Budgeting theory

Question 1

What is a budget?

Answer 1

A budget is a financial plan of future costs and revenues (income) for a definite period of time.

Question 2

Give four purposes of budgeting

Answer 2

Compare budgeted costs with actual costs at the same level of activity.
Help in controlling costs-identify differences that arise
Plan production levels.
Take corrective action to ensure all targets and objectives are achieved

Question 3

What are the Advantages of budgeting?

Answer 3

Comparisons can be made- actual vs budgeted costs
Identifies problems that arise
Business can plan ahead
Budgets set performance targets that act as motivating factor for management/staff
Ensures the resources of business are used as efficiently as possible
Allows controls to be put in place

Question 4

Explain the principal budget factor

Answer 4

This is a factor that limits output and stops the firm from expanding.

Question 5

Give five examples of the principal budgeting factor

Answer 5

Sales demand
Supply of materials
Availability of labour
Capacity of the factory
Availability of capital

Question 6

What is a Sales Budget

Answer 6

Show the quantities and the sales value of each product company intends to sell
A sales forecast for the must be made before the budget can be prepared. Expected sales will be based on the previous year’s figures.
Prepared by the sales manager.

Question 7

What is a Production budget?

Answer 7

Decides the quantities of finished goods that must be produced to meet the expected demand (from sales budget) plus / minus the budgeted increase / decrease in closing stock levels of finished goods.
Expressed in units (quantities) only.
Prepared by the production manager.

Question 8

What is a direct materials usage budget?

Answer 8

The direct materials usage budget is used to find the quantity of the direct materials needed to meet the levels of production.
Expressed in units (quantities) only.
Prepared by the production manager.

Question 9

What is a Direct materials purchases budget?

Answer 9

When quantities of required materials are known (from usage budget), this can be prepared
Expressed in units (quantities) and value.
Prepared by the production manager.

Question 10

What is a Direct Labour budget?

Answer 10

Used to establish the number of direct labour hours and related direct labour wage.
Expressed in hours and value.
Prepared by the production manager.

Question 11

What is a factory overheads budget?

Answer 11

Takes into account indirect materials, indirect labour and indirect expenses.
Expressed in hours and value.
Prepared by the production manager.

Question 12

What is a administration budget?

Answer 12

Deals with all the administration expenses involved in running business.
Expressed in value.
Prepared by the office manager.

Question 13

What is a selling and distribution budget?

Answer 13

Deals with the costs that are likely to be incurred in the selling and distribution of the budgeted sales to customers.
Expressed in value.
Prepared by the sales and/or the distribution manager.

Question 14

What is a capital budget?

Answer 14

This budget deals with planned capital expenditure and planned capital receipts
Decisions regarding capital items are the responsibility of the Board of Directors and carrying out the capital budget is the role of the financial controller

Question 15

What is a master budget?

Answer 15

Gives an overall view of the planned operations of the company for a specific period.
Done after all the other budgets have been prepared.
It consists of a budgeted manufacturing account, budgeted trading account , budgeted profit and loss account and a budgeted balance sheet.

Question 16

What is a cash budget?

Answer 16

A cash budget is a plan that summarises the expected inflows and outflows of cash in a business.
The cash budget is prepared by the management or financial accountant.

Question 17

What is the formula for net cash

Answer 17

Total Income - Total Expenditure

Question 18

What is the formula for closing cash

Answer 18

Net Cash + Opening Cash

Question 19

Give three purposes of a cash budget

Answer 19

Ensures there is always enough cash available to meet day-to-day needs of the organisation
Anticipates periods where will have a cash surplus
Anticipates periods where will have cash deficit

Question 20

What is a flexible budget?

Answer 20

A flexible budget is one which shows the adjustment of the original budget to the actual level of activity
Flexible budget allows an organisation to compare like with like.
Prepared to show different costs at different production levels, up to and including maximum capacity.

Question 21

Give four purposes of a flexible budget

Answer 21

To show management the cost levels associated with different levels of production.
To compare actual costs and budgeted costs so as to be able to identify variances and take corrective action
To compare budgeted costs and actual costs at the same level of activity
To compare like with like

Question 22

Explain Variable Costs

Answer 22

Costs that will will change with the level of production

Question 23

Explain fixed costs

Answer 23

Costs that will remain the same regardless of the level of production

Question 24

Explain mixed costs

Answer 24

Costs that have fixed and variable elements

Question 25

What is an ‘adverse variance’

Answer 25

An adverse variance is when the actual costs exceed budgeted costs.

Question 26

How can an adverse variance occur?

Answer 26

An adverse variance in direct materials may be due to:
The purchase price of raw materials being higher than expected.
The quantity of materials used being higher than expected.

Question 27

Why might managers of different cost centres not have responsibility for variances that exist between actual and budgeted costs within their department?

Answer 27

Costs may be the responsibility of another departmental manager.
Example: Labour hours is responsibility of the production manager (a controllable cost) but the wage rate paid is responsibility of the personnel manager.

Question 28

Outline the factors which a company should take into account when estimating future sales figures

Answer 28

Market research and trends/opinion of sales representatives may be a reliable indicator of potential sales
Price to be charged 
Level of competition in  marketplace 
Luxuries versus necessities
State of Economy
Is company expected to grow

Question 29

What options does business have when it has a cash surplus

Answer 29

Money could be placed in short term investment opportunities to gain the most interest
Predicting surplus means business have time to arrange for investment of money to gain maximum interest. The surplus could be used to pay off any loans or purchase fixed assets

Question 30

What options does business have when it has a cash deficit

Answer 30

Needs to arrange alternative sources of finance ex: bank overdraft to get them over the period of deficit. Lots of time with budgeting ways to get over deficit: longer periods of credit or bank overdraft accommodation to cover such deficits

Question 31

Recommendations to make in a cash budget

Answer 31

Change credit terms for debtors to encourage more prompt payment ex:discount for cash payment in month of sale
Hire equipment instead of buying to reduce cash expenditure
Agree better credit terms with creditors
Examine variable overheads and wage bill to see if they can be reduced

Question 32

Four reasons for product costing

Answer 32

Establishes the selling price for tendering purposes
Controls costs by comparing budgeted with actual costs
Helps with planning and decision making
To find the value of closing stock to be used when calculating profit

Question 33

State two other factors that could also be considered to be the principal Budget factor

Answer 33

Apart from the sales demand the principal budget factor could also be :
Availability of materials
Availability of labour
Capacity of the plant
Availability of capital

Question 34

List the components of a master budget for a manufacturing firm

Answer 34

Components: Budgeted manufacturing account, budgeted trading account and profit and loss account, budgeted balance sheet

Question 35

Explain contribution

Answer 35

Contribution is sales revenue less variable costs. This goes towards paying off the fixed costs. Once the fixed costs are paid off, any further contribution goes towards profit.

Question 36

Explain profit

Answer 36

Profit is sales revenue less total costs (fixed and variable)

Question 37

Explain with example controllable costs

Answer 37

Costs that can be controlled by the manager of a cost centre. They will make a decision about the amount of the cost or if the cost should be incurred and can be held responsible for variances in these costs. Ex: all variable costs are controllable. Commision to sales personnel can be controlled by the sales manager

Question 38

Explain with example uncontrollable costs

Answer 38

Costs over which manager of cost centre has no control and cannot be held responsible for any variance in these costs ex: rates to the local authority are uncontrollable