Budgeting

Question 1

What are the 2 types of variances?

Answer 1

Planning variance - shows financial affect of factors OUTSIDE our control

Operational variance - shows financial affect of factors WITHIN our control

Question 2

What are fixed and flexible budgets?

Answer 2

A fixed budget is prepared at a single level of activity

A flexible budget is prepared with all cost elements known, classed as either fixed or variable
The budget can be flexed to the actual level of activity for budgeting purposes

Question 3

What are incremental budgets?

Answer 3

An incremental budget starts with the previous period’s budget or actual results, and adds/subtracts an incremental amount to cover inflation and other known changes

Question 4

What type of business environment is incremental budgeting suitable for?

Answer 4

A stable business, where costs aren’t expected to change significantly

Good cost control

Question 5

What is zero-based budgeting?

Answer 5

Zero based budgeting is a method of budgeting that requires each cost element to be specifically justified, as if the activities were being undertaken for the first time
Without approval, the budget remains at zero.

Question 6

What type of business environment is zero-based budgeting suitable for?

Answer 6

Fast moving industries
Discretionary costs such as R&D
Public sector organisations such as local authorities

Question 7

What is a rolling budget?

Answer 7

A rolling budget is one that is kept continuously up to date by adding another accounting period (e.g. month or quarter)

Question 8

What type of business environment is a rolling budget suitable for?

Answer 8

When accurate forecasts can’t be made e.g. a dynamic business environment or in a new business

For any area which needs tight control

Question 9

What is activity based costing (ABC)?

Answer 9

The aim of ABC is to calculate the full production cost per unit.
It is an alternative to absorption costing in a modern business environment

Question 10

What are the steps in ABC?

Answer 10

1. Group production overheads into activities (cost pools)
2. Identify the cost drivers for each activity
3. Calculate an absorption rate (OAR) for each activity
4. Absorb the activity costs into the product
5. Calculate the full production cost and/or the profit or loss

Question 11

How does activity based management improve performance of the overall business?

Answer 11

Repricing or eliminating unaffordable products

Eliminate activities which do not add value

Design improvements to products

Improving relationships with customers and suppliers

Ensures that the needs of customers are being met

Question 12

What are the 2 types of activity based management?

Answer 12

Operational - to improve overall efficiency
Activities which add value are identified and improved
Activities which don’t add value are reduced or eliminated to cut costs

Strategic - to satisfy customers needs
Which products to develop and sell based on profitability
Identify the most profitable customers and focus on them

Question 13

What is activity-based budgeting (ABB)?

Answer 13

Activity-based budgeting uses the principles of ABC to estimate the firms future demand for resources so it can help the firm to get these resources more effectively

Question 14

What is a benefit of ABB?

Answer 14

+ Useful for TQM environment, by relating the cost of an activity to the level of service provided

Question 15

What are the implications of using ABB?

Answer 15

Traditional variance analysis will have to be adapted to focus on activity costs
The resulting variances should facilitate better control and planning for overheads as it focuses on what generates the costs

Question 16

What are the implications of using ZBB?

Answer 16

Targets may be unrealistic, as often used when there is a high level of uncertainty
Targets may be too difficult as the culture of ZBB is to eliminate all waste
As a result the firm may have more adverse variances but these may be more due to planning than operational ones

Question 17

What are the implications of using incremental budgeting?

Answer 17

Managers will often spend their whole allowance to ensure that they get it for the next period
As a result, favorable variances will be small and will not reveal areas for further improvement

Question 18

What are the implications of using fixed budgets?

Answer 18

Not very useful for controlling a business, as actual and budget figures may not be comparing like for like in terms of volume

Question 19

What is the advantage of splitting into planning and operational variances?

Answer 19

Managers can concentrate on the operational variances which they actually have control over

Question 20

What is the disadvantage of splitting into planning and operational variances?

Answer 20

All adverse variances are explained anyway as being planning errors

If the revised variances are higher, managers will feel demotivated by moving targets, especially if they have lost a bonus

Question 21

What is the learning curve effect in forecasting?

Answer 21

As workers become more familiar with the production of a new product, the average labor time (and labor cost) per unit will decline

Question 22

When can the learning curve model ONLY be applied?

Answer 22

there are no breaks in production 
the product is new
the product is complex
the process is repetitive
the process is labor intensive