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3.9 Budgets (HL ONLY) 2014
Transcript of 3.9 Budgets (HL ONLY) 2014
Controlling revenue and costs
- Part of an organizations corporate objectives will include aiming to achieve a target level of profit, which means reaching a budgeted revenue and keeping costs to budgeted levels.
Managing resources effectively
- It is crucial for businesses to have resources in the right amounts and in the right place to be efficient.
- budgets provide managers and employees with targets that can motivate them to work effectively.
- the whole organization and individual parts can be judged on the success or failure to achieve the targets set.
Budgets are set for the coming year during the current year.
Firms start by
(4.3) which sets the
level of production
Once the production level is set, the business can set
budgets for raw materials and labour
and then for
direct and indirect costs
After costs and revenues have been budgeted, the
budgeted profit and loss account
can be fixed
Alongside budgeted costs and revenues, the business can budget for changes in assets and liabilities. Setting a
is an important part of this.
3.9 Budgets HL
the importance of budgeting for organisations
the role of budgets and variances in strategic planning
Possible Causes of Adverse Variances
is the process of investigating any differences between
figures. It is essential because:
it measures differences each month and at the end of the year
it assists in analyzing the causes of deviations
an understanding of the deviations can be used to change future budgets
the performance of each budget-holding section may be appraised in an accurate and objective way
Sales revenue is below budget either because units sold were fewer than planned for or the selling price had to be lowered due to competition.
Actual raw material costs are higher than planned for either because output was higher than budgeted or the cost per unit of materials increased.
Labour costs are above budget either because wage rates had to be raised due to shortages of workers or the labour time taken to complete the work was longer than expected.
Overhead costs are higher than budgeted, perhaps because the annual rent rise was above forecast.
Possible causes of favorable variances
Revision Activity 1
Sales revenue is above budget either due to higher than expected economic growth or problems with one of the competitor's products.
Raw material costs are lower either because output was less than planned or the cost per unit of materials was lower than budget.
Labour costs are lower than planned for either because of lower wage rates or quicker completion of the work.
Overhead costs are lower than budgeted, perhaps because advertising rates from TV companies were reduced.
3.9 Questions + Exam Practice Question
Kraft Case Study Budgeting and Strategy
Look at the case study below and answer the questions.
Kimball Timber Ltd. Budgeted and actual figures for year ended 31 December 2010.
1. Calculate the budgeted profit and actual profit
PROFIT = REVENUE - EXPENSES (COSTS)
2. Using variance analysis, discuss whether the management of Kimball Timber Ltd should be satisfied with the performance of the business over the last 12 months
Cost and profit centers
Different parts of an organization can be considered
for setting up budgets.
A cost center of an organization could be a production department responsible for maintenance or a service department such as marketing.
In the context of budgeting the managers of cost centers have a responsibility of keeping the costs of their department within their cost budget.
Businesses can be divided into
in some of the following ways:
- finance, production, marketing and HR, where each department is a specific cost center.
- businesses producing several products could ensure that each product is a cost center.
By Geographical Location
- businesses that are located in different parts of the world and in each of the areas they are located could be treated as cost centers.
A profit center can operate like a separate business within the main organization.
Profit centers have a responsibility to control costs and revenues to achieve budgeted profit.
Profit centers too can be divided according to product, department or geographical location as long as, in addition to cost, revenue is also generated.
The role of cost and profit centers
Aiding decision making:
cost and profit centers help in providing managers with financial information about the different parts of a business and this information can assist them in decided whether to continue or discontinue producing a particular product.
cost and profit centers help to hold specific business sections accountable.
Tracking problem areas:
can lead to a quick solution.
Empowering and delegating control as well as bonuses or promotion for meeting targets.
Comparing the performances in the various cost and profit centers can help to check areas of most or least efficiency.
Problems of cost and profit centers
Indirect cost allocation:
indirect costs such as advertising, rent or insurance are difficult to allocate specifically to particular cost centers. They may be allocated unfairly.
factors beyond the control of the business such as competition may affect specific cost and profit centers differently (such as higher competition in one).
staff and managers may consider the performance in their own center to be superior. This could lead to unhealthy competition between the centers.
the pressure of managing a cost and profit center may be very high for some staff.
The role of budgets and variances in strategic planning
are an important part of a business's
because they set out the precise financial targets needed to achieve the corporate aims of the business.
because they give managers the financial information they need to make judgements about the success or failure of different departments in the organization in achieving the corporate aims and how those departments might be managed in the future.
help to control revenue and expenditure.
provide realistic targets understood by all internal stakeholders.
help in the coordination of various business departments.
aims to compare actual performance to budgeted performance, helping to assess organizational performance.
assists it detecting the causes of any deviations in the budget so that corrective measures can be taken to rectify them.
provides an objective way of appraising budget holders responsible for their various departments.
Inflexible budgets that do not consider any unforeseen changes in the external environment may be unrealistic.
Significant differences between the budgeted and actual results could make the budget lose its importance as a planning tool.
Since most budgets are based on the short term, long term future gains such as increased sales potential due to unexpected increases in demand could be lost by looking only at the current budgeted amount.
Highly underspent budgets towards the end of the year could lead to unjustified wasteful expenditure by managers
Setting budgets without involving some people could result in their resentment and affect their motivation levels.
Revision Activity 2
The following information refers to XAV Ltd.
Direct labour costs
Sales of radios
Sales of Apple iPod
1. Calculate the missing figures from the table above. Note whether the variance is favorable or adverse
2. Interpret the material costs variance and suggest possible reasons.
3. What do the overall variance figures tell you about the business?
Percentage Change Calculation
Watch short video about zero based budgeting:
Do you budget?
is a plan for the future costs, revenues and use of resources by a business.
Once the budget is fixed for the firm, it is communicated to managers (budget holders) who are responsible for carrying it out.
is a department within an organizations that does not generate revenues but is only associated with costs.
is a department within an organization that is responsible for generating
is where a business has a difference between an actual figure achieved in its operation in an accounting year and a budgeted figure.
is where the actual figure achieved is different to the budgeted figure, which causes the actual
figure to be
than the budgeted figure.
is where the actual figure is different to the budgeted figure which causes the actual
figure to be
than the budgeted figure.
Variance = budgeted amount - actual amount
is where senior managers in an organization set out the corporate aims of the organization and put in place a plan that sets out how the business is going to achieve its corporate aims.