Chapter 8 - Budgeting

Question 0

The Performance Hierarchy

Answer 0

Strategic - Long term, looks at the whole organisation and defines resource requirements. E.g. Develop new products in response to customer needs

Tactical - Medium term, looks at the departmental/divisional level and specifies how to use resources. E.g. Train staff with challenges that this new product presents.

Operational - Short term, detailed and concerned with control. E.g. A budget is set for the new product to include advertising expenditure, sales forecasts, labour, material etc.

Question 1

The purpose of budgets

Answer 1

Planning - Look to future. Key for survival since stops management from relying on poor co-ordinating.

Control - Actuals compared against budget and auctioned where appropriate.

Communication - Allows juniors and managers to converse.

Co-ordination - Towards a common corporate goal.

Evaluation - Divides the organisation into budget centres each with a responsible manager and evaluated in terms of cost and revenue control.

Motivation - Budget used as a target and rewards for operating within or under budget levels of expenditure.

Authorisation - Formal method of authorisation to a manager for expenditure, hiring staff and plans contained within the budget.

Delegation - Managers may be involved in setting the budget with extra responsibility for motivation and realistic targets.

Question 2

Top down and bottom up budgeting and the advantages/disadvantages

Answer 2

Top down budget - Set without the ultimate budget holder to participate in the process.

Bottom up budget - Budget holders participate in setting their own budgets. (Participative budgeting).

Advantages:-

1. Increased motivation.
2. Better information.
3. Increases managers understanding and commitment.
4. Better communication between departments.
5. Senior managers can concentrate on strategy.

Disadvantages:-

1. Senior managers resent loss of control.
2. Dysfunctional behaviour. Managers lack strategic perspective and focus on divisional concerns.
3. Bad decisions from inexperienced managers.
4. Slow preparation and disputes can arise.
5. Budgetary slack. Managers set targets too easy to achieve.

Question 3

Incremental budget and its advantages/ disadvantages

Answer 3

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

Advantages:-

1. Quick and easy.
2. Suitable for stable businesses.

Disadvantages:-

1. Builds in previous problems and inefficiencies
2. Uneconomic activities my be continued.
3. Managers may spend unnecessarily to use up their budgeted allowance this year to get the same budget for next year.

Question 4

Zero-based budgeting and its stages

Answer 4

A method of budgeting that requires each cost element to be specifically justified as if the activities were undertaken for the first time. Without approval the budget allowance is zero.

It is suitable for:-

1. Allocating resources where spend is discretionary e.g. R&D, advertising and training.
2. Public sector such as local authorities.

There are 4 stages in ZBB:-

1. Managers specify activities that can be individually evaluated.
2. Each individual activity is described in a decision package which states the costs and revenues expected. It should be drawn up in a way where the package can be evaluated and ranked against other packages.
3. Each decision package is evaluated and ranked using cost/benefit analysis.
4. The resources are then allocated to the various packages.

Question 5

Advantages/disadvantages of Zero based budgeting.

Answer 5

Advantages:-

1. Inefficient or obsolete operations can be identified and discontinued.
2. Increased staff involvement at all levels.
3. Responds to changes in the business environment.
4. Knowledge and understanding of cost behaviour enhanced.
5. Resources allocated efficiently and economically.

Disadvantages:-

1. Emphasises short term benefits to the detriment of long term goals.
2. Process may be too rigid and unable to react to unforeseen opportunities or threats.
3. Management skills may not be required.
4. Managers may feel demotivated due to time spent.
5. Ranking may be difficult.

Question 6

Rolling budget and its advantages/disadvantages.

Answer 6

A budget kept continuously up to date by adding another accounting period (e.g. Month or quarter) when the earliest accounting period has expired.

Suitable if:

1. Accurate forecasts cannot be made.
2. Any area of business that needs tight control.

Advantages:-

1. Planning and control based on more accurate budget.
2. Rolling budgets reduce the element of uncertainty.
3. Always a budget that extends into the future.
4. Forces management to reassess the budget regularly.

Disadvantages:-

1. More costly and time consuming than Incremental budgets
2. May demotivate employees spending time since budgets constantly changing.
3. Danger the budget might become the last budget ‘plus or minus a bit’
4. An increase in budgeting may lead to less control of the actual results.
5. Issues with version control as full year numbers change each month.
6. Confusion in meetings with which numbers working towards.

Question 7

Activity based budget and its advantages/disadvantages.

Answer 7

A method of budgeting based on an activity framework and utilising cost driver data in the budget setting and variance feedback processes.

Advantages:-

1. Draws attention to the costs of overhead activities which can be a large proportion of total operating costs.
2. Recognises that activities which drives costs.
3. Can provide useful information in a TQM environment.

Disadvantages:-

1. Time and effort needed to establish the key activities and their cost drivers.
2. Difficult to identify clear individual responsibilities for activities.
3. In the short term, many overhead costs are not controllable and do not vary directly with changes in the volume of activity for the cost driver.

Question 8

Feed forward control and its advantages/ disadvantages.

Answer 8

Operates by comparing budgeted results against a forecast. Control action is triggered by differences between budgeted and forecasted results. (A Feedback system would compare actual results with budgeted results).

Advantages:-

1. Encourages managers to be active and deal with problems before they occur.
2. Reforecasting monthly can save time for quarterly or annual budgets.

Disadvantages:-

1. Time consuming as control reports must be produced regularly.
2. May require sophisticated control system which could be expensive.
3. Takes focus off day to day organisation.

Question 9

Advantages/disadvantages of spreadsheets.

Answer 9

A spreadsheet is a computer package which stores data in a matrix format where the intersection of each row and column is referred to as a cell.

Advantages:-

1. Can include large volumes of information.
2. Formulae and lookups can be used.
3. Results can be printed or distributed easily.
4. Can also represent the results graphically.

Disadvantages:-

1. Takes time to develop. The benefit must be greater than the cost of developing and maintaining.
2. Data can be accidentally changed or deleted.
3. Errors in design e.g. Formulae.
4. Data used subject to a high degree of uncertainty.
5. Security issues.
6. Version control issues.
7. Training staff to use spreadsheets/ models is time consuming.