Budgeting theory Flashcards
What is a budget?
A budget is a financial plan of future costs and revenues (income) for a definite period of time.
Give four purposes of budgeting
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
What are the Advantages of budgeting?
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
Explain the principal budget factor
This is a factor that limits output and stops the firm from expanding.
Give five examples of the principal budgeting factor
Sales demand Supply of materials Availability of labour Capacity of the factory Availability of capital
What is a Sales Budget
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.
What is a Production budget?
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.
What is a direct materials usage budget?
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.
What is a Direct materials purchases budget?
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.
What is a Direct Labour budget?
Used to establish the number of direct labour hours and related direct labour wage.
Expressed in hours and value.
Prepared by the production manager.
What is a factory overheads budget?
Takes into account indirect materials, indirect labour and indirect expenses.
Expressed in hours and value.
Prepared by the production manager.
What is a administration budget?
Deals with all the administration expenses involved in running business.
Expressed in value.
Prepared by the office manager.
What is a selling and distribution budget?
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.
What is a capital budget?
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
What is a master budget?
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.
What is a cash budget?
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.
What is the formula for net cash
Total Income - Total Expenditure
What is the formula for closing cash
Net Cash + Opening Cash
Give three purposes of a cash budget
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
What is a flexible budget?
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.
Give four purposes of a flexible budget
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
Explain Variable Costs
Costs that will will change with the level of production
Explain fixed costs
Costs that will remain the same regardless of the level of production
Explain mixed costs
Costs that have fixed and variable elements
What is an ‘adverse variance’
An adverse variance is when the actual costs exceed budgeted costs.
How can an adverse variance occur?
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.
Why might managers of different cost centres not have responsibility for variances that exist between actual and budgeted costs within their department?
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.
Outline the factors which a company should take into account when estimating future sales figures
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
What options does business have when it has a cash surplus
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
What options does business have when it has a cash deficit
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
Recommendations to make in a cash budget
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
Four reasons for product costing
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
State two other factors that could also be considered to be the principal Budget factor
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
List the components of a master budget for a manufacturing firm
Components: Budgeted manufacturing account, budgeted trading account and profit and loss account, budgeted balance sheet
Explain contribution
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.
Explain profit
Profit is sales revenue less total costs (fixed and variable)
Explain with example controllable costs
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
Explain with example uncontrollable costs
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
