M4: Budgetary Planning, Cost ACCT

Question 1

What is a budget for a business?

Answer 1

Business budget serves as a financial plan that outlines income and expenses, providing a crucial framework for assessing an organisation’s financial well-being both in the short and long term.

Also, helps guide essential decisions such as resource allocation, staff recruitment, and equipment procurement, ensuring a clear overview of financial transactions.

Question 2

What are the six key areas where the preparation and ongoing use of a budget helps a business?

Answer 2

1. Planning: A well-structured budget aids in planning various aspects of a business, including staffing and sales strategies.
2. Communication: Budgets convey the organisation’s plans to all employees, clarifying expectations and responsibilities.
3. Coordination: Combining budgets from different functional areas creates a master budget, promoting smooth operations and preventing clashes between departments.
4. Control: Budgets are integral to ongoing control processes. They involve comparing actual results to the budget and responding to unexpected variances.
5. Motivation: A budget represents the organisation’s goals, making it a powerful motivator for managers responsible for achieving those objectives. Involving managers in the budget-setting process enhances motivation.
6. Evaluation: Directors, managers, and employees can be evaluated based on the successful attainment of budgeted income or expenditure targets, provided they had some influence over actual results.

Question 3

What is the typical sequence of budget creation?

(What budgets get made first)

Answer 3

• Sales budget
• Production budget (including labour and materials budgets)
• Overheads budget
• Research and development budget
• Administrative budget
• Master budget (comprising forecast profit and loss accounts, balance sheets, and cash
  budgets)
• Capital budget - focuses on planned spending on Fixed assets and long-term projects.

Question 4

What are the weaknesses of budgets?

Answer 4

• Limiting managers activities
• Hard to evaluate managerial performance
• Reducing resources while demanding higher output

Question 5

What are some ways of improving the effectiveness of budgeting within organisations?

Answer 5

• Align Budgeting with Strategy
• Top Management Support
• Participative Budgeting: Involve those responsible for achieving the budget in the budget-
  setting process.
• Use Budget as a Control Tool
• Human Aspect: Recognise that budgeting is a human process.
• Balance Financial and Non-Financial Aspects

Question 6

What are the different approaches to budgeting? Explain their main features.

Answer 6

1. Incremental budgeting - updates PY figures by a %, accounting for inflation or expected activity changes.
2. Zero-based budgeting - Each budget starts with 0, requiring departments to justify their budgets from scratch.
3. Rolling budgets - Continuously updated on a monthly/quarterly basis.
4. Activity-based budgeting - Budgets based on major activities.

Question 7

What are some of the advantages/dis-advantages of the main budgeting methods?

Answer 7

Incremental:
Adv: Simple, easy to apply and understand.
Dis: Perpetuates past inefficiencies.

Zero-based budgeting:
Adv: Allocates based on need and Value for money. Helps incorporate employees into the process.

Rolling budgets:
Adv: Realistic and achievable budgets
Dis: Incentivises budgetary slack

Activity-based budgeting:
Adv: Helps identify resource needs and makes it more realistic to major activities.
Dis: Expense due to additional analysis and slower to make.

Question 8

What is budgetary slack?

Answer 8

Budgetary slack is the name given to a deliberate overestimate (not underestimate) of future cost performance in order to create a good appraisal of the manager responsible for meeting or beating the budget.

Question 9

What are the different costs a business can incur, and why might this differ for different types of businesses (eg a services firm vs a manufacturer)?

Answer 9

Different costs can include:
* Purchase of raw materials
* Labour costs
* Rent of factory
* Cost of machinery
* Interest on bank loans
* Cost of finance function

A different type of business will have a different measurement e.g. law firm = one hour of client work whereas manufacturing = one pack of biscuits

Question 10

What are the differences between the costs below?
- Fixed costs vs variable costs
- Direct costs vs indirect costs
- Controllable costs vs non-controllable costs

Answer 10

Fixed costs remain constant regardless of production. Variable costs rise or fall with production.

Direct costs can be directly tied to production. Indirect costs are more general costs of running business.

Controllable costs are what managers can control. Non-controllable costs are managed at group level.

Question 11

Explain the differences between the three types of responsibility centres

Answer 11

Cost centre: Incurs costs but generates no revenue. e.g. HR

Profit centre: Manages costs, revenues and profits.

Investment centre: Oversees costs, profits and capital expenditure.

Question 12

What is an overhead?

Answer 12

An overhead is any cost which doesn’t relate to one specific product (eg the cost of running a machine used for multiple products, factory
rent or supervisor costs).

Question 13

What are sunk costs, relevant costs, avoidable costs, unavoidable costs, incremental costs and opportunity costs, and how do they differ with regards to analysis for decision making?

Answer 13

• Sunk costs - costs already incurred and irrecoverable, are not relevant.
• Relevant costs - costs associated with business decisions and savings resulting from those decisions.

Different types of relevant costs:

• Avoidable Costs: Cease when a decision is made (relevant).
• Unavoidable Costs: Continue after a decision (irrelevant).
• Incremental costs are additional expenses incurred when pursuing a particular course of action. They are relevant because they only arise when a specific decision is made.
• Opportunity costs represent lost profit or savings resulting from choosing one option over another. This concept extends beyond monetary values to include alternative uses of resources like labour and materials.

Question 14

What is contribution?

Answer 14

Contribution indicates how much profit a product contributes to a business.

Therefore helps decide which products to manufacture when resources are limited.

Question 15

What is CVP and what is it used in?

Answer 15

CVP analysis examines the connection between cost, volume, and profit, proving invaluable for planning and control.

e.g.
* Adaptation to changing product mixes.
* Evaluation of advertising campaigns.
* Assessment of sales promotions and discount campaigns.
* Analysis of price fluctuations.
* Exploration of changes in salespeople’s compensation methods.

Question 16

What are the 3 main assumptions around CVP?

Answer 16

1. Variable cost per unit remains constant, with total variable costs varying with sales volume.
2. Fixed costs remain unchanged.
3. Selling price per unit remains constant, causing sales revenue to increase or decrease proportionally with sales volume.

Question 17

Can you explain how different CVP scenarios change the profit of a business?

Question 18

Can you calculate CVP ratios?

Answer 18

𝐶/ 𝑆 𝑟𝑎𝑡𝑖𝑜 = Contribution per unit / Sales price per unit

More profitable products have higher C/S ratios, indicating a larger profit share in the sales price.

Question 19

What is the break-even point and can you calculate this?

Answer 19

1. Break-even units = Fixed costs / Contribution per unit
2. Break-even revenue = Fixed costs / Contribution-to-Sales (C/S) ratio

Question 20

What is the break-even price and can you calculate this?

Answer 20

Break-even price is the highest cost per hour or per kilogram of material a business can afford before incurring losses.

𝐵𝑟𝑒𝑎𝑘 𝑒𝑣𝑒𝑛 𝑝𝑟𝑖𝑐𝑒 = Available profit + current cost /Total usage required

Question 21

What is the target profit and can you calculate this?

Answer 21

Target profit involves determining how many units a business must sell to achieve a specific profit goal.

Process:
1. Begin by defining the profit target.
2. Add back any fixed costs to determine the contribution.
3. Add back any variable costs to determine the necessary sales.
4. Calculate the number of units required to meet the sales figure.

Question 22

What is the margin of safety for a business?

Answer 22

How much sales can drop before reaching the break-even point, at which the company stops making a profit.

It’s a risk indicator expressed in units, monetary terms, or as a percentage of current sales.

Question 23

How would you calculate the margin of safety for a business?

Answer 23

MOS UNITS: Units sold − Break even units
Units %: (Units sold − Break even units) / Units sold

MOS (£): Sales revenue – Break even revenue
MOS £ %: (Sales revenue − Break even revenue) / Sales revenue

Question 24

What information do you need to calculate the margin of safety for a business?

Answer 24

Units revenue / Break-even revenue

Question 25

What is the difference between budgeted cost and standard cost?

Answer 25

• Budgeted costs: Total costs to manufacture for all anticipated units of a product.
• Standard costs: Budgeted cost per unit of output.

Question 26

What is the set process for variance analysis?

Answer 26

Process:
1. Set standard costs (based on prior period costs, engineering specifications, or industry
knowledge).
2. Create a budget based on planned output.
3. Prepare a flexed budget using standard costs and actual units sold.
4. Calculate the actual results for the period.
5. Determine variances based on actual and expected results.

Question 27

What are the seven types of variances?

Answer 27

1. Sales volume contribution variance: Organisation has sold more/fewer units than expected
2. Sales price variance: Organisation sold units for a higher/lower price than expected
3. Material price variance: Materials cost more/less per unit than expected
4. Materials usage variance: More/less material was used to make each unit than expected
5. Labour rate variance: Labour cost more/less per hour than expected
6. Labour efficiency variance: Labour took more/less hours to make each unit than expected
7. Fixed overhead variance: Fixed overheads cost more/less than expected

Question 28

What are the differences between planning variances, cost variances and operating variances?

Answer 28

Planning variances because they compare planned activity or volume to actual.

Cost variances include materials price variance, labour rate variance, and fixed overhead expenditure variance. They identify where an item costs more or less than budgeted.

Operations variances include materials usage variance and labour efficiency variance, indicating when something operates differently than expected.

Question 29

Can you calculate the variance analysis by reconciling profits?

Answer 29

1. Start with the original budgeted profit figure.
2. Add or subtract the sales volume contribution variance to obtain the flexed budget profit.
3. Add or subtract all other variance figures to arrive at actual profit.

Question 30

Can you list the favourable and unfavourable variances for the seven types of variances?

Question 31

What are the two main types of variance categories?

Answer 31

• Efficiency/Volume variance: Using more or less of a resource then expected
• Price/Rate variance: Resource costing more or less than anticipated.

Question 32

What are the problems with standard costing?

Answer 32

1. Timeliness: Variance reports are often outdated, hindering timely adjustments to standard costs.
2. Negative Focus: It tends to highlight adverse variances, potentially fostering blame cultures and
   affecting morale.
3. Direct vs. Indirect Costs: In modern production, direct costs may be minimal compared to overall costs.
4. Positive Variances, Negative Impacts: Achieving positive variances may lead to negative consequences like lower quality.
5. Ethics: Ethical considerations are vital when assessing variances and management actions.

Question 33

What are the exam Golden Rules when working out variances?

Answer 33

1. Use the actual number of units sold for all variances except the sales volume contribution
   variance.
2. For price or rate variances, use the actual number of units and actual kg or hours per unit.
3. For efficiency variances, use the actual number of units and calculate the difference in kg or hours, then quantify it in terms of profit using the standard cost per hour or per kg.
4. Be mindful of units and ensure you use costs per hour or per kg, kg or hours per unit, and multiply by the total number of units actually sold.

Question 34

Can you walk through the variance analysis process for an example?

Question 35

Can you work out how much profit changes for the seven different variances?