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3.9 Budgets (HL ONLY) 2014

Material gleaned from the Stimpson and Smith Cambridge BM 2015 text and the OUP 2014 BM Course Companion and Alex Smith's Business Management Exam Preparation Guide (2017).
by

Deborah Kelly

on 17 May 2018

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Transcript of 3.9 Budgets (HL ONLY) 2014

The importance of budgets for organizations
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.

Setting targets
- budgets provide managers and employees with targets that can motivate them to work effectively.

Measuring performance
- the whole organization and individual parts can be judged on the success or failure to achieve the targets set.
Budgets
Budgets are set for the coming year during the current year.
Firms start by
forecasting sales
(4.3) which sets the
budgeted revenue
and determines
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
cash budget
is an important part of this.
3.9 Budgets HL
Understand
the importance of budgeting for organisations
Calculate
and
interpret
variances
Analyse
the role of budgets and variances in strategic planning

Variance Analysis
Possible Causes of Adverse Variances
Variance analysis
is the process of investigating any differences between
budgeted
figures and
actual
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.
Do:
3.9 Questions + Exam Practice Question

Read:
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.
$000

Sales Revenue
Direct Labour
Direct Materials
Fixed Costs
Profit
Budgeted Figures

66
15
12
6
?
Actual Figures

70
18
17
5
?
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
cost
and
profit centers
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
cost centers
in some of the following ways:

By Department
- finance, production, marketing and HR, where each department is a specific cost center.

By Product
- 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.
Profit 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.

Better accountability:
cost and profit centers help to hold specific business sections accountable.

Tracking problem areas:
can lead to a quick solution.

Increasing motivation:
Empowering and delegating control as well as bonuses or promotion for meeting targets.

Benchmarking:
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.

External factors:
factors beyond the control of the business such as competition may affect specific cost and profit centers differently (such as higher competition in one).

Center conflicts
:
staff and managers may consider the performance in their own center to be superior. This could lead to unhealthy competition between the centers.

Staff stress:
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
Budgets
are an important part of a business's
strategic planning
because they set out the precise financial targets needed to achieve the corporate aims of the business.

Variances
support
strategic planning
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.
Advantages
Limitations
Budgets:
help to control revenue and expenditure.
provide realistic targets understood by all internal stakeholders.
help in the coordination of various business departments.

Variance analysis:
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.
Particulars

Material costs
Direct labour costs
Sales of radios
Sales of Apple iPod
Advertising costs
Budgeted
($)
12,000
9,000
25,000
15,000
6,000
Actual
($)
18,500
7,800
25,600
12,750
7,100
Variance
($)
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?
http://www.forbes.com/sites/greatspeculations/2015/03/30/analysis-of-the-kraft-heinz-merger/
Percentage Change Calculation
Further reading:
Watch short video about zero based budgeting:
Do you budget?
A
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.
A
cost center
is a department within an organizations that does not generate revenues but is only associated with costs.
A
profit center
is a department within an organization that is responsible for generating
costs
and
revenues
.
A
variance
is where a business has a difference between an actual figure achieved in its operation in an accounting year and a budgeted figure.
A
favourable variance
is where the actual figure achieved is different to the budgeted figure, which causes the actual
profit
figure to be
higher
than the budgeted figure.
An
adverse variance
is where the actual figure is different to the budgeted figure which causes the actual
profit
figure to be
lower
than the budgeted figure.
Variance = budgeted amount - actual amount
Strategic planning
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.
http://www.wsj.com/video/kraft-heinz-zero-based-budgeting-shakes-up-industry/8B71F11D-9674-4175-BD11-40C960172800.html
Full transcript