and b?
b=( nExy - ExEy)/ nEx2 - (Ex)2
a=avg of y - b x avg of x
How is linear regression used in budgeting?
time series and time trend
- alternative to calculating moving averages as trend line is established
- x is time, y is dependent variable
total costs, where costs are a combo of FC and VC
- alternative to high/low as more data is used
- x is volume
- y is TC
- a is FC
- b is VC
What is a perfect linear correlation?
values lie exactly on straight line
-r = +1 or -1
What is a partial correlation?
not an exact relationship
-if r<0 or >0
How can more meaningful information be gathered from the correlation coefficient?
calculating the coefficient of determination, r^2
How is the coefficient of determination interpreted?
proportion of total variation in y variable that is explained by regression equation
higher r-squared: more confidence in equation i.e higher proportion of total variation explained by x variable
What is the error term of the coefficient of determination?
remainder of r-squared (1-r-squared) e.g 20% variance is accounted for by something other than x
What are some limitations of simple linear regression?
- assumes linear relationship
- only measures relationship between 2 variables, not other factors
- only interpolated forecasts tends to be reliable; should avoid extrapolation i.e data outside range
- assumes historic behaviour continues
- interpolated predictions are only reliable if there is a significant correlation between the data
Why do forecasts need to be adjusted by inflation?
historical data should allow for price and cost inflation in the future
-same index level for prices and costs
What are the 4 components of a time series?
T-the trend
S-seasonal variations
C-cyclical variations
R-residual variations
What do time series analyse?
- underlying historical trends
- forecast trend in the future
- identify seasonal variations around trend
- predictions by applying estimate seasonal variations to trend line forecast
What is a trend?
some sort of long term movement
What are seasonal fluctuations?
short-term fluctuations usually related to different periods
- if there is a straight line in the time series, seasonal variation over each cycle must cancel out to zero
- better seasons cancel out worse ones
What are cyclical variations?
medium-term to long term influences usually associated with the economy
- rarely consistent length
- need 6/7 full cycles to be sure what it is
What is a residual/random factor in a time series?
difference between the actual value and the predicted using the trend
What are the 3 main methods of finding underlying trend in data?
1) Inspection: by eye
2) Least squares regression analysis
3) Moving averages:removes seasonal or cyclical variations by a process of averaging, calculate over full cycle
How are seasonal variations calculated?
based off of underlying trend data using either additive or multiplicative model
- difference between trend line value and actual historical value for period
- sum should be 0
How is the prediction calculated?
Prediction = T + S
- T is trend
- S is seasonal variation
What are the advantages of forecasting using time series analysis?
- based on clearly understood assumptions
- trend line can be reviewed periodically
- accuracy can be improved with experience
What are the disadvantages of forecasting?
- assumption that past is reliable indicator of future
- assumption that straight line trend exists
- assumption that seasonal variations are constant, either in actual values using the additive model or as a proportion of trend line value using the multiplicative model
What is budgetary control?
assessing actual performance against budgeted performance
What are the characteristics that are common to businesses with effective budgetary control?
- serious attitude taken to the system
- clear demarcation between areas of managerial responsibility
- budget targets that are challenging yet achievable
- established data collection, analysis and reporting techniques
- reports aimed at individual managers
- fairly short reporting periods
- timely variance reports
- action being taken to get operations back under control if they are shown to be out of control
What are the two main types of control system?
- feedback control
- feedforward control
What is feedback control?
the system aim is to correct problems discovered at period end when actual is compared to budget
-‘modification of subsequent action’
What is feedforward control?
aim is to anticipate problems with the aim of preventing them from occurring
- ‘forecasting of problems and implementing actions before they occur’
- can be used in conjunction with feedback control
What is positive feedback?
corrective action that increases the difference between actual and target
-e.g if sales higher than budget
What is negative feedback?
corrective action that decreases the difference between actual and target
-eg costs higher than budget
What are the advantages of feedforward control?
- forward looking and pre-emptive
- feedback is backward looking
What are the problems with feedforward control?
-control reports should be produced regularly so need efficient forecasting system
What are the different uses in feedback vs feedforward control reports?
- feedback will look backwards at performance for period and consider any difference from the planned performance for the time
- feedforward will look forward and create expectations about expected future performance with the aim of identifying potential future issues for resolution
What is a fixed budget?
contains information on costs and revenues for ONE level of activity
In budgetary control systems, what type of budget should managers always compare performance to?
flexed
What must be determined before a budget is prepared?
cost behaviour
- fixed costs unchanged
- VC and SVC vary with activity
What is the total budget volume variance?
fixed budget - flexed budget
What is the total budget expenditure variance?
flexed less actual budget
How can budgets be designed to help incorporate both flexed and fixed budget?
- distinguish fixed costs from variable
- facilitate preparation of budget cost allowance (flexed budget) for control period when activity is known
What are controllable costs?
costs which can be influenced by the budget holder
- variable
- directly attributable fixed costs
What are uncontrollable costs?
costs that cannot be influenced by management action i.e value cant be increased or decreased
What are directly attributable fixed costs?
directly related to department
-although fixed, department could drastically change this e.g salaries, rent
What is the difference between a committed fixed cost and a discretionary fixed cost?
committed: uncontrollable in short term
discretionary: treated as fixed but can be controlled in short term as they are directly attributable e.g ad expenditure, executive travel
What is a criticism of controllability accounting?
managers are not encouraged to think about uncontrollable costs that they are not responsible for
What are the advantages of recharging uncontrollable costs?
- business unit managers are made aware of the significance of other OH costs
- business unit managers are made aware that they need to earn sufficient profit to cover a fair share of other overhead costs
What are the disadvantages of recharging uncontrollable costs?
- business unit managers are made accountable for a share of other OH costs but can’t control them
- the apportionment of other overhead costs between business units like OH apportionment generally is a matter of judgement, lacking economic or commercial justification
What are some of the purposes that are enhanced by manager involvement in budgeting?
PLANNING: junior managers have better insight as they are closer to the action thus improving budget quality
COMMUNICATION: better understanding of overall budget and goals
MOTIVATION:given power, extra responsibility motivates, personal ownership to achieve goals
What are the purposes that might be distorted if junior managers are involved in the budget setting process?
CO-ORDINATION:more complicated and slower, no bigger picture understanding
EVALUATION:might build ‘slack’ so targets are easily achievable or loose
AUTHORISATION: harder to control the authorisation if there are no checks on manager, they could disagree over responsibility and try allocate cost to other managers
What are the conflicts between goals and budgets?
- fair evaluation vs demotivating managers
- if too cost focused, may distort communication of goals
- managers might follow plan at expense of other critical success factors that arise internally/externally e.g customer demand
- mainly arise due to human nature of budgetary control system
What are the 2 extreme styles of budgetary participation?
imposed style:
- set centrally
- little involvement from budget holder
- no scope for slack
- improved ordination
- avoids some goal congruence issues
participative style
- budget holder involved
- more accurate budget
- better motivator to budget holder
What are the advantages of the imposed/top down budget?
- less time consuming
- managers may not have skills or motivation to participate effectively in process
- senior managers have better overall view or resources and allocation
- senior mgmt have better knowledge of LT strategy
- managers might build in slack/bias
- managers can’t use budget to disadvantage other budget holders
- as someone outside department is imposing budget, more of an objective, fresher perspective gained
- if senior mgmt changes budget holder’s budget, will cause dissatisfaction and demotivation
What are the advantages of the participative style budget?
- morale improved as opinion listened to
- managers more likely to accept plan and strive to achieve target as it is more personal
- lower level mgmt have more detailed knowledge of their particular part of the business so more accurate budget
What are some other behavioural aspects of budgeting?
- PERSONAL goals e.g income, status
- goal CONGRUENCE between org & budget holder’s goals
- avoid budget holders spending ‘POT OF CASH’
- NEGOTIATION of budgets
- coping with CONFLICTS in accounting treatments e.g recharging
- allowing FREEDOM in budget setting
- setting CORRECT LEVEL of ‘difficulty’
What were the main findings of the ‘budget stretch’?
1) Loose budgets (easy targets) are poor motivators
2) As budgets are tightened, up to a point they become more motivational
3) Beyond that point, a very tight budget ceases to be motivational
What are the ethical aspects of budgeting when managers are allowed a high level of participation and a bottom-up approach is taken?
- inclusion of slack:knock on effect of resource allocation
- putting personal goals first before firm’s
- overly-optimistic budgets:to look good, fraudulent recording
What are the ethical aspects of budgeting related to level of participation when a top-down approach is taken?
- budget preparer may be imposing undue pressure through achieving a desired effect
- ‘pseudo-participation’ of budget holders
What are some other ethical issues, not to do with level of participation, in the budgetary control process?
- budget holder may overstate results to seem like target was met, leading to undue rewards
- short-termism e.g reduced staff training costs
- unethical practices to meet targets
- ‘management by exception’:only unusual performances reviewed so those who meet target ignored
- top down approach may lead to increase of responsibility past point of control for budget holders
What issues does focusing on a single financial measure of performance usually cause in budgeting? What is the solution
- dishonest accounting
- improper allocation of resources
- lack of balance between motivation and ethical balance
=> Beyond Budgeting is a possible solution
How is ABB implemented?
- establish activities that drive cost and level of activity
a. For machinery, would be routine services and repairs - Once level of activity quanitified, total time taken is calculated
a. How long service will take in hours - Total hours for maintenance and how many employees required
