Kaplan 5: Preparing Budgets - Planning phase

Question 1

A business needs a production budget as a ..

Answer 1

.. quantitative expression of its operational plan

Question 2

In exam will generally produce which budgets?

Answer 2

The FUNCTIONAL BUDGETS:
Notice they are interrelated

1. Sales budget
2. Production budget of finished goods.
   (Same as sales budget apart from change in OI/CI)
   (Always work in units first)
3. Raw materials purchases budget.
   (Follows from production budget which needs done first)
   (Always work in kg first)
4. Labour budget
   (Follows from production budget)
5. Overheads budget
   (Might have to return to labour budget if based on LHs)

Question 3

Permanent budget record important for

Answer 3

• Facilitate the eventual explaination of any differences between budgeted and actual results
• Provide a starting point for budget revisions of for the preparation of budgets in future years.

IMPORTANT features of the record should be:

• Details of the budget calculation
• Comparison with actual figures for previous year
• Basis of variability, noting how the amount is related to such factor as levels of output or numbers of people employed.

Question 4

Cap ex budget

Answer 4

Short term operating budgets are in effect abstracts from a continuously developing long-term plan.

This, however is particularly true of the capex budget because the major items included in it will not be completed within the bounds of any one budget year.

The main purpose therefore of the capex budget is to provide a foecast of the cash needed for investment projects during the year ahead.

It also indicates what items of plant, equipment, vehicles etc will be needed for the purpose of implementing the P&L (or operating) budget; and therefore must be submitted for approval at an early stage in the budgeting timetable.

Question 5

Any capex budget would include the following

Answer 5

1. A descriptive TITLE for the project
2. The TOTAL required expenditure
3. An ANALYSIS of costs over various time periods.
4. Where appropriate, expenditure to date
5. Estimates of future benefits from the project.
6. Investment appraisal calculations (incl. details of assumptions)
7. Intangible benefits from the project

Question 6

The Master budget will be approved by ?

Answer 6

The board

Question 7

The master budget will contain

Answer 7

1. A budgeted income statement (SPL)
2. A forecast SFP as at year end
3. A cash budget

These will be supported by:

1. Such summaries of the various functional budgets as may be required
2. Calculations of the key ratios which indicate conformity with the objectives for the year.

Question 8

The budgeted Income statement (SPL)

Answer 8

Shows the net profit by deducting the budgeted costs from the budgeted sales revenue.

A column with:

+ Sales

+ Mat
+ Lab
+ OHs
= Total Prod cost

TP from above
+ OI
- CI
= COS ( remember COS = OI + Prod - CI )

+ Sales
- COS
= Profit

Question 9

The forecast Statement of Financial Position (SFP)

Answer 9

In arriving at the forecast SFP it will be necessary to take account of:

1. The Capex budget
2. Changes in Inventory levels & WIP.
   If WIP & FGs are valued on a TAC basis (Total Absorbption Cost Vs Marginal Cost - MC), then it will be necessary to calculate OR rates
3. Change in receivables balances.
   Subject to any special delays in collection, the closing receivables balances will be calculated by applying the company’s normal credit terms to the phased budget of sales
4. Changes in Payables Balances.
   In theory CPs will be calces by applying a normal credit period. In ractice might have to review budgeted cash flow before finalising a decision on credit to be taken.
5. Changes in cash balance.
   Initially Closing cash balance may be taken as the balancing figure on the SFP but at some stage this should be validated by building up a cash budget itemised from other budgets.

Question 10

Methods of Budgeting need to know for exam

Answer 10

1. Incremental budgeting
2. Zero-based budgeting
3. Priority based budgeting
4. Activity based budgeting

Question 11

Incremental budgeting description

Answer 11

• Starts with previous period’s budget or actual results.
• Adds (or subtracts) to cover inflation/ other changes
• Suitable for stable businesses where costs not expected to change significantly
• There should be good cost control and limited discretionery costs

Question 12

Incremental budgeting pros & cons

Answer 12

PROs:

1. Quick & Easy
2. Sutible for stable biz and historic figs acceptable since only the increment needs to be justified

CONS:

1. Builds in previous probs & inefficiencies
2. Managers may spend budget so as not to reduce
3. Uneconomic activities may be continued. Eg might be cheaper to outsource

Question 13

Zero Based budgeting description

Answer 13

Requires each cost element to be specifically justified as though the activities it relates to are being undertaken for the first time.

Suitable for allocating resources where spend is non-essential. Eg R&D, Advertising, Training.

Often practiced in public sector

1) Managers specify, for their reponsibility centres, those activities that can be individually evaluated
2) Each activity then described in a ‘Decision package’ stating costs/revenues
3) Each decision package is evaluated and ranked - usually using cost/benefit analysis
4) Resources are allocated

Question 14

Zero-based budgeting PROs & CONs

Answer 14

PROs
1. Inefficient/obsolete ops can be identified & discontinued.

2. Increased staff involvement at all levels
3. Responds to changes in business environment
4. Understanding of the cost behaviour patterns of the org will be enhanced
5. Resources should be allocated efficiently & economically

CONs
1. Emphasises short-term benefits to detriment of long-term goals

2. Budgeting process ay become too rigid & org may not be able to react to unforseen opps or threats.
3. Management may not have the skills
4. Managers may be demotivated by the time spent on the process
5. Ranking can be difficult for diff types of activities or where the benefits are qualitative

Question 15

Priority based budgeting description

Answer 15

Designed to produce a competitively ranked listing of high to low priority discrete bids for resources which are called ‘decison packages’

1. It is a method whereby all activities are re-evaluated each time a budget is set.
2. Discrete levels of each activity are valued from a minimum level of service upwards and an optimum combination chosen to match the level of resources available and level of service required.
3. The concept of ranking bids for Capex spend is well known… priority-based budgetig applies a similar process to more routine expenditure

Question 16

Priority based budgeting pros & Cons

Answer 16

None listed in Kaplan

Question 17

Activity-Based budgeting description

Answer 17

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

Or more simply

Preparing budgets using overhead costs from activity based costing methodology

Question 18

Activity based budgeting PROs & CONs

Answer 18

PROs
1. Draws attention to costs of ‘overhead activities’ which can be a large proportion of total operating costs

2. Recognises that it is activities which drive costs. If we can control the causes (drivers) of costs then costs should be better managed & understood.
3. ABB can provide useful info in a Total Quality Management (TQM) environment, by relating the cost of an activity to the level of service provided.

CONs

1. Time & effort required to establish the key activities & their cost drivers may be considerable.
2. It may be difficult to identify clear individual responsibilities for activities.
3. It could be argued that in the short-term many OH costs are not controllable and do not vary directly with changes in the volume of activity for the cost driver. The only cost variances to report would be fixed OH expenditure variances for each activity.