Budgeting Flashcards
How are key planning assumptions derived?
Key planning assumptions represent those factors that are to some extent beyond management control and set a limit on the overall activities of the firm. They must be forecast nased on past experience, field estimates and/or statistical analysis.
Define budget variance
A budget variance occurs when actual expenses do not match budgeted expenses exactly or when budgeted revenues do not match actual revenues exactly.
Are budgets part of the performance measurement system or the performance reward system?
Budgets are part of both. Most managers are evaluated in part on how well they are able to meet the budget expectations of their department, division, and so on. Budhet variances are indicators of whether managers are meeting expectations. A large unfavorable variance may cause managers to be emoted or lose his job.
What are some of the synergies that budgets provide within a large corporations?
(1) A communication device involving both vertial and horizontal information transfers
(2) A negotiation and internal contracting procedure
(3) A role in the performance evaluation and reward system
(4) A role in partitioning decision rights.
How do budgets partition decision rights within a firm?
Budgets seperate decision management from decision control. Managers have the decision management rights. The budget of directors has the decision control rights (budget revuew and pproval and financial statement review).
What purposes are served by the budgeting process in a large firm?
The budgeting process serves as a cummincation device in lager firms. the process gives managers incentives to share their specific knowledge, thus transmitting this knowledge vertically and horizontally trhoughout the firm. Key planning assumptions are shared and develped in this process as well. The information-sharing process also serves as a negotioation and contracting procedure between different subunits within the firm. Review of the prior year’s budget is a part of this process, and therefore budgeting is part of the performance evaluation andreward and punishment system. These processes partition decision right within the firm.
Why would managers bias their forecats when preparing a budget?
This is just another example of the trade-off between decision making and control. the budget system transfers specialized knowledge abouyt key planning assumptions. However, if the budget is also used for control and provides incentives for meeting the budget, the managers will “shade” their forecast to enchange their performance whenever perfroamcne is measured by comparing actual result with budget.
What is a bottom-up budgeting system?
A bottom-up budgeting system means that lower levels in the organization prepare the initial budgets because they have the specialized knowledge, and as the budget winds its way trhough the decision ratification process, higher levels in the organization review the budget and bring to bear additional knowledge.
What is the ratchet effect?
The ratchet effect refers to basing next year’s budget on this year’s actual performance if this years actual performance exceeds this year’s budget.If, in this year actual pefrmance falls short of budget, next year’s budget is not reduced. Budget ratcheting causes employees to reduce output this year to avoid being held to higher standard in future period.
Describe participative budgeting?
Participative budgeting occurs when the person ultimately held responsible for meeting the target makes the initial budget forecast.
What are the short-run and long-run budgets?
A short-run budget is one year-budget. Like all budgets, it forces managers with specific knowlegde to communicate their forecasts and becomes the internal contract between the manager and the firm. A long-run budget project from 2-10 years into the future and is a key part of a firm’s strategic planning process. A short-run budget involves both decision management and decision control, while a long-run budget is primarily for decision management.
What are the advantages and disadvantages of line-item budgets?
Line-item budgets authorize a manager to spend only up to a specific amount on each line item. Thesebugets are an extreme form of control; decision rights to substitute resources are denied. The benefit of such control is
- A reduction of agency costs.
The disadvantage of these budgets is
- That managers are disinclined to look for savings because they cannot transfer the saving to another line item.
- If coming in under budget reduces the next year’s budget for that line item, then the manager has no incentive to search for savings.
Why do some organizations practice budget lapsing? What are the disadvantages?
Budget lapsing provides tigher controls on managers that budget that do no lapse. The primary purpose os to prevent certain agency problems from occuring. The opportunity cost of lapsing budgets is usually less efficient operations. Managers will devote time at year-end to ensure that the budget is fully spent, thereby protecting future budget levels.
Define static and flexible budgets. Discuss their advantages and weaknesses.
A static budget is a budget that does not change with colume, while a flexible budget changes with volume. The major reason for using flexible budget is to be better measure the actual performance of a person or entity after controlling for volume effects, assuming that the person/entity being evaluated cannot control the volume changes. However, if a manager can influence, the ffect of the volume change, then it is unwise to shield the manager form the volume changes.
Define incremental and zro-based budgeting. Discuss their advantages and weaknesses.
With incremental budgeting, each lower-level manager submits a budget by making incremental changes to each line item. Detailed explanations justifying the incremental changes are submitted and review by the organization. Base budgets are taken as given. Zero-based budgeting (ZBB) resets reach line item in the budget to zero and the entire amount must be justiied. ZBB, in principle, maximizes firm valye by identifying and eliminating expenditures whose total costs are greater than total benefits, whereas inefficient base budgets can still exist with incremental budgeting. The same justifications are submitted to support to incremental changes.The volume of report under ZBB is larger than under incremental budgeting, causeing senior managers to focus on changes.
