Week 7-budgeting

Question 1

Budget

Answer 1

A financial plan of action relating to a given
period, typically one year or less, the identifies
how much a business would earn, spend or
save, based on how much funds are available.

Question 2

Budgeting

Answer 2

The process of systematically collecting,
evaluating and communicating (quantified)
information about an organisation’s future
activities

Most organisations prepare budgets for income
and spending to ensure they are on course to
what the analysts and shareholders are
expecting.

For cost savings and revenue generation,
planning is key and budgets are a means to
present the plans in monetary terms.

Effective vehicle in: 
Planning
Controlling
Communicating
Coordinating and integrating
Motivating
Delegating etc.

Question 3

What are the most common budgets?

Answer 3

master, cash, capital, operating

Question 4

What are master budgets?

Answer 4

• It is at the top of the cascade, and appear very
similar to the published financial accounts.

• This budget consolidates all subsidiary
budgets and usually comprises the budgeted
profit and loss account, balance sheet and
cash flow statement.

Budget schedules are reviewed and coordinated
with different departments (top-down or bottomup).

A master budget represents a summary of all of management’s plans and goals for the future, and
outlines the way in which these plans are to be accomplished. The master budget is composed of a
number of smaller, specific budgets encompassing sales, production, raw materials, direct labour,
manufacturing overhead, selling and administrative expenses, and inventories. The master budget
generally also contains a budgeted profit statement, balance sheet, and cash flow data.

-guides day to day operations in an organisation

Question 5

What are thse steps in preparing an operating budget?

Answer 5

FMsheet

Question 6

Production budget

Answer 6

Budgeted sales

Required closing inventory

Required units in December

less Opening inventory (available)

Budgeted production (requirement)

After allowing for defective units (100/percentage of defective units x budgeted production)

Question 7

Raw materials budget

Answer 7

Raw materials usage budget ( x required production)

Required closing raw materials iventory

Total raw materials need

less: Opening raw materials inventory

Raw materials purchase budget

Question 8

Cash budget

Answer 8

• This is a detailed budget of estimated cash
inflows and outflows incorporating both
revenue and capital items.
• It assists management to keep cash balances
at reasonable level in relation to its needs. It
aids in avoiding unnecessary idle cash or
possible cash shortages.

Its principal purpose is to provide
information on probable cash needs during the budget period, so that required bank loans and other
sources of financing can be anticipated and arranged well in advance of the actual time of need.

Question 9

Is profit the same as cash?

Answer 9

NO.

-depreciation would reduce profit but not cash
-loans increase cash but not profit
-depreciation & amortisation of non-current assets
• provisions, e.g. for bad debts
• receivables vs sales
• purchases vs payables
• inventory vs purchases
• accruals and prepayments
• loans and share capital (Balance sheet items)

Question 10

Cash budget

Answer 10

Production requirements
Closing inventory
=solution
less opening invenory
Purchase budget 
Payment for purchases x price per kg

Question 11

What is capital budgeting?

Answer 11

This is a process concerned with decision making
in respect of specific investment project choices
and the total amount of capital expenditure to
commit.

Question 12

What is operating budget?

Answer 12

This is the budget of the revenue and expenses

expected in a forthcoming period.

Question 13

What are the essential ingredients for effective budgets?

Answer 13

• Predictive power (nearer to what the future is
likely to be)
• Unambiguity of channels of communication,
authority, and responsibility
• Accuracy, reliability, and timeliness of
information
• Strategic, tactical and operational level support
(at all levels of the organisation)

Question 14

What are the two types of budgetary approaches?

Answer 14

• top-down (imposed): pace and financial coontrol, inaccurate, underperformance and staff morale
• bottom-up (participative)

advantages: Motivation, better information, staff ownership of
responsibility, better morale, Senior management
can concentrate on other tasks of strategic
importance.

disadvantages:Inexperienced managers, Budgetary slack (easy
income targets or higher spending targets) slow
budgeting process, dysfunctional (when budgets
are not in line with the corporate objectives)

Question 15

Give 6 examples of budgetary systemes

Answer 15

• Incremental budgeting.
• Zero-based budgeting (ZBB)
• Rolling budgets
• Activity based budgeting
• Feed forward control
• Flexible Budgets

Question 16

What is incremental budgeting?

Answer 16

Incremental budgeting is a method of budgeting in
which next year’s budget is prepared by using the
current’s year’s actual results as a starting point,
and making adjustments for expected inflation,
sales growth or decline and other known changes.

Used to budget rent.: Estimated on the basis of current rent plus an
increment for the annual rent increase.

The traditional approach to budgeting in the public
sector in most parts of the world has been
incremental and in many cases has resulted in
inefficiencies.

Question 17

What are flexible budgets?

Answer 17

Where there is a lot of uncertainty or
volatility**, and it is possible to produce flexed
budgets to anticipate performance at different
levels of activity. The budget is still fixed, but it
has some predefined and explained tolerance.
• Budget flexing is defined as: ‘Flexing variable
costs from original budgeted levels to the
allowances permitted for actual volume
achieved while maintaining fixed costs at
original budget levels.’

Question 18

What are rolling budgets?

Answer 18

Continuously updated by adding a further
accounting period (month/quarter) when the
earliest accounting period has expired. Its use is
particularly beneficial where future costs and/or
activities cannot be forecast accurately.

Instead of preparing a periodic budget, once
annually for the full budget period, new budgets
are prepared every one, two, three or four
months. Each of these budgets would cover for
the next twelve months/quarter or the
relevant period.

Question 19

Zero-based budgeting

Non-traditional approach

Answer 19

Implicit in the traditional approach is an
assumption that current expenditure adds
value to the customer.
• ZBB requires each cost element to be
specifically justified, as if the activities to
which the budget relates were being undertaken
for the first time. The budget at zero unless
justified and approved.

-encourages a more questioning approach but may be csotly to implement and may make employees feel threatened.

Advantages:
• It is possible to identify and remove inefficient or
obsolete operations.
• It forces employees to avoid wasteful expenditure.
• It can increase motivation of staff by promoting a
culture of efficiency.
• It responds to changes in the business
environment.
• ZBB documentation provides an in-depth
appraisal of an organisation’s operations.
• It challenges the status quo.
• In summary, ZBB should result in a more efficient
allocation of resources.

DIsadvantages:
-Enormous extra volume of paperwork created and
the extra time required to prepare the budget. The
following problems might also occur.
-Short-term benefits might be emphasised to the
detriment of long-term benefits.
-It might give the impression that all decisions have to
be made in the budget.
-Management must be able to meet unforeseen
opportunities and threats at all times, however, and
must not feel restricted because they were not
approved by a decision package, cost benefit analysis
and the ranking process.
-It may call for management skills both in
constructing decision packages and in the ranking
process which the organisation does not possess.
-Managers may have to be trained in ZBB
techniques.
• Difficult to rank qualitative rather than quantitative
staff welfare and working conditions. benefits –
such as spending on
• The organisation’s information systems may not
be capable of providing suitable information.

Question 20

Activity-based budgeting

Answer 20

Budgets prepared
according to cost-driving
activity rather than
function can provide.

• more accurate budgets
• closer links between costs and management responsabilities

Question 21

What are the steps of activity based budgeting?

Answer 21

See formula sheet

Question 22

How budgets help managers?

Answer 22

• promote forward-thinking and identification of short-term problems
• motivate managers to better performance
• provide a basis for a system of control
• help co-ordination between various sections of the business
• provide a system of authorisation

Question 23

What are the points of conflicts about budgeting?

Answer 23

Budgets should be:
–quantified
–integrated
–formalised
(period, content, process)

There is debate over:
–frequency and detail of
updates
–predominant direction of
the process
(top-down, bottom-up)
–philosophy of process (zerobase, incremental)
–tightness of integration

Question 24

What are the limitations of budgeting?

Answer 24

• Strengthen vertical command and control.
• Encourage ‘gaming’ and perverse behaviours
(Budgetary slack: Budgetary slack is the deliberate under-estimation of budgeted revenue or over-estimation of budgeted expenses. This allows managers a much better chance of “making their numbers,” which is particularly important for them if performance appraisals and bonuses are tied to the achievement of budgeted numbers.)
• Are developed and updated too infrequently, usually annually.
• Reinforce departmental barriers rather than encourage knowledge sharing.
• Make people feel undervalued.

Not everything that counts
can be counted, and not
everything that can be
counted, counts.
Albert Einstien

Question 25

What are the main ides of Chris Argyris?

Answer 25

• Believed that managers who treat people positively and as responsible adults will achieve productivity.
• Concluded that problems regarding employees emerge because mature personalities are managed using outdated practices.
-Reaction of factory management to budgets:
– If met: sense of personal success
– If missed: Sense of personal failure and
embarrassment
The consequences if missed: “devastating effects”
upon the individual as well as the organisation
=> Budgets ultimately fail to increase human
efficiency

As a consequence:
-workers become suspicious of management
-formen and supervisors of different departments tried to blame each other for shortfalls against budget
-budget supervisors became defensive, “watchdog of the company”
-Budgets promoted self-interested behaviour of departmental heads.
-Budgets can lead to tunnel vision and a lack of
goal congruence

Question 26

Do you agree with the statement ‘The variable overhead efficiency variance is a misnomer’?

Answer 26

The overhead efficiency variance does not measure efficiency in the use of overhead. It instead
measures efficiency in the use of the absorption basis e.g. labour hours, machine hours etc. Hence
overhead efficiency variance does not indicate the efficiency in the use of overhead, rather it points to
the use if the base itself. Hence it can be viewed as a misnomer (a wrong or inaccurate name or designation.)

Question 27

Cost of goods sold

Answer 27

COgs= opening inventory+ purchases -closing inventory