Chapter 17 Exercise Review

Question 1

Suggest two actions the owner may take to plan for the deficit in bank balance

Answer 1

Reduce payments, such as drawings

Reduce or defer the loan repayment

Pay only 6 months’ rent in advance

Defer or purchase the shop fittings on credit

Increase inflows by making a capital contribution

Use a loan to purchase the fittings

Organise a bank overdraft

Question 2

Suggest two actions the owner might take to address any problems by deficit in one of the three months

Answer 2

Defer the purchase of the vehicle until March 2016

Bring the capital contribution forward to February 2016

Use credit/a loan to purchase the vehicle

Organise a bank overdraft

Question 3

Explain one benefit of preparing a budgeted cash flow statement for consecutive periods

Answer 3

Monthly trends can be identified, allowing the owner to plan the best time to undertake a cash activity (such as the purchase of an NCA).

Question 4

Suggest one reason for the trend in Sales from August to December

Answer 4

Start of summer sports (such as cricket, tennis)

Christmas

Question 5

Explain one reason why the budgeted Net Profit and Budgeted Net Increase in cash position are likely to be different for December

Answer 5

Credit sales ($12 000) is budgeted to be higher than Receipts from debtors ($11 770), meaning cash inflows and budgeted Net Cash Flows from Operations will increase by more than revenues and budgeted Net Profit.

Question 6

Explain how the preparation of budgeted Cash Flow Statement can assist planning

Answer 6

It allows the owner to prepare in advance for a budgeted increase or decrease in cash.

A budgeted decrease in cash might require the organisation of an overdraft or other finance, or the deferment of certain payments.

A budgeted increase in cash might allow for the repayment of loans, purchase of assets, or extra drawings.

Question 7

Explain your treatment of depreciation of equipment (in relation to cash flow statement)

Answer 7

Excluded as it is does not involve a cash flow. It is a non-cash expense involving the allocation of the cost of a non-current asset over its useful life

Question 8

Explain how cash drawings would be reported in the budgeted cash flow statement

Answer 8

As a Financing Outflow, as it is a cash outflow related to a change in the firm’s financial structure

Question 9

Explain how the preparation of a budgeted cash flow statement can assist decision making

Answer 9

It can identify problem areas in the management of cash, so that corrective action can be taken. (This is particularly the case when it is used in conjunction with a Cash Variance Report.)

Question 10

Explain two reasons why the budgeted Net Increase in Cash Position is much larger than the budgeted Net Profit for May

Answer 10

Capital contribution / Loan – ZNA are both cash inflows, which contribute to the Net Increase in Cash Position but are not revenues and so have no effect on Net Profit.

Depreciation – shelving / Stock loss are both expenses, which decrease Net Profit but are not cash flows and so do not affect the Net Increase in Cash Position.

Question 11

Explain how a Budgeted Balance Sheet can assist planning

Answer 11

It predicts assets and liabilities at some point in the future, so the owner can:

• Begin preparing for the replacement of non-current assets, or the repayment of loans.
• Forecast liquidity by calculating budgeted Working Capital Ratio/Quick Asset Ratio
• Forecast stability by calculating budgeted Debt Ratio.

Question 12

Explain two reasons why the net cash flows from operations is budgeted to be greater than the Net profit for the reporting period

Answer 12

Receipts from Debtors ($19 360) is a cash inflow, which will increase Net Cash Flows from Operations more than Credit Sales ($18 000) revenue will increase Net Profit.

Cost of Sales ($20 000) is an expense, which will decrease Net Profit more than cash Payments to Creditors ($9 405) will decrease Net Cash Flows from Operations.

Question 13

Explain the importance of budgeted sales in the budgeting process

Answer 13

Budgeted Sales is a key revenue in the Budgeted Income Statement and cash inflow in the Budgeted Cash Flow Statement.

Further, a number of other budgeted items vary directly with the level of sales, such as purchases of stock/Cost of Sales/Wages/Receipts from Debtors

Question 14

Explain one benefit of preparing a cash budget variance report

Answer 14

It aids decision-making by providing a benchmark for assessment of actual cash performance so that problems can be identified and corrective action taken.

OR

It aids planning by providing a basis for the formulation of the next Budgeted Cash Flow Statement.

Question 15

State whether the variance in payments to creditors is favorable or unfavorable. Justify

Answer 15

Unfavourable

Actual Payments to Creditors is greater than budgeted, meaning the cash balance will decrease by more than expected.

Question 16

Suggest one possible reason for the capital contribution

Answer 16

To prevent the business from exceeding its overdraft limit

Question 17

Explain the effect on the actual closing bank balance of the variances in investing activities

Answer 17

The cash balance will be $14 000 lower than expected, because the equipment was sold for $2 000 less than budgeted, and the purchase of the shelving for $12 000 was not expected at all.

Question 18

Given that credit sales decreased, suggest one possible reason for the variance in Receipts from Debtors (more than expected)

Answer 18

Decreased bad debts

Faster paying debtors

Better debtor management

Question 19

Explain the importance of variance analysis in the budgeting process

Answer 19

It is a means of checking the performance of the business, and the accuracy of the budgets, before decisions are made and budgets are prepared for the next period.

Question 20

Explain why the owner should be concerned about the firms profit performance when compared to the budget

Answer 20

Without the higher than expected profit on disposal of the vehicle, the profit variance would have been unfavourable, and such a profit is unlikely to happen every period.

Question 21

Suggest two possible reasons for the variance in Sales Returns (Favourable)

Answer 21

Lower sales

Better quality/more suitable stock

Question 22

Suggest one possible reason for the variance in Interest Expense (favourable)

Answer 22

Lower interest rate

Repaid more of the loan principal than expected

Question 23

Explain one advantage of preparing budgets more than once a year

Answer 23

Variance reports can be prepared more frequently, allowing problems to be identified earlier so that more timely corrective action can be taken.

OR

More frequent budgets are likely to be more accurate, and thus more useful as a benchmark for comparison with actual figures.

Question 24

Explain how a Budgeted Balance Sheet can be sued to assist planning

Answer 24

It details the expected carrying value of non-current assets at some time in the future so the owner can prepare for their replacement (by investigating options / prices).

It can be used to plan for the repayment of loans and to set a level for Drawings (must be done in conjunction with the Budgeted Cash Flow Statement).

Question 25

Explain how the preparation of a Budgeted Income Statement could assist with planning to achieve an improved Gross Profit

Answer 25

It allows the owner to assess the adequacy of the firm’s mark-up, so that preparations can be made to access a cheaper supplier/raise or lower selling prices.

Question 26

Explain one benefit of preparing a Budgeted Balance Sheet

Answer 26

It predicts assets and liabilities at some point in the future, so the owner can:

• Begin preparing for the replacement of non-current assets, or the repayment of loans
• Forecast liquidity by calculating budgeted Working Capital Ratio/Quick Asset Ratio
• Forecast stability by calculating budgeted Debt Ratio.