Chapter 33- Budgets

Question 1

Budget

Answer 1

A quantitative economic plan prepared and agreed in advance

A budget is a financial plan that is agreed in advance – it must be a plan and not a forecast – a forecast is a prediction of what might happen in the future, whereas a budget is a planned outcome that the firm hopes to achieve – A budget will show the money needed for spending and how this is financed.

Budgets are based on the objectives of businesses – they force managers to think ahead and improve co-ordination – most budgets are set for twelve months in advance to coincide with the accounting period, but there are exceptions.

Question 2

4 purposes of Budgets

Answer 2

Budgets fulfil the following specific purposes:

Control and monitoring: Budgeting allows management to control the business – it does this by setting objectives and targets – these are then translated into budgets for a particular period

Planning: Budgeting forces management to think ahead, Without, budgeting managers might work on a day-by-day basis, only dealing with opportunities and problems as they arise – budgeting, however, plans for the future – it anticipates problems and their solutions

Communication: Planning allows the objectives of the business to be communicated to the workforce – by keeping to a budget, managers and workers have a clear framework within which to operate – so budgeting removes an element of uncertainty within decision-making throughout the business

Efficiency: in a business with many workers, it becomes important for management to empower staff by delegating decision-making – in a medium to large business, senior management cannot efficiently make every decision on behalf of every employee, department or site.

Question 3

Three key types of Budget

Answer 3

Sales
Production cost
Historical

Question 4

Zero Based Budgeting

Answer 4

A system where no money is allocated for costs or spending unless they can be justified by the fund holder, if they can’t they are set to 0

• The financial information used in most budgets is based on historical data – for example, the cost of materials in this year’s production budget may be based on last year’s figure, with perhaps an allowance for inflation – production and manufacturing costs, such as labour, raw materials and overheads, are relatively easy to value and tend to be controlled using methods such as standard costing
• However, in some areas such as administration, it is not so easy to quantify costs -where costs cannot be justified then no money is allocated in the budget for those costs – this is known as zero-based budgeting

Question 5

Zero Based Budgeting advantages

Answer 5

• The allocation of resources should be improved
• A questioning attitude is developed which will help to reduce
  unnecessary costs and eliminate inefficient practices
• It encourages managers to look for alternatives

Question 6

Zero-Based Budgeting disadvantages

Answer 6

• It is time-consuming because the budgeting process involves the
  collection and analysis of quite detailed information so that spending
  decisions can be made
• Skilful decision making is required – such skills may not be available in
  the organisation – in addition, decisions may be influenced by
  subjective opinions

Question 7

Budgetary Control

Answer 7

A plan that takes the budget plan and compares it against the actual results, more qualitative

Question 8

Variance

Answer 8

Difference between actual financial outcomes and the budget ones

• Variances can be calculated for a wide range of financial outcomes –
  most budgets are set for expenditure (costs) and income (sales
  revenue) – consequently, variances will also focus on a firm’s
  expenditure and income
• Examples of variances could be wages, materials, overheads and
  sales revenue

Question 9

Variance Analysis

Answer 9

Calculating variances and attempting to identify their causes
- It is important to identify the reasons why variances have occurred
- If variances are adverse it will be necessary to take action to ensure
that adverse variances are avoided in the future
- If variances are favourable the business can learn from understanding
why this has occurred and can introduce strategies and systems to
help sustain performance improvements in the future
- If the cause was higher prices charged by suppliers – the business
may look for new suppliers

Question 10

Difficulties of Budgeting

Answer 10

• Setting budgets- it is hard to set the budgets as they are based on
past figures and human judgement, this means that the targets may
not be accurate and so people stop working as hard

• Motivation- If workers are left out of the budget then it may
demotivate them

• Manipulation- a manager can make their budget really low so that they
look good when they smash it

• Rigidity- people may want to spend more for unforeseen
circumstances but the budget may constrict them

Question 11

Historical Figures

Answer 11

Quantitative information based on past trading results

Question 12

Production Cost Budget

Answer 12

planning the production costs

Question 13

Sales Budget

Answer 13

A firms planned sales for future

Question 14

Historical Figures

Answer 14

Quantitative information based on past trading results

Question 15

Production Cost Budget

Answer 15

Planning the production costs

Question 16

Sales Budget

Answer 16

A firms planned sales for future