B.4. Budget Methodologies

Question 1

What is the master budget?

Answer 1

A full set of budgeted financial statements for the budget year, including budgeted balance sheet, income statement, and statement of cash flows, all of which are broken down into monthly or at least quarterly interim budgeted financial statements by responsibility center.

The master budget is also called the comprehensive budget and is prepared by responsibility center and consolidated into company-wide budgeted financial statements.

Question 2

What distinguishes a pro forma financial statement from the master budget?

Answer 2

A pro forma financial statement is a forecasted financial statement prepared for a specific purpose, such as “what if” analysis, and is not used for formal variance reporting like the master budget.

Pro forma financial statements are used for planning and decision-making purposes and may differ significantly from the master budget.

Question 3

What kind of budget is the master budget?

Answer 3

A static budget

A static budget is prepared for one planned activity level, based on projections before the period begins.

The master budget is prepared for one planned activity level.

Question 4

What is the difference between a static budget and a flexible budget?

Answer 4

• Items in a static budget are developed for one activity level, usually sales volume.
• In a flexible budget, the variable revenues and costs in the master budget (the static budget) are adjusted to what they would have been if the actual sales volume had been known in advance and used in preparing the master budget.

Question 5

How is a flexible budget amount calculated for a single-product company?

Answer 5

A flexible budget cost is the standard or budgeted cost per unit multiplied by the actual quantity produced or sold.

A flexible budget revenue is the budgeted price multiplied by the actual quantity sold.

Question 6

If actual revenues and expenses and the static budget revenues and expenses are given in income statement format, how are the flexible budget revenues and expenses calculated for a single-product company?

Answer 6

If actual revenues and expenses and the static budget revenues and expenses are given in income statement format, the flexible budget revenues and expenses are the static budget amounts divided by the static budget sales volume and multiplied by the actual sales vol-ume.

Question 7

What are the components of the master budget?

Answer 7

• Operating budgets
• Financial budgets

Operating budgets identify resources needed for planned activities, while financial budgets identify sources and uses of funds.

Question 8

What is the purpose of a flexible budget?

Answer 8

It adjusts the master budget amounts to reflect what the budgeted amounts would have been if the actual sales volume had been used.

A flexible budget is prepared after the actual level of activity is known and focuses on variances caused by factors other than volume differences.

Question 9

When is a flexible budget prepared?

Answer 9

After the actual level of activity is known.

Flexible budgets are prepared for the actual level of activity using standard variable costs per unit and standard total fixed costs.

Question 10

What is the relationship between flexible budgeting and standard costing?

Answer 10

Flexible budgets are prepared for the actual level of activity using standard variable costs per unit and standard total fixed costs.

The standard cost for production is the standard quantity of inputs for the actual production priced at the standard cost per unit of input.

Thus, a standard cost for production is a flexible budget cost.

Question 11

What is a project budget?

Answer 11

A budget for a specific project, covering its entire life span, and it includes all costs required for the project.

Project budgets must be integrated into the master budget for the relevant period or periods.

Question 12

What is a life-cycle budget?

Answer 12

It plans incomes and expenses for one specific product throughout its entire life cycle, from development through decline.

It enables management to set a price covering costs and required return on investment.

Question 13

What factors should be considered when determining whether a variance is significant enough to investigate?

Answer 13

• Magnitude of the variance in proportion to the budget line item
• Trend of the variance over time
• Likelihood that an investigation will lead to changes that could eliminate or mitigate future occurrences

These factors help determine whether a variance is material and warrants investigation.

Question 14

What is the purpose of a life-cycle budget?

Answer 14

To see the planned cash flows from a product over its entire life and set a price that covers costs and required return on investment.

Question 15

What are the benefits of project budgeting?

Answer 15

• Can help determine project feasibility in advance
• Enables planning for the level of resources needed
• It focuses management’s attention on cash inflows and outflows and decisions that will affect the cash flows.
• Fosters cooperation among the responsibility centers that will be affected by the project
• Covers an identifiable project with its own specific time span

Question 16

What are the limitations of project budgeting?

Answer 16

• Projects must be planned over their entire life spans and viewed as special commitments.
• Budgeted amounts for projects must be integrated into the master budget for the relevant period or periods.

Question 17

What is activity-based budgeting?

(ABB)

Answer 17

Similar to activity-based costing, activity-based budgets are prepared based on the budgeted overhead costs to perform the budgeted activities.

Activities that drive the costs are identified and a budgeted level of activity for each of the drivers is determined based on a budgeted level of production.

Budgeted overhead costs are allocated to products based on the budgeted levels of each activity for each product.

Question 18

How are overhead costs allocated in activity-based budgeting?

Answer 18

Based on the budgeted levels of each activity for each product.

Question 19

What are the benefits of activity-based budgeting?

Answer 19

• Identifies cost reduction opportunities
• Helps identify needed resources
• Defines clear relationship between resource consumption, costs, and output
• Identifies budgetary slack
• Managers are able to examine the effects of changes made to products, product design, product mix, manufacturing processes, and so forth on budgeted activities and on their costs.

Question 20

What are limitations of activity-based budgeting?

Answer 20

• It must be used in conjunction with activity-based costing
• Requires more work and is costlier to implement than traditional systems

Question 21

What is zero-based budgeting?

Answer 21

A budgeting approach where every planned activity must be justified with a cost-benefit analysis, starting from zero.

Question 22

What are the benefits of zero-based budgeting?

Answer 22

• Activities are Identified and justified
• Forces prioritization of activities
• Because managers need to examine every single expenditure and activity, they are more likely to develop better or less costly methods of accomplishing the same objectives

Question 23

What is a limitation of zero-based budgeting?

Answer 23

It requires extensive work to review and plan all activities and costs annually.

Question 24

What is a continuous (rolling) budget?

Answer 24

A budget prepared for a certain period ahead, continuously updated to always cover the same future time span.

Question 25

What are the **benefits** of rolling budgets?

Answer 25

* Greater flexibility * Assists in longer-term planning * More up-to-date budgets * Supports better decision making * Improves communication and collaboration

Question 26

What are **limitations** of rolling budgets?

Answer 26

* More time-consuming * More resource-intensive potentially increasing costs * Potential resistance from managers and staff because of the time requirements * Increased costs, such as investment in special software, may be required * Frequent updates and revisions to budgeted amounts can cause volatility in budgeted amounts and may undermine long-term planning