B2 : Budgeting Concepts

What are some contemporary budget problems?

- Budget assumptions become quickly outdated. - Conformance to budgets may stifle innovation. - Budgets can impede cooperation across different organizational levels.

A company allows its managers to regularly revise the budget whenever they feel that circumstances merit a change. The risks are:

- Employees may not be motivated to work as hard toward their goals. -Managers may set the threshold for revisions too low, and changes could occur too frequently. - Managers may anticipate changes and not prepare budgets carefully.

How are budgets and standards different?

- Standards often are stated on a per-unit basis. - Budgets are usually expressed in total dollars. Standards show up in the general ledger. (Budgets do not.)

significant reasons for planning

- promoting coordination among operating units. - providing a basis for controlling operations. - forcing managers to consider expected future trends and conditions. Planning does not ensure profitable operations. It is merely a tool to move in the direction of improved profitability. As Wharton Professor Emeritus Russell Ackoff once said, "If you fail to plan, plan to fail."

advantages of the use of budgets in a management control system except that budgets:

- provide performance criteria. - force management planning. - promote communication and coordination within the organization.

Budgeting Problems

1. Budget assumptions typically are outdated by the time budgets are used. 2. Budgets traditionally have been used as control systems for individual performance (i.e., employees are rewarded for ensuring operations conform to the plan). However, this stifles innovation, prevents employees from pursuing new opportunities, and focuses attention on short-term goals. 3. Budgets can impede cooperation across departments and business units when different units try to manipulate the budget in unproductive ways.

Which of the following refers to a quantitative expression of proposed management actions for a set period of time?

A budget is a plan, expressed in financial terms, and is for a set period of time. A budget is a plan expressed in dollar terms. The process of creating a formal plan and translating goals into a quantitative format Budgets are quantitative business plans used in coordination, control, communications, authorization, motivation, and evaluation.

How is forecasting related to planning?

A forecast is not the same thing as a plan, but plans should be based on a forecast.

How is strategic analysis related to budget development?

A prerequisite for budget development is a strategic analysis that matches an entity's capabilities with available marketplace opportunities. Strategy addresses the objectives of the organization; locates potential markets; considers the impact of events, competitors, and the economy; addresses the structure of the organization; and evaluates the risks of alternative strategies.

When budgets are used for performance evaluation and to set limits on spending, the process will often result in departments adding something "extra" to ensure the budgets will be met. This "extra" is called:

An extra cushion built into the budget to protect against the unexpected is called budget slack. It involves over-budgeting (or padding) expenses and under-budgeting revenues to make the budget targets easier to meet.

an attribute of a participative approach to budgeting:

Ans: Expertise leads to informed budget decisions. In a participative budget (bottom-up or self-imposed budget), managers at all levels and certain key employees cooperate to set budgets for their areas, and top management usually retains final approval.

How does a budget slack affect the master budget?

Answer: Cumulative budget slack at each sublevel can result in an inaccurate master budget. Budget slack occurs when budgeted performance differs from actual performance because managers tend to build in some extra money for their budget to deal with the unexpected. Budget slack is built-in freedom to fail, and cumulative budget slack at each sublevel can result in a very inaccurate master budget.

Which of the following would effectively commit responsibility center managers to the company strategy in a top-down environment?

Answer: The CEO sends a memo to each manager with specific instructions on forming their budgets. In a top-down environment, a budget proposal is the initial step in a budgeting process, and before managers make a preliminary budget, the CEO sends a directive or memo to each manager explaining what the corporate strategy is so they can create their budgets with this in mind.

Identify the contribution of process experts in the preparation of participative budgets.

Answer: They aid in having a detailed understanding of the costs of a particular area. When participative budgeting is used, often certain key nonmanagerial employees are added to the team. Team participants tend to be those who have a detailed understanding of the costs for a particular area, especially those areas that are extremely complex or variable. Such participants will not only bring more focus to a budget but will also take ownership of the budget and increase its likelihood of being followed at the operational level.

The budgeting technique that is most likely to motivate managers is:

Answer: bottom-up budgeting. Motivation is enhanced by having lower-level managers involved in the budgeting process. Bottom-up, participative budgeting promotes such involvement.

A major difference between governmental budgeting and business budgeting is that:

Answer: governmental budgeting usually represents a legal limit on proposed expenditures. In governmental bodies, expenditures are based upon legislative appropriations. These appropriations create legal limits on expenditures.

The major disadvantage of a top-down budgeting process is:

Answer: lack of buy-in by middle and lower-level management. In a top-down approach, upper-level management creates the budget and communicates goals to managers at lower levels. Two advantages of this method are lack of budgetary slack and consistency of goals with strategic plans. One disadvantage is lack of buy-in from lower-level managers.

Define budgetary slack.

Budgetary Slack is when managers build some extra money into their budget to deal with the unexpected. Budget slack is a built-in freedom to fail.

What are three characteristics of successful budgeting?

Budgets should - Compel planning. - Promote communication. - Provide performance criteria.

In developing the budget for the next year, which one of the following approaches would most likely result in a successful budget with the greatest amount of positive motivation and goal congruence?

Feedback: In any organization, it is important for the divisional and senior management to jointly develop goals, as it should be assured that these goals meet the strategic goals of the organization The implementation plan should be developed by the divisional manager, as the divisional manager understands the roles of the members of the division and their impact on working towards the goals of the department.

"A higher authority, other than the team that developed a budget, must review and approve the budget."

Higher authorities are in a better position to identify flaws and discrepancies in a budget. They are also capable of identifying unrealistic goals and targets set in budget. Moreover, they also vouch for the adequacy of the targets. Managers sometimes set low targets which are easily attainable in order to meet performance standards. However, this affects organizational goals in the long run.

statements concerning standard costs are

In a standard costing system, time and motion studies are often used to determine standard costs, are usually set for one year, and can be used in costing inventory accounts. Standard costs are never stated in total, but rather on a per unit basis, where the budgeted costs are states in total.

What is the most effective approach to a budgeting process:

In an authoritative budget (top-down budget), top management sets everything from strategic goals down to the individual items of the budget for each department and expects lower managers and employees to adhere to the budget and meet the goals. In a participative budget (bottom-up or self-imposed budget), managers at all levels and certain key employees cooperate to set budgets for their areas, and top management usually retains final approval. The ideal process combines the features of each and falls somewhere between these methods.

What does the term relative performance evaluation mean?

Instead of comparing budget to actual, the comparison is made between benchmarks (i.e., budgets with hindsight) and actual.

advantage of a formal budgetary process

It provides management with a means of dealing with uncertainty. It serves as a coordination and communication device between management and subordinates. It forces management to evaluate the reasonableness of assumptions used and goals identified in the budgetary process.

How can using relative performance evaluation reduce budget problems?

Managers are free to challenge the budget to take advantage of opportunities. Managers focus more on creating value than on manipulating the budget.

Which of the following groups is most likely to introduce budget slack into a budget?

Middle and lower managers introduce budget slack by building in some extra money for their budget to deal with the unexpected.

Which budget is always completed before the others?

Sales budget.

component of the master budget?

Sales budget. Direct material budget. Selling and administrative budget.

Define strategic budgeting.

Strategic budgeting implies a long-range view to planning based on the identification of action plans to achieve the company's goals and ultimately its mission.

Which of the following best describes the function of strategic analysis?

Strategy addresses the objectives of the organization and evaluates the risks of alternative strategies.

synchronize the budgeting and accounting system with the organizational structure.

Synchronizing the budgeting and accounting system with the organizational structure would allow management to use budgets for control purposes. Control is the process of monitoring the actions of those responsible for executing the plan, measuring the actions against the plan, and making the necessary corrections to the actions and/or the plan.

During a planning process, which of the following activities would be completed last?

The logical order for the activities listed is 1) vision and mission, 2) strategic objectives, 3) tactical goals, and 4) operational plans. An operational plan formulates specific goals for each SBU, with detailed revenue and expense budgets.

The budget will have higher negative variance from actual.

The target set by the management representative is unrealistic. The actual daily production will be lower than the targets. Therefore, the negative variance will be higher implying that the workers are not meeting their targets.

Higher authorities are in a better position to identify flaws and discrepancies in a budget.

They are also capable of identifying unrealistic goals and targets set in budget. Moreover, they also vouch for the adequacy of the targets. Managers sometimes set low targets which are easily attainable in order to meet performance standards. However, this affects organizational goals in the long run.

Which of the following is the element that if inaccurate will throw off all of the other master budget elements?

Without an accurate sales forecast, all other budget elements will be inaccurate because production levels, purchases, etc., are set to match expected sales.

Theoretical and practical standards

are covered in greater detail in the Supply Chain Management lesson. Theoretical (ideal) standards are considered perfect world standards while practical (currently attainable) standards are considered real-world standards. These standards are developed based on historical experience to achieve challenging but attainable goals.

Authoritative standards

are determined solely by management and ideal standards allow for no work delays, interruptions, waste, or machine breakdown. Since the management representative is the sole person proposing the budget and he is considering there will be no work delays, interruptions, waste, or machine breakdown, this is an authoritative ideal standard.

Cost standards

are often developed during the budgeting process to provide comparison to actual performance goals for the purpose of motivation and to encouraging efficient performance.

A forecasting technique that is a combination of the last forecast and the last observed value is called:

exponential smoothing.

There are four main reasons a company creates a budget:

planning (examining the future), improving communications and coordination of efforts in the organization, monitoring the progress of the organization in meeting its goals, and evaluation of key players and their performance in relation to the budget.

Relative performance evaluation

relative performance evaluation the comparison is made between benchmarks (budget with hindsight) and actual. 1. The idea is for managers to be free to search for initiatives that may challenge the budget yet provide opportunities to the organization. 2. The most important advantage is that managers focus more attention on creating value than on manipulating the budget. 3. One major drawback to relative performance evaluation is that organizations may lack the necessary benchmark data.

The steps that responsibility centers take in preparing their budgets include:

the initial budget proposal, budget negotiation, review and approval, and revision.

In an authoritative budget (top-down budget)

top management sets everything from strategic goals down to the individual items of the budget for each department and expects lower managers and employees to adhere to the budget and meet the goals.