(PAPER 2) 2.2.4 Budgets

Question 1

budgets definition

Answer 1

a financial plan that is agreed in advance. it is a planned outcome that the firm hopes to achieve

Question 2

purpose of budgets

Answer 2

• planning: allows the business to think ahead
• communication: can share financial objectives with the workforce
• motivation: improving the budget position indicates success, fear of failing provides an incentive
• control and monitoring: compare actual figures with budgeted figures (variance analysis)

Question 3

types of budget:

Answer 3

• sales (volume or value)
• costs (fixed, variable, total, individual)
• profit

Question 4

forming a budget- budgeting methods

Answer 4

• historical: use current financial figures to prepare the new budget. adjustments made such as change in cost of production.
• zero based: use figures based on potential performance to show that the spending will generate an adequate return

Question 5

drawbacks of HISTORICAL budgeting method

Answer 5

• there is no incentive to reduce costs if the same budget is given every year- managers might just spend on unnecessary resources
• may become out of date- if budgets are given without thinking about the future

Question 6

drawbacks of ZERO BASED budgeting method

Answer 6

• time and effort is required to budget from scratch
• short-termism the business might shift resources to activities that will increase sales or profit over the next year, rather than investing for the long term

Question 7

difficulties of budgeting

Answer 7

• setting budgets- conflict between opinions, time consuming, over ambitious
• unrealistic figures could cause stress/reduce productivity
• short termism- too much focus on the current budget or year, which could undermine future performance

Question 8

variance analysis

Answer 8

difference between budgeted and actual figures. the result is classed as favourable or adverse

favourable: when actual sales or profits are higher than budgeted sales or profit or when actual costs are lower than budgeted costs
adverse: this is when actual sales or profits are lower than budgeted sales or profit, or when actual costs are higher than budgeted costs

Question 9

formulae (can be for sales, cost or profit)

Answer 9

actual figure- budgeted figure

the figures need to be analysed to find the cause of the problem