Chapter 3 - Budgeting & Control Flashcards
What is the role of the budgetary system?
Budgets show how the overall goals of the organisation is I’ll be achieved.
What does the budgetary system support all levels of management with?
- Planning
- Control
- Integration
- Motivation
- Evaluation
What are the objectives of the budgetary system?
- Compel planning
- Co-ordinate activities
- Communicate activities
- Motivate managers
- Establish systems of control
- Evaluate performance
- Delegate authority
- Ensure achievement of objectives
What information is used in the budget system?
- Internal historic information
- External historic information
- Internal anticipated information
- External anticipated information
What is a rolling budget?
When the budget is established at the beginning of the period and is then constantly amended and extended
What are the uses of rolling budgets?
- Producing regular revisions to the budget will result in better information for control and decision making purposes.
- Encourages staff to be continually looking at changing internal and external variables.
What are the problems with rolling budgets?
- Involves much time and effort
- Concept is not as readily understood by managers within an organisation
- Continually changing the goalposts can lead to de-motivation
What is top down budgeting?
When you start with the overall corporate objectives set by senior management and then work down through the different levels of the organisation.
What is another name for top down budgeting?
Imposed budget
What is bottom up budgeting?
When you start with the individual personal and departmental objectives set by the local management and then work up through the different levels of the organisation
What is another name for bottom up budgeting?
Participative budgeting
What are the advantages of bottom up budgeting?
- Set by those closer to the action so should be more informed and realistic
- Staff take ownership if budgets and are more committed to achieving them
- Greater staff participation leads to greater motivation
- Doesn’t take up as much senior management time
- Encourages communication between departments
What are the disadvantages of bottom up budgeting?
- More scope for non-goal-congruent behaviour as budgets will be fitting local objectives rather than corporate goals
- More scope for disagreement between staff
- Lack of overall coherence
- More time consuming and costly
- Budgetary slack is built in
- Budgets may be inaccurate is less experienced managers in place
What are the disadvantages of top down budgeting?
- Set by those at the top so less informed and may be less realistic
- Senior management take ownership so staff may be less committed to achieving them
- Lack of staff participation so less motivation
- Takes up valuable senior management time
- No communication between individual departments
What are the advantages of top down budgeting.
- Goal congruence built in to the budget, fits overall objectives of the business
- Less scope for disagreements between staff
- More overall coherence
- Less time consuming and costs less
- Budgetary slack is omitted
- Budget is more accurate as more experienced management sets them
What is zero based budgeting?
Requires management to justify every item of expenditure
What are the uses of zero based budgeting?
- Very responsive to changes in economic environments
- Efficient allocation of resources as based on needs and benefits
- Drives managers to find cost effective ways to improve operations and identify opportunities for outsourcing
- Detect inflated budgets
- Identifies and eliminates waste and obsolete operations
- Increases staff motivation - greater initiative and responsibility
- Increases communication and co-ordination
- Forces cost centres to adopt questioning attitude - overall goals considered
What are the problems with zero based budgeting?
- Difficult to define decision units and packages - very time consuming and exhaustive
- Difficult to rank decision packages
- Some decisions (e.g. R&D) may find it more difficult to justify expenditure
- Necessary to train managers
- Difficult to administer and communicate
- Volume of data may be so large that no one person could read it all
- Honesty of managers must be reliable and uniform
- Could cause conflict between departments
- May prevent managers reacting to changed circumstances once the budget is set
What are the steps for zero based budgeting?
- Identify every item that needs to be budgeted as a ‘decision package’
- Review each decision package and rank them based on their benefits/importance to the organisation
- Allocate resources to decision packages in ranking order until all the available resources are used
What is activity based budgeting?
When work is done initially to identify the cost drivers within the organisations activities. The required level of activity is identified and a budget is produced.
What are the uses of activity based budgeting?
- Focuses on true drivers behind costs within an organisation
- Enable more efficient improvement programmes to be implemented
What are the problems with activity based budgeting?
- Time consuming and resource intensive
- Concept is not readily understood by managers
What is incremental budgeting?
When the budget for the forthcoming period is calculated by taking the current budget or actual results and adjusting for changes
What are the uses of incremental budgeting?
- Budget is stable and change is gradual
- Managers can operate their departments on a consistent basis
- Simple and quick to operate and easy to understand
- Departments can be treated similarly so conflicts can be avoided
- Co-ordination between budgets is easier to achieve
- Impact of change can be seen quickly
What are the problems with incremental budgeting?
- Assumes activities and methods of working will continue in the same way
- No incentive for developing new ideas
- Encourages spending up to the budget
- Budget may become out of date and no longer relevant to the activity/level
- Priority for resources may have changed
- Budgetary slack built into the budget
What does the master budget do?
Collate together the individual budgets for the business functions into a format consistent with the overall financial statements
What is the use of the master budget?
Provides an overall picture of the planned performance for the budget period
What is the problem with the master budget?
Not very helpful for management control at a detailed level
What is a functional budget?
Budgets for each of the business functions for an organisation
What is the use of an functional budget?
Reflects the organisational structure and responsibilities
What is the problem with functional budgeting?
A lot of costs do not relate specifically to individual functions
What is a fixed budget?
The main budget that is produced at the start of the year, based on anticipated level of sales and production
What are the uses of a fixed budget?
- Benchmark for control purposes
- Highlight what can be achieved with the expected level of resources
What are the problems with fixed budgets?
- Not a good comparison in situations where the environment is changing rapidly
- Not useful as a performance appraisal basis if actual volume of sales/production are different to what was expected
What are flexible budgets?
Multiple budgets produced at the start of the year at different activity levels
What is the use of flexible budgets?
Allow for changes in the actual production and sales volume
What is the problem with flexible budgets?
Require detailed analysis of the organisations cost structures
What may cause uncertainty in budgeting?
- Unforeseen changes in customer demand
- Stronger or weaker competition
- Technological advantages
- Under-performance by workforce
- Breakdowns in machinery
- Unforeseen changes in price or availability of materials
- Inflation or exchange rate changes
How can budgeting systems deal with uncertainty in the environment
- Producing a range of possible outcomes
- Using past data and forecasting techniques
- Reducing the uncertainties by research techniques
- Using expected value techniques
What is a feed-forward system?
When you compare the forecast results to the budget and taking corrective action where deviations are identified to ensure the budget is achieved
What is a feed-back system?
When you compare actual events that have happened with an original budget. This is a reactive system.
What are the difficulties of budgets?
- If a budget is too easy it might promote laziness and lack of desire to excel, staff would be able to gain rewards for a very average performance.
- If a budget is based on ideal conditions and consequently too hard, staff will stop trying as they know they cannot meet the target
- Challenging but achievable targets encourage internal processes to become more efficient and the organisation to become competitive
What is the difficulty of changing a budgetary system?
- Staff resistance to changes
- Poor control as the managers may face a period of adaptation to the new system and may struggle for a while to interpret results
- Motivational problems
- Lack of staff know how and the need for retraining
- Additional costs associated with the implementation of the new system
- Lack of comparative information
- Lack of systems and spreadsheets
What are the two main concepts of Beyond Budgeting?
- A more adaptive way of managing in place of fixed annual budgets that tie managers to predetermined actions, targets are reviewed regularly and based on stretching goals linked to performance against world-class benchmarks, competitors and prior periods. There is more focus on cash forecasting rather than cost control.
- Enables decision making and performance accountability to be developed, and creates a working environment and a culture of personal responsibility.
Hope & Fraser
Harvard business school press
2003
Criticisms of budgeting
What criticisms of budgeting did Hope & Fraser put forwards?
- Time consuming and expensive
- Provides poor value to users
- Fails to focus on shareholder value (focuses on internally negotiated targets)
- Too rigid and prevents fast responses
- Budgets stifle product and strategy innovation
- Budgets protect rather than reduce costs (use it or lose it)
- Focuses on sales targets rather than customer satisfaction
- Budgets are divorced from strategy
- Reinforce a dependency culture
- Leads to unethical behaviour
What are the benefits of Beyond Budgeting?
- Faster response time (more flexible)
- More innovation
- Lower costs (see it as costs to be minimised rather then budgets to spend)
- Performance targets are based on competitive success and are more flexible
- Greater motivation for managers because of devolution of responsibilities
- Greater motivation for front line staff dealing with customers
- Better relations with customers and suppliers
- Facilitates improvements in information systems throughout the organisation
What are the steps for high/low method?
- Select the highest and lowest activity levels, and their associated total costs
- Find the variable cost/unit
- Find the fixed cost, using either the high or low activity level
What is regression analysis used for?
To find the ‘line of best fit’ between two variables
What are the advantages of regression analysis?
- It takes all pairs of data into consideration unlike the high/low method
- It gives a statistically accurate link between the two variables
What are the disadvantages of regression analysis?
- It assumes a linear relationship between variables
- Does not consider that there may be other factors affecting variables
- Assumes historic behaviour patterns will continue in the future
- Does not adjust for inflation
- Less reliable for predictions outside the range of data used
What is the correlation coefficient?
It indicates the strength of the relationship between the variables (how close the line of best fit is to the actual variables). It will always be between -1 and +1, the sign simply indicates the gradient of the line.
What is the coefficient of determinations?
It indicates the proportion of change in the dependent variable that can be explained by the change in the independent variable. It will always be somewhere between 0 and +1 (0.64 = 64%)
What are the limitations of correlation?
- May suggest a cause and effect relationship where in fact there isn’t one
- If using a sample of data, the correlation could be misleading
What is time series analysis?
A set of data observed over a period of time, it identifies four components from a series of past figures recorded over time and then uses them to forecast the future
What is a trend?
The underlying long-term movement overtime in historic data
What is seasonal variation?
Short-term period fluctuations in historic values
What is cyclical variations?
Longer-term fluctuations caused by such factors as economic activity or economic cycles
What is random variation?
Unpredictable fluctuations such as an act of nature
What is the additive model?
TS=T+SV In actual (absolute) terms/values
What is the multiplicative model?
TS=TXSV
A % or fraction of the trend
What does the additive model assume?
That seasonal variations are independent of the trend
What does the multiplicative model assume?
Seasonal variations are linked to the size of the trend
What are the advantages of times series analysis?
- Forecasts will be based on identified patterns in historic data
- Trend lines can be continually updated after each future period occurs, allowing predictions to be assessed and improved upon for future forecasts
What are the disadvantages of times series analysis?
- Assumes the historic trends and seasonal variations will continue into the future
- Becomes less reliable if you go outside the ranges of existing observations
- Assumes that a straight line trend exists
What is the learning effect?
The learning effect reflects the fact that when labour undertakes a new repetitive task, the time taken will reduce the more the task is performed
What is the learning effect formula?
Y=ax^b
a= cost/time of first batch/unit x= total number of batches/units produced b= learning factor (logRN/log2) LR= the learning rate as a decimal
When may the cumulative average time per unit become constant in the learning effect?
When:
- Staff reach their physical limit
- Staff being restricted by labour agreements
- Staff being restricted by other resource limits such as machine time
- Lack of incentives to improve further
What is it called when the cumulative average time per unit becomes constant in the learning effect?
Steady state
What are the problems with the learning effect?
- In the real world the rate of learning will not be constant
- In modern manufacturing most repetitive tasks have been automated and machines do not learn
- Learning curve only applies in very limited situations
What are standard costs?
Pre-determined unit costs based on anticipated levels of efficiency and price
What can a standard cost be used for?
- Help to produce the fixed, flexible and flexed budgets
- Compare with the actual costs and hence as a control technique
- Motivate staff
- Value inventories in the actual SOPL and SOFP as well as the budgeted SOPL and SOFP
What are the types of standard?
Basic
Current
Attainable
Ideal
What is the basic standard?
Nothing has changed since the standard was first set
What is the current standard?
Current efficiency and cost levels will be maintained
What is an attainable standard?
Assumes some improvement in current efficiency and cost levels
What is an ideal standard?
Assumes an optimum level of efficiency and cost
What can standard costs be?
Standard marginal cost (only variable production costs) OR standard absorption cost (variable and fixed production costs)
Usage variance =
Mix variance + Yield variance
What does a usage variance indicate?
Whether more or less material than expected was used.
What does a mix variance show?
How much of the overall usage variance is down purely based to the proportions of the material input into production being different to the proportions that were expected
What does the yield variance show?
Whether the actual amount of material input into production led to more or less output than would have been expected
What is the materials mix variance?
The difference between the standard mix of materials and the actual mix of material, valued at the standard material cost.
What does the materials mix variance look at?
The quality of material actually input.
How the actual mix of the material compares to what we would have expected to have used of each material.
What is the material yield variance?
The difference between the actual output from the materials used and the standard output, valued at the standard material cost.
What does the materials yield variance look at?
If we get more or less finished output than we’d have expected from the amount of material being input into the process.
What are the non-financial control techniques for variance analysis?
- Continuous supervision and monitoring
- Staff training
What is the sales mix variance?
The difference between the standard mix of actual sales volume and the actual mix of actual sales volume, valued at the standard profit/contribution
What does the sales mix variance look at?
The volume of actual sales.
How the actual mix of sales compare to what we would have expected to have sold of each product to make up actual volume.
When might an adverse sales mix variance arise?
If you proportionally sell fewer of your more profitable products and more of your less profitable products.
What could cause an adverse sales mix variance?
- Downturn in the economy, customers being more cost conscious and purchasing cheaper goods
- Failure of a marketing campaign
- Increased competition
What is a sales quantity (volume) variance?
The difference between the actual sales volume and the budgeted volume valued at the standard profit/contribution
What does the sales quantity variance measure?
The impact on profit resulting purely from selling more or less units than budgeted and is unaffected by the actual mix of sales
What could cause a favourable sales quantity variance?
- Increase in the overall market size for the company’s products
- Good performance by the sales team in exceeding targets
What does the planning variance compare?
The flexed original budget to the revised budget
What does the operational variance compare?
The revised budget to the actual results
For what reasons should the original budget be revised?
- Poor planning
- Uncontrollable factors
What is the equation for planning variances for sales price?
Planning variance for sales price =
(Revised selling price per unit - original selling price per unit) X revised budget sales volume
What is the equation for planning variances for sales volume?
Planning variances for sales volume =
( revised budget sales volume - original budget sales volume) X original standard contribution per unit
What is another term for planning variances for sales volume?
Market size variance
What is another term for operational sales volume?
Market share variance
What is the planning variance for material price based on?
The actual usage/purchases of material
What is the operational variance for material usage based on?
The original standard cost per KG/Litre
What may cause a planning material price variance?
- Error in the original standard
- Market price change
- Closure of a supplier
- Imflation
What may cause a planning material usage variance?
- Errors in the original standard
- Changes in technology
- Changes in regulatory requirements
- Material being destroyed
What may cause operational material price variances?
- Lower/higher quality material
- Change if supplier
- Bulk buying discounts
What may cause operational material usage variance?
- Training of staff being better or worse than expected
- Quality of material being used was different to expected
What is the planning variance for labour rate based on?
The actual hours for labour
What is the operational variance for labour efficiency based on?
The original standard cost per hour
What could cause planning labour rate variances?
- Error in original standard
- Labour shortage or surplus
- Change in product specification due to change in law this different labour grade needed
What may cause a planning labour efficiency variance?
- Error in original standard
- Change in work practices due to regulatory requirements
- Increased quality requirements set externally
What may cause an operational labour rate variance?
- Overtime working required
- Employing different quality staff
- Bonuses
What may cause an operational labour efficiency variance?
- Different quality of staff used
- Poor work scheduling
- Training of staff is better or worse than expected
What can constantly revising budgets lead to?
The danger that operational managers will try to blame all of the adverse changes on planning or uncontrollable factors
What extreme forms of behaviour can be caused by budgets?
- Unrealistically high level or low level of budget to try and impress others
- Unrealistically high or low level of budget to try and make actual performance impressive
What are two key influences on behaviour?
Participation and ability
What may be done with traditional systems to achieve a favourable material price variances?
- Large orders may be placed to achieve quantity discounts
- Lower quality materials may be purchased leading to product quality issues
What may be done with traditional systems to achieve a favourable material usage variance?
- Materials may be used even if they are below standard, leading to quality issues
What may be done with traditional systems to achieve a favourable labour efficiency variance?
- Work may be rushed and errors made leading to product quality issues
What may be done with traditional systems to avoid labour idle time variances?
- Production may be continued even though there is no immediate requirement
What behaviour problems may be caused but the modern environment?
- Standards are ignored and consequently the control benefits are lost
- Actual operations are modified to fit the standard and consequently the organisation does not change and falls behind its environment
What is just in time purchasing?
When suppliers deliver items just as you need to use them in production
What is just in time production?
When finished goods are produced just in time for customers to come and purchase them
What is Total Quality Management?
It is an overall philosophy within organisations of getting it right first time and continuous improvement. Everyone throughout the organisation strives for excellence in all products.
What does total quality management focus on?
Quality with the idea that there is no waste or rejection
