Week 7

Question 1

Budget

Answer 1

Plan for the acquisition and use of resources over a specified period. It functions both as a guideline for operations and a projection of the operating results for the budgeted period.

Question 2

Budgeting

Answer 2

Process of preparing budgets, and allows management to develop strategies and communicate expectations of performance throughout the organization.

Question 3

Role of Budgets

Answer 3

Budgets serve multiple purposes, including:
● Allowing management to anticipate and develop future strategies;
● Allowing top management to communicate expectations to departments;
● A motivational device;
● Allowing coordination of activities in the subunits;
● Giving authority to resources;
● Allowing assessment of performance at the end of an operating period.

Question 4

Capital budgeting

Answer 4

The process of evaluating, selecting and financing long-term projects and programs (e.g. purchase of new equipment). The strategic goals and objectives are accomplished through a focused set of initiatives and projects.

Question 5

Strategic budget expenditures

Answer 5

Planned spending on initiatives and projects that lead to long-term value and competitive advantage for the organization.

Question 6

Operating budgets

Answer 6

Plans that identify resources needed to implement strategic projects and to carry out budgeted activities;

Question 7

Financial budgets

Answer 7

Identify sources and uses of funds for budgeted operations and capital expenditures. They include the cash budget, budgeted statement of cash flows, the budgeted balance sheet and the capital expenditures budget.

Question 8

The Budgeting Process

Answer 8

The budgeting process varies depending on the size of the firm, especially in terms of time required. The following steps are usually applied:
1. Formation of a budget committee

2. Determination of the budget period
3. Specification of budget guidelines
4. Negotiation, review and approval.
5. Revision

Question 9

Formation of a budget committee

Answer 9

Oversees all budget matters. It sets and approves the overall budget goals for all major business units, coordinates the preparation of budgets, resolves conflicts and differences that might arise, approves the final budget, and reviews the operating results;

Question 10

Determination of the budget period

Answer 10

Most commonly for the fiscal year, with sub-period budgets for each of the constituent quarters or months;

Question 11

Specification of budget guidelines

Answer 11

Must be followed by each subunit when it prepares its initial budget proposal;

Question 12

Negotiation, review and approval

Answer 12

Procedures for budgetary revision vary among firms, but – in general – obtaining approval to modify a budget can be difficult.

Question 13

Revision

Answer 13

Sometimes, budgets may need to be revised to better fit the procedure. Revising budgets can be a difficult process, and can vary among organizations.

Question 14

The sales budget

Answer 14

Shows forecasted sales (in units and dollars) for the upcoming period. The sales forecast is the starting point. Forecasts are in part subjective. Therefore, to reduce subjectivity different factors should be taken in consideration:

● Current sales level and sales trends of the past;
● General economic and industry conditions;
● Competitors’ actions and operating plans;
● Pricing policies;
● Credit policies;
● Advertising and promotional activities;
● Level of unfilled back orders.

Question 15

A production budget

Answer 15

Shows planned production for a given period. For manufacturers, the planned production depends on budgeted sales, the desired ending inventory, and the units of finished goods inventory on hand at the beginning of the period.

Before finalizing a production budget, the production manager reviews the feasibility of the budget in view of the available facilities and the other activities scheduled.

If the budgeted production exceeds the maximum capacity available, management must revise the sales level or find alternatives to satisfy demand.

Instead, if the available capacity exceeds the budgeted production level, management has time to find alternative uses of the idle capacity.

Question 16

Direct Materials Usage Budget and Direct Materials Purchases Budget

Answer 16

The direct materials’ usage budget shows the amount and budgeted cost of direct materials required for budgeted production. The cost of direct materials for the budgeted period can be completed only after the direct materials purchases budget is completed, which shows the physical amount and cost of planned purchases of direct materials (e.g. raw materials, components parts) to meet the production and ending materials inventory requirements.

Question 17

Direct Labour Budget

Answer 17

To prepare the direct labour budget, the information from the production budget is needed. This budget enables the personnel department to plan for the hiring and repositioning of employees if needed.

A good budget should help the firm avoid emergency hiring, prevent labour shortages, and reduce or eliminate the need to lay off workers.

Question 18

A factory overhead budget

Answer 18

Includes all production costs other than direct materials and direct labor. Some firms separate these costs into variables (e.g. power, fringe benefits) and fixed costs (e.g. factory insurance, property taxes).

Question 19

Merchandise Purchases Budget

Answer 19

Merchandising firms do not have a production budget, but instead prepare a merchandise purchase budget, which shows the amount and cost of the merchandise it needs to purchase during the budgeted period.

Question 20

Cash Receipts (Collections) Budget

Answer 20

The cash receipts budget provides details regarding anticipated collections of cash from operations for the upcoming period. Cash receipts from investing and financing activities are reported elsewhere. The information from the last line of this budget is then incorporated into the cash budget for the quarter.

Question 21

Cash Budget

Answer 21

The cash budget brings together the cash effects of all budgeted activities. By preparing this budget, management can take steps to ensure having sufficient cash on hand to carry out planned activities, allow sufficient time to arrange for additional financing that might be needed – hence avoid high costs of emergency borrowing – and plan for investments of excess cash on hand. The preparation of the cash budget requires a careful review of all budgets to identify all revenues, expenses, and other transactions that affect cash. Three major sections are usually included:

● Net cash flow from operating activities;
● Net cash flow from investing activities (acquisitions and divestitures of investments and
long-term assets);
● Net cash flow from financing activities (issuance, payment and retirements of debt and
equity).

Question 22

Budgeted Income Statement

Answer 22

The budgeted income statement describes the expected net income for an upcoming period. In the case that it falls short of the pre-specified goal, management can investigate actions to improve the operating results. Once it has been approved, it can be used as a benchmark against which the performance of the period is evaluated.

Question 23

Uncertainty and the Budgeting Process

Answer 23

There are three techniques to better understand and deal with such uncertainty:
1) What-if analysis

2) Sensitivity analysis
3) Scenario analysis

Question 24

What-if analysis

Answer 24

Examines how a change in one or more budgetary items affects another variable or budget of interest;

Question 25

Sensitivity analysis

Answer 25

Determines the extent to which a change in the forecasted value of one or more budgetary inputs affects individual budgets and financial statements of the master budgeting process.

One of the main advantages of sensitivity analysis is the ability to isolate risks associated with components of operations and to develop contingency plans for dealing with these risks;

Question 26

Scenario analysis

Answer 26

Consists of creating and examining several realistic scenarios. The range of outcomes for the scenarios gives us an idea of how bad or good things might turn out to be in the future.

Furthermore, the range of possible outcomes provides a rough measure of risk. To enhance the analysis, it is possible to assign subjective probabilities to each of the various scenarios.

However, the most sophisticated way to handle uncertainty is through the Monte Carlo simulation.

Question 27

Zero-base budgeting

Answer 27

Requires managers to prepare budgets each period from a zero base.

Typically, the budgeting process is incremental in nature, meaning that it starts with the current budget, assuming most current activities and functions will continue into the next budget period.
The primary focus in a typical budgeting process is on changes to the current operating profit. Instead, with zero-base budgeting, no activities or functions are included in the budgets unless managers can justify their needs.

Question 28

Activity-based budgeting (ABB)

Answer 28

Extension of activity-based costing (ABC). It starts with the budgeted output and segregates costs required for the budgeted output into homogeneous activity cost pools (e.g. unit, batch, product-sustaining, customer-sustaining, and facility-sustaining).

ABB begins by budgeting activity requirements based on estimated product demand for the upcoming period. Then, it budgets the cost of resources needed to perform the set of activities needed to meet this demand.

Question 29

Time-Driven Activity-Based Budgeting

Answer 29

Time-driven activity-based costing is an alternative to ABC. To build such a system, management needs only two estimates for each department or business process:

● Total cost and amount of resources supplied for a period;
● The amount of resource capacity, measured in time that is consumed by each of the organization’s cost objects.

Time-driven activity-based budgeting is a method of budget preparation used in conjunction with a TDABC system. It works backward from forecasted sales volume to calculate resource spending needed to support production and sales plans. To generate these estimates, time equations for each major activity or process can be used.

Question 30

Kaizen budgeting

Answer 30

Approach that incorporates continuous-improvements expectations in the budget. It adjusts required resource demands based on targeted efficiency and productivity gains.

It can be used to complement traditional and activity-based costing systems. Kaizen budgeting promotes active engagement in reforming or altering practices. Therefore, a decrease in cost in a Kaizen budget is a result of performing the same activity more efficiently and with higher quality. It is not a result of arbitrary elimination of activities or components.

Question 31

Budgetary slack

Answer 31

Practice of managers knowingly including a higher amount of expenditures or a lower level of revenue in the budget than they believe will occur.
In this way, when the actual cost amounts are realized and compared to the budgeted figures, it seems as if there was a successful effort.

Managers use such practices as insurance against uncertain future events.

Question 32

Goal congruence

Answer 32

Refers to the degree of consistency between the goals of the firm, its subunits, and its employees. There are at least three major factors that affect the level of goal congruence achieved:

1. Authoritative v. Participative Budgeting
2. Difficulty Level of the Budgetary Target
3. Linkage of Compensation and Budgeted Performance

Question 33

Authoritative v. Participative Budgeting

Answer 33

A top-down budgeting process is referred to as an authoritative budgeting, while a participative budgeting entails a bottom-up approach. The former provides better decision-making control, but often lacks the commitment (buy-in) of lower-level managers and employees responsible for implementing it.

Instead, a participative budget can be a good communication device, since during the preparation upper-level managers can gain a better understanding of the problems the employees face. In turn, employees realize the dilemmas top management deals with. Furthermore, it is more likely to gain employee commitment to fulfil the goals.

Question 34

Difficulty Level of the Budgetary Target

Answer 34

An easy target may fail to encourage employees to give their best effort, while a difficult target to attain can discourage managers from even trying to achieve it. Ideally, budget targets should be challenging but attainable.

Question 35

Linkage of Compensation and Budgeted Performance

Answer 35

Budgets often play a role in determining employee and executive compensation. A fixed-performance contract is an incentive compensation plan whereby compensation (reward) is a function of actual performance compared to a fixed (budgeted) target.

However, this method can have some dysfunctional consequences. For instance, such a system provides an incentive to submit biased information in the budgets (e.g. budgetary slack).
In addition, it motivates managers to game the performance measure, which means taking actions to make the performance indicator look better but do not increase the value of the firm.
Another critique to fixed-performance contracts is the fact that some factors (e.g. macroeconomic conditions) are beyond managers’ control. As an alternative, two methods were suggested:

● Use of linear compensation plans
● Use of relative performance contracts

Question 36

Linear compensation plans

Answer 36

Independent of budgeted targets and managerial reward is a linear function of actual performance. This system rewards people for what they do, and not relative to what they say they can do;

Question 37

Relative performance contracts

Answer 37

Reward managers for performance based on comparison of actual results with specified benchmarks, not budgeted targets. This represents a radical decentralization and significant reliance on self-regulation.

Question 38

Operational control

Answer 38

Focuses on short-term operating performance, including both financial and non-financial control systems.

Question 39

Financial control

Answer 39

Defined as the comparison between budgeted and actual financial results, with the difference being defined as the variance. The letters F and U are used to label variances as favourable or unfavourable.

Favourable variances are those that increase short-term operating income, while unfavourable variances decrease short-term operating income.

Question 40

Short-Term Financial Control

Answer 40

An important short-term financial goal is to achieve the budgeted operating income for the period. The difference between the actual operating income and the master budget operating income is the total operating income variance (or the master static budget variance).

Question 41

Static budget

Answer 41

The master budget is useful for initial planning and coordination of activities. However, the operating conditions rarely turn out to be the way they were forecasted in the master budget. This is sometimes called the static budget, as it refers to a single output level.

Whenever the output attained differs from the budgeted output, the organization needs to revise the master budget before assessing short-term performance.

Question 42

Flexible budget

Answer 42

Budget that adjusts revenues and costs to the actual output level and sales mix achieved.

The flexible budget can be developed in three steps:

1. Determine the output of the period;
2. Use the selling price and the variable cost per unit from the master budget, to calculate the budgeted sales revenues and budgeted variable expenses for the output of the period and to compute the flexible budget contribution margin;
3. Determine the budgeted amount of fixed cost and then compute the flexible-budget operating income.

Question 43

The direct materials flexible budget variance for each material

Answer 43

Difference between the actual direct materials cost and the total standard direct materials cost for a period’s output.

The variance reflects efficiencies or inefficiencies in buying and using direct materials, which requires controls over price of the materials and the quantities used in production.

However, price and usage often move in opposite directions. Therefore, we must analyse a total variance for each raw material in terms of price and quantity.

Question 44

A materials usage ratio

Answer 44

The ratio of quantity used over quantity purchased.

A low ratio suggests that the purchasing department bought for materials inventory, not the operational needs of the period.

Question 45

The direct materials usage variance (UV) (or quantity variance)

Answer 45

Refers to the efficiency with which each raw material was used during the period.

Question 46

A standard cost

Answer 46

Determined cost that a firm or organization sets for an operation. It is usually expressed on a per-unit-of-output basis. These costs are incorporated into budgets to monitor and control operations for performance evaluations.

Question 47

A standard cost system

Answer 47

One in which standard, not actual, costs flow through the formal accounting records. Firms have different expectations for the level at which they want to set their standards. Therefore, three types of standards can be considered:

1) Ideal standard
2) Continuous-improvement standards
3) Currently attainable standard

Question 48

Ideal standard

Answer 48

Maximum efficiency in every aspect of an operation, by assuming peak operating efficiency and the absence of any production disruption;

Question 49

Employ continuous-improvement standard

Answer 49

Which, as a function of time, become progressively more difficult to achieve;

Question 50

Currently attainable standard

Answer 50

Sets the performance expectation to a level that a person with proper training and experience can attain most of the time, without having to exert extraordinary effort.
It allows for some imperfections and inefficiencies. The selection of either standard costs depends on the unique firm situation.

Question 51

Authority standard – set by management V.S Participative standard

Answer 51

Participative standard calls for active participation throughout the standard-setting process by employees affected by the standard.

Firms using an authoritative process can ensure that all operational factors are considered, and that the management’s expectations are incorporated. However, it is useless if the employees do not comply.

On the other hand, a participative standard may increase the chance that employees will adopt the standard, as it is thought to produce product important behavioural effects.

Question 52

Establishing Standard Costs

Answer 52

A standard cost for direct materials of a product has three features:

● Quality of the direct material, which determines the quality of the final product and affects many phases of the manufacturing process;

● Quantity needed to manufacture the product, which is set once the quality of direct materials is established;

● Price standards of materials can be influenced by quality, quantity, and at times the timing of purchases.

Question 53

Quantity standard for direct labour

Answer 53

Direct labour costs vary with types of work, product complexity, employees’ skill level, the nature of the manufacturing process, and the type and condition of the equipment to be used.

The personnel department determines the standard wage rate for the type and skill level of employees needed. The standard wage rate usually includes fringe benefits and the required payroll taxes. Often, overtime premium is treated as part of factory overhead.

Question 54

The Strategic Role of Non-financial-Performance Indicators

Answer 54

A series of limitations of the use of standard costs and variance analysis for operational control purposes must be considered:
● Because of the short-term nature of performance indicators, actions that improve short-term financial performance at the expense of long-term performance might be made;
● Focusing on individual variances may result in optimizing local, but not global, performance. For instance, the purchase of non-standard raw materials may result in a favourable materials-purchase price variance for the purchasing manager. However, it harms the production manager, who will have more scrap and other quality-related costs due to the nature of the material;
● Operating personnel may not be able to readily interpret or act upon financial-performance indicators;
● Financial performance indicators are backward-looking measures;
● Making, applying, updating and using cost systems can be costly when looking from a systems-design perspective.

Therefore, non-financial operating performance measures can be used as a complement.

Question 55

Business Processes

Answer 55

Common business processes include:
● Operating processes: day-to-day activities that produce the outputs of the organization and deliver them to customers;
● Customer-management processes: activities that focus on creating customers and expanding and deepening relationships with these customers;
● Innovation processes: activities designed to produce new processes, services and products;
● Social/Regulatory processes: activities related to the organization’s environmental and community responsibilities, as well as its legal responsibilities at both local and national level.

Question 56

Just-in-Time (JIT) Manufacturing

Answer 56

JIT manufacturing process is where production at any stage of a process does not take place until an order, from an internal or external customer, is received.

The underlying system is referred to as demand-pull. One implication of JIT is the reduction of inventory buffer stocks. When inventory is kept to a minimum, quality at each stage of the production process is expected.

Question 57

Customer-response time

Answer 57

Operating measure defined as the elapsed time between the time a customer places an order and the time the customer receives the order. It is particularly useful to firms who compete based on time.

Question 58

Key determinants of productivity for most organizations

Answer 58

● Control of waste, which is achieved through efforts in workflow management and quality (also known as lean manufacturing);

● Product and manufacturing process innovation, which is often achieved through the implementation of information technology;

● Fluctuations in demand due to changes in the business cycle or for other reasons.

Question 59

Analysing Productivity

Answer 59

Productivity is the ratio of output to input

Operational productivity is the ratio of output units to input units;

Financial productivity is the ratio of dollar output to dollar input.

Question 60

A partial productivity

Answer 60

Focuses on the relationship between one of the input factors and the output attained (e.g. direct materials productivity, workforce productivity, etc.).

Question 61

Total productivity

Answer 61

Includes all input resources in computing the ratio of output attained to input resources consumed.

Question 62

Partial Productivity: Operational vs. Financial

Answer 62

Using physical measures (i.e. partial operational productivity) makes it easier for operational personnel to understand and use in operations. Furthermore, it is unaffected by price changes or other factors, which makes it easier to benchmark.

Instead, partial financial productivity has the advantage of considering the effects of both cost and quantity. At management level, the effect of cost is the main concern.

Question 63

Limitations of partial productivity measure

Answer 63

● Measures only the relationship between an input resource and the output, ignoring any effect that changes in other manufacturing factors have on productivity;
● Any effect that changes in other production factors may have on productivity are ignored;
● The analysis and interpretation of partial productivity should include effects that changes in the firm’s operating characteristics have on the productivity of the input resource;
● An improved partial productivity does not necessarily mean that the firm or division operates efficiently.

Question 64

Total productivity limitations

Answer 64

● The use of a total productivity measure in performance evaluations decreases the possibility of manipulating some manufacturing factors to improve the productivity measure of other manufacturing factors;

● Decreases in total productivity can result from an increase in the cost of resources or a decrease in the productivity of some input resources. Ambiguity in the relationship between the controllability of operations and a performance measure based on total productivity could defeat the purpose of having a productivity measurement.

● Productivity measures can ignore the effects of changes in demand for the product, changes in selling prices of the goods or services, and changes in special purchasing or selling arrangements on productivity.

Question 65

Sales quantity variance

Answer 65

First contributing factor to sales volume variance.

Focuses on deviations between the number of units sold and the number of units budgeted to be sold, and measures the effect of these deviations on operating results. It is the product of three elements:

● The difference in total units of all products between the actual amount sold and the budgeted amount;
● The budgeted sales mix ratio of the product, which is its sales in units as a percentage of total sales in units;
● The budgeted contribution margin per unit of the product.

Question 66

Sales mix

Answer 66

Second component of the volume variance

Relative proportion of a product’s sales to total sales. A product’s sales mix variance refers to the effect that a change in the relative proportion of the product from the budgeted proportion has on the total contribution margin of the period.

Question 67

Two determinants of the sales quantity variance

Answer 67

● Changes in the market size (as the global market size for its product expands, the firm is likely to sell more units. Conversely, as the market size contracts, firms are likely to sell fewer units).

● Changes in the firm’s share of the market (when a firm’s share of the market increases, the firm sells more units and when market share decreases, sales fall).

Question 68

Market size variance

Answer 68

Measures the effect of changes in market size on a firm’s total contribution margin. When determining the market size variance of a firm, we assume that the firm maintains the budgeted market share and the budgeted average contribution margin per unit.

Question 69

The market share variance

Answer 69

Compares a firm’s actual market share to its budgeted market share and measures the effect of the difference in market shares on the firm’s total contribution margin and operating income. Notice that the computation uses the actual, not budgeted, total market size and the budgeted, not actual, weighted-average contribution margin per unit.