Part 1
Study Unit 8
Budgeting Concepts & Forecasting
Techniques
Ronald Schmidt, CMA, CFM
SU 8.1 - Correlation and regression
• Forecasting Methods
– Qualitative – Manager’s experience and intuition
• Can you think of some methods
– Quantitative – Mathematical models and graphs
• Regression
• Trend analysis
SU 8.1 - Correlation and regression
• Correlation Analysis
– Foundation of any quantitative method of
forecasting
– Strength of the linear relationship between two
variables
– Value ranges from 1 to -1
– The more a straight line the greater correlation (r)
SU 8.1 - Correlation and regression
• Qualitative methods:
forecast based on
manager’s experience and
knowledge
• Quantitative methods use
mathematical models
– Correlation analysis: strength
of a linear relationship
between 2 variables 
coefficient of correlation (r)
– r = [ -1 ; +1]
SU 8.1 - Correlation and regression
• Coefficient of determination (r2)
– Also coefficient of correlation squared
– Is a measure of how good fit between the two
variables
– Total variation in the dependent variable that is
accounted for by the independent variables
Statistic Definitions
(to know and remember)
• Correlation coefficient may refer to:
– Pearson product-moment correlation coefficient, also known as r, R, or
Pearson's r, a measure of the strength and direction of the linear relationship
between two variables that is defined as the (sample) covariance of the
variables divided by the product of their (sample) standard deviations.
• Related concepts:
– Correlation and dependence, a broad class of statistical relationships between
two or more random variables or observed data values
– Goodness of fit, any of several measures that measure how well a statistical
model fits observations by summarizing the discrepancy between observed
values and the values expected under the model in question
– Coefficient of determination, a measure of the proportion of variability in a
data set that is accounted for by a statistical model; often called R2; equal in a
single-variable linear regression to the square of Pearson's product-moment
correlation coefficient.
Statistic Definitions
(to know and remember)
• Coefficient of determination (r^2)
This is a measure of how good the fit between 2
variables is
– Regression Analysis : y = a + bx
•
•
•
•
y = dependent variable
a = the y intercept
b = slope of the regression line
x = independent variable
 RELEVANT RANGE
SU 8.1 - Question 1
Jura Corporation is developing standards for the
next year. Currently XZ-26, one of the material
components, is being purchased for $36.45 per
unit. It is expected that the component’s cost
will increase by approximately 10% next year
and the price could range from $38.75 to $44.18
per unit, depending on the quantity purchased.
The appropriate standard for XZ-26 for next year
should be set at the
A.
B.
Current actual cost plus the forecasted 10% price
increase.
Lowest purchase price in the anticipated range to keep
pressure on purchasing to always buy in the lowest price
range.
C.
Highest price in the anticipated range to ensure that
there are only favorable purchase price variances.
D.
Price agreed upon by the purchasing manager and the
appropriate level of company management.
SU 8.1 - Question 1 Answer
Correct Answer: D
Standard prices are designed for internal performance measurement. Standards
should be attainable, but not so easily as to not provide motivation. Management
should decide its objectives and set a standard that will achieve that objective when
the standard is met. For example, the lowest price might not be selected if the
company is using a JIT system, for which the primary objective is the minimization of
inventories.
Incorrect Answers:
A: The actual cost could be more or less depending in the quantity purchased.
B: The lowest price may not always be in the company’s best interests if the
quantity required to obtain the lowest price would lead to much higher carrying costs.
C: Standards should be set tightly enough to provide motivation to purchasing
management.
SU 8.1 - Question 2
Lake Corporation manufactures specialty
components for the electronics industry in a
highly labor intensive environment. Arc
Electronics has asked Lake to bid on a
component that Lake made for Arc last month.
The previous order was for 80 units and
required 120 hours of direct labor to
manufacture. Arc would now like 240 additional
components. Lake experiences an 80% learning
curve on all of its jobs. The number of direct
labor hours needed for Lake to complete the
240 additional components is
A.
B.
C.
D.
360.0
187.2
307.2
256.0
SU 8.1 - Question 2 Answer
Correct Answer: B
One common assumption made in a learning
curve model is that the cumulative average
time per unit is reduced by a certain
percentage each time production doubles. An
80% learning curve results in the following
performance for the lots shown:
Units
80
160
320
Cumulative
Average Hours
1.5 hours (120 ÷ 80)
1.2 hours (1.5 × .8)
.96 hours (1.2 × .8)
Thus, to produce 320 units, total production time will be 307.2
hours (320 × .96). The total time for the last 240 units will be
187.2 hours (307.2 – 120). Incorrect Answers: A: Assuming no
learning curve effect results in 360 hours. C: The total time for
completing 320 units is 307.2 hours. D: The figure of 256 hours
is a nonsense answer.
SU 8.2 -Learning curve analysis
• Increased rate at which people perform
tasks as they gain experience
• % of reduced time to complete a task for
each doubling of cumulative production
• 2 methods:
- cumulative average-time learning
model
- incremental unit-time learning model
SU 8.2 - Question 1
The average labor cost per unit for the first batch
produced by a new process is $120. The
cumulative average labor cost after the second
batch is $72 per product. Using a batch size of 100
and assuming the learning curve continues, the
total labor cost of four batches will be
A.
B.
C.
D.
$4,320
$10,368
$2,592
$17,280
SU 8.2 - Question 1 Answer
A. The cost of the items in the fourth batch equals $4,320.
B. The amount of $10,368 is based on the assumption that the cumulative average
unit labor cost is reduced by the learning curve percentage with each batch, not each
doubling of output.
C. The amount of $2,592 represents the labor cost of 100 units at the unit rate
expected after another doubling of production to eight batches.
D. *Correct Answer* The learning curve reflects the increased rate at which people
perform tasks as they gain experience. The time required to perform a given task
becomes progressively shorter. Ordinarily, the curve is expressed in a percentage of
reduced time to complete a task for each doubling of cumulative production. One
common assumption in a learning curve model is that the cumulative average time
(and labor cost) per unit is reduced by a certain percentage each time production
doubles. Given a $120 cost per unit for the first 100 units and a $72 cost per unit when
cumulative production doubled to 200 units, the learning curve percentage must be
60% ($72 ÷ $120). If production is again doubled to 400 units (four batches), the
average unit labor cost should be $43.20 ($72 × 60%). Hence, total labor cost for 400
units is estimated to be $17,280 (400 units × $43.20).
SU 8.2 - Question 2
A particular manufacturing job is subject to an
estimated 80% learning curve. The first unit
required 50 labor hours to complete. What is
the cumulative average time per unit after
eight units are completed?
A.
B.
C.
D.
20.0 hours.
25.6 hours.
32.0 hours.
40.0 hours.
SU 8.2 - Question 2 Answer
A. The figure of 20.0 hours assumes three successive reductions of 10 hours [50
– (50 × 80%)] each.
B. *Correct Answer* The learning curve reflects the increased rate at which
people perform tasks as they gain experience. The time required to perform a
given task becomes progressively shorter. Ordinarily, the curve is expressed in a
percentage of reduced time to complete a task for each doubling of cumulative
production. One common assumption in a learning curve model is that the
cumulative average time (and labor cost) per unit is reduced by a certain
percentage each time production doubles. Thus, an 80% learning curve indicates
that a doubling of production will reduce the cumulative average unit
completion time by 20%. For example, if the first unit required 50 hours to
complete, the average completion time after two units will be 40 hours (50
hours × 80%). If production is again doubled (to four units), the average
completion time will be 32 hours (40 hours × 80%). When production is doubled
again to eight units, the cumulative average completion time will be 25.6 hours
(32 hours × 80%).
C. The average completion time after four units have been produced is 32 hours.
D. The average time after two units have been produced is 40 hours.
SU 8.3 -Time-series analysis
• Projects future trends based on past experience
– Secular trend: long-term change
– Seasonal variations
– Cyclical fluctuations: variations with level of activity
tied to the business cycle
– Irregular or random variables: unexpected
happenings (weather, strikes, fires…)
Techniques:
- Simple moving average
- Weighted moving average
- Exponential smoothing (3 steps)
SU 8.3 - Question 1
A forecasting technique that is a combination of the last forecast and the last observed
value is called
A
Delphi.
B
Least squares.
C
Regression.
D
Exponential smoothing.
SU 8.3 - Question 1 Answer
Correct Answer: D
Exponential smoothing is a widespread
technique for making projections because it
requires less data be kept on hand than the
moving average methods. The technique
involves weighting the actual result for the
previous period by a smoothing factor,
weighting the forecast for the previous period
by the smoothing factor’s complement, and
combining the two.
SU 8.3 - Question 2
Sales of big-screen televisions have grown steadily during the past 5 years. A dealer
predicted that the demand for February would be 148 televisions. Actual demand in
February was 158 televisions. If the smoothing constant (α) is 0.3, the demand
forecast for March, using the exponential smoothing model, will be
A
148 televisions.
B
151 televisions.
C
155 televisions.
D
158 televisions.
SU 8.3 - Question 2 Answer
Correct Answer: B
Exponential smoothing is a widespread technique for
making projections because it requires less data be kept
on hand than the moving average methods.
Mathematically, a forecast is arrived at with exponential
smoothing according to the following formula:
Forecast
=
(Smoothing factor ×
Previous month result) +
(Smoothing factor
complement × Previous
month forecast)
=
(0.3 × 158) + (0.7 × 148)
=
47.4 + 103.6
=
151
SU 8.3 - Question 3
The four components of time series data are secular trend, cyclical variation,
seasonality, and random variation. The seasonality in the data can be removed by
A
Multiplying the data by a seasonality
factor.
B
Ignoring it.
C
Taking the weighted average over four
time periods.
D
Subtracting a seasonality factor from the
data.
SU 8.3 - Question 3 Answer
Correct Answer: C
Time series analysis relies on past experience.
Changes in the value of a variable may have several
possible components including secular trends,
cyclical variation, seasonality, and random variation.
Seasonal variations are common in many
businesses. A variety of methods exist for including
seasonal variations in a forecasting model, but most
methods use a seasonal index. Alternatively,
seasonal variations can be removed from data by
using a weighted average of several time periods
instead of data from individual periods.
SU 8.4 - Expected value
• Possible outcomes of a probability distribution
• Highest expected monetary value
– Decision alternative
– State of nature = future event
– Payoff = financial result of combination (decision &
state of nature)
Work on the example to understand method
Expected value forces managers to evaluate decisions
in a more organized manner
Perfect information (EVPI)
SU 8.4 - Question 1
The probabilities shown in the table
below represent the estimate of sales for
a new product.
Sales (Units)
Probability
0-200
15%
201-400
45%
401-600
25%
601-800
15%
SU 8.4 - Question 1 (cont.)
What is the probability of selling between 201 and 600 units of the product?
What is the probability of selling
between 201 and 600 units of the
product?
A.
B.
C.
D.
0%
11.25%
70%
25%
SU 8.4 - Question 1 Answer
Correct Answer: C
The probability of selling between 201 and 400 units is 45%, and the
probability of selling between 401 and 600 units is 25%. Hence, the
probability of selling between 201 and 600 units is the sum of these
probabilities, or 70%.
Incorrect Answers:
A: There is a 70% probability of selling between 201 and 600 units.
B: There is a 70% probability of selling between 201 and 600 units.
D: This percentage is the probability of selling between 401 and 600 units.
SU 8.4 - Question 2
The expected value of perfect information is the
A. Same as the expected profit under certainty.
B. Sum of the conditional profit (loss) for the best event of each act
times the probability of each event occurring.
C. Difference between the expected profit under certainty and the
expected opportunity loss.
Correct D. Difference between the expected profit under certainty
and the expected monetary value of the best act under uncertainty.
SU 8.4 - Question 2 Answer
A.
The expected value of perfect information is the difference between the
expected profit under certainty and the profit from the best decision
under uncertainty.
B. The expected value of perfect information is the excess of the total
conditional profits under certainty over the profit from the best decision
under uncertainty.
C. There is no expected opportunity loss under conditions of certainty.
D. *Correct Answer* Perfect information permits certainty that a future state
of nature will occur. The expected value of perfect information determines
the maximum amount a decision maker is willing to pay for information. It is
the difference between the expected value without perfect information, that
is, the expected value of the best action under uncertainty and the expected
value under certainty. Under certainty, a decision maker knows in each case
which state of nature will occur and can act accordingly
SU 8.4 - Question 3
In decision making under conditions of uncertainty, expected
value refers to the
A. Likely outcome of a proposed action.
B. Present value of alternative actions.
C. Probability of a given outcome from a proposed action.
D. Weighted average of probable outcomes of an action.
SU 8.4 - Question 3 Answer
A. The expected value is a long-range average; it is likely
that the expected value will never be exactly achieved for
a particular event.
B. Expected value does not consider present values.
C. Probability is only one component of expected value.
D. *Correct Answer* The expected value of an action is
found by multiplying the probability of each possible
outcome by its payoff and summing the products. It
represents the long-term average payoff for repeated
trials. In other words, expected value is the weighted
average of probable outcomes.
SU 8.5 – Sensitivity Analysis
• How sensitive expected value calculations are
to the accuracy of the initial estimate
• Example: How much are my sales affected by
a change in price?
• See example B on page 257
SU 8.5 - Question 1
A quantitative technique useful in projecting a firm’s sales and
profits is
A.
B.
C.
D.
Probability distribution theory.
Gantt charting.
Learning curves.
Queuing theory.
SU 8.5 - Question 1 Answer
A. *Correct Answer* Probability distribution theory can be used to
project sales. It is a mathematical method for making decisions about
the likelihood of future events (such as sales) in the face of
uncertainty. Various estimates of sales (generated from the sales force)
can be weighted with different probabilities.
B. A Gantt chart is a bar chart used to measure progress toward a goal.
C. A learning curve measures the benefit of experience in the early
stages of a new task.
D. Queuing (waiting-line) theory is used to determine the optimum
balance between the cost of providing service to reduce waiting lines
and the cost of allowing waiting lines to exist when items in the queue
arrive at random.
SU 8.5 - Question 2
A widely used approach that managers use to recognize
uncertainty about individual items and to obtain an immediate
financial estimate of the consequences of possible prediction
errors is
A.
B.
C.
D.
Expected value analysis.
Learning curve analysis.
Sensitivity analysis.
Regression analysis.
SU 8.5 - Question 2 Answer
A. Expected value is the probabilistically weighted average of the outcomes of
an action.
B. Learning curve analysis quantifies how labor costs decline as employees
learn their jobs through repetition.
C. *Correct Answer* Sensitivity analysis determines how a result varies with
changes in a given variable or parameter in a mathematical decision model.
For example, in a present value analysis, a manager might first calculate the
net present value or internal rate of return assuming that a new asset has a
10-year life. The NPV or IRR can then be recalculated using a 5-year life to
determine how sensitive the result is to the change in the assumption.
D. Regression, or least squares, analysis determines the average change in the
dependent variable given a unit change in one or more independent
variables.
SU 8.6 Strategic Management
• Sets overall objectives for an entity and guides
the process of reaching those objectives
• Strategic management and planning have a
long-term planning horizon
– A five-stage process
•
•
•
•
•
Mission and goals
SWOT Analysis
Strategy
Implementation
Controls
SU 8.6 Strategic Management
• Porter’s Five Competitive Forces
– analysis of the five competitive forces that
determine long-term profitability as measured by
long-term return or investment
•
•
•
•
•
Threat of new entry
Bargaining power of suppliers
Threat of substitutes
Bargaining power of customers
Intensity of rivalry among established firms
SU 8.6 Strategic Management
• Generic Competitive Analysis (Strategies)
Model
– Strategies with a Broad Competitive Scope
• Cost leadership
• Differentiation
– Strategies with a narrow Competitive Scope
• Cost focus
• Focused differentiation
SU 8.6 Strategic Management
• Five Operations Strategies
– Cost strategy
– Quality Strategy
– Delivery Strategy
– Flexibility Strategy
– Service Strategy
SU 8.6 - Question 1
Intensity of rivalry among existing firms in an
industry increases when Products are relatively
undifferentiated
Consumer switching costs are low
A.
B.
C.
D.
I only.
II only.
Both I and II.
Neither I nor II.
SU 8.6 - Question 1 Answer
A. Low consumer switching costs also increase rivalry.
B. A low degree of product differentiation also increases
rivalry.
C. *Correct Answer* The degree of product
differentiation and the costs of switching from one
competitor’s product to another increase the intensity of
rivalry and competition in an industry. Less differentiation
tends to heighten competition based on price, with price
cutting leading to lower profits. Low costs of switching
products also increase competition.
D. Both low consumer switching costs and a low degree
of product differentiation increase rivalry.
SU 8.6 - Question 2
A corporation is performing research to determine the
feasibility of entering the truck rental industry. The
decision to enter the market is most likely to be
deterred if
A. The fixed costs are high in relation to variable costs in
the truck rental industry.
B. Buyers view the product as differentiated.
C. The market is dominated by a small consortium of
buyers.
D. Buying firms enjoy large profit margins on their end
products.
SU 8.6 - Question 2 Answer
A. High fixed costs in relation to variable costs indicate
that rivalry among firms is intense.
B. Buyers are in a weaker position when the supplier’s
product is differentiated.
C. *Correct Answer* When purchasing power is
concentrated in a few buyers or when buyers are well
organized, their bargaining power is greater. This effect is
reinforced when sellers are in a capital-intensive industry,
such as trucking.
D. Buyers are most likely to bargain aggressively when
their profit margins are low, especially if the supplier’s
product accounts for a substantial amount of their costs.
SU 8.6 - Question 3
Michael E. Porter’s competitive strategies model includes an analysis
of the competitive forces that determine the attractiveness of an
industry. These forces include
A. The stage of the industry life cycle
B. Threats of, and barriers to, entry
C. Threat of substitutes
D. The threat of suppliers’ bargaining power
A.
B.
C.
D.
I and II only.
I and III only.
II, III, and IV only.
I, II, III, and IV.
SU 8.6 - Question 3 Answer
A. The stage of the industry life cycle is one of many variables that affect the
degree of rivalry among existing firms and the threat of entry. Thus, it is not
one of the basic competitive forces.
B. The stage of the industry life cycle is one of many variables that affect the
degree of rivalry among existing firms and the threat of entry. Thus, it is not
one of the basic competitive forces.
C. *Correct Answer* Michael E. Porter has developed a model of the
structure of industries and competition. It includes an analysis of the five
competitive forces that determine long-term profitability measured by longterm return on investment. This analysis results in an evaluation of the
attractiveness of an industry. The five forces are (1) the degree of rivalry
among existing firms; (2) threats of, and barriers to, entry; (3) the threat of
substitute products or services; (4) the threat of buyers’ bargaining power;
and (5) the threat of suppliers’ bargaining power.
D. The stage of the industry life cycle is one of many variables that affect the
degree of rivalry among existing firms and the threat of entry. Thus, it is not
one of the basic competitive forces.
SU 8.7 Balanced Scoreboard
• Critical Success factors (SCFs)
– Balanced scoreboard approach
– Critical success factors are specific
• SWOT Analysis
– Addresses internal factors (its strengths and
weaknesses) and external factors (its opportunities
and threats)
• PEST Analysis
– Analysis of certain factors in the external environment
of an organization, which can affect its activities and
ethical considerations
SU 8.7 - Question 1
The balanced scorecard provides an action plan for achieving
competitive success by focusing management attention on
critical success factors. Which one of the following is not one of
the perspectives on the business into which critical success
factors are commonly grouped in the balanced scorecard?
A.
B.
C.
D.
Competitor business strategies.
Financial performance.
Internal business processes.
Employee innovation and learning.
SU 8.7 - Question 1 Answer
A. *Correct Answer* A typical balanced scorecard classifies
critical success factors and measures into one of four
perspectives on the business: financial, customer satisfaction,
internal business processes, and learning and growth.
B. Financial performance measures are among the tools used
in a typical balanced scorecard.
C. A typical balanced scorecard contains critical success
factors and measures focused on internal business processes.
D. Employee innovation and learning is one of the
perspectives on the business commonly used in a balanced
scorecard.
SU 8.7 - Question 2
Using the balanced scorecard approach, an organization
evaluates managerial performance based on
A. A single ultimate measure of operating results, such as
residual income.
B. Multiple financial and nonfinancial measures.
C. Multiple nonfinancial measures only.
D. Multiple financial measures only.
SU 8.7 - Question 2 Answer
A. The balanced scorecard approach uses multiple measures.
B. *Correct Answer* The trend in managerial performance
evaluation is the balanced scorecard approach. Multiple
measures of performance permit a determination as to
whether a manager is achieving certain objectives at the
expense of others that may be equally or more important.
These measures may be financial or nonfinancial and usually
include items in four categories: profitability; customer
satisfaction; innovation; and efficiency, quality, and time.
C. The balanced scorecard approach uses financial and
nonfinancial measures.
D. The balanced scorecard approach uses financial and
nonfinancial measures.
SU 8.7 - Question 3
On a balanced scorecard, which of the following would not be
an example of a customer satisfaction measure?
A.
B.
C.
D.
Market share.
Economic value added.
Response time.
Customer retention.
SU 8.7 - Question 3 Answer
A. Market share is a customer satisfaction measure.
B. *Correct Answer* Customer satisfaction
measures include market share, retention, response
time, delivery performance, number of defects, and
lead time. Economic value added, or EVA®, is a
profitability measure.
C. Response time is a customer satisfaction
measure.
D. Customer retention is a customer satisfaction
measure.
SU 8.7 - Question 4
Two examples of the learning and innovation measures of a
balanced scorecard are
A. Employee promotion rate and number of environmental
incidents.
B. Employee training hours and product defect rates.
C. Number of employee suggestions and finished products per
day per employee.
D. Employee turnover rate and number of internal process
improvements.
SU 8.7 - Question 4 Answer
A. The number of environmental incidents are outside of the control of
management and are not an appropriate measure for learning and
growth (innovation).
B. Product defect rates are a quality measure and relate more to
internal business processes rather than learning and innovation
measures.
C. Finished products per day per employee is a measure of productivity
and relates more to internal business processes rather than learning
and innovation measures.
D. *Correct Answer* Learning and growth (innovation) critical success
factors may include the development of new products, promptness of
their introduction, human resource development, morale, and the
competence of the work force. Both employee turnover rates and the
number of internal process improvements are appropriate measures.
SU 8.8 Strategic Planning
• Determination of what is to be done and of
how, when, where and by whom it is to be
done
• Long range strategic planning includes
strategic budgeting
– Horizon of 1-10 years
– General and exclude operational detail
SU 8.8 Strategic Planning
• Premises are the underlying assumptions
about the expected environment in which the
strategic plan will be carried out
• Organizations may have multiple objectives
that are contradictory
• Primary task of management is to carry on
operations effectively and efficiently
SU 8.8 Strategic Planning
• Policies, Procedures, and Rules
– Elements necessary at all levels of organization
• Policies and procedures provide feedforward
control
– Policies: general statements that guide thinking and
action
– Procedures: specific directives that define how work is
to be done
– Rules: specific, detailed guides that restrict behavior
SU 8.8 - Question 1
A distinction between forecasting and planning
A. Is not valid because they are synonyms.
B. Arises because forecasting covers the short-term and
planning does not.
C. Is that forecasts are used in planning.
D. Is that forecasting is a management activity whereas
planning is a technical activity.
SU 8.8 - Question 1 Answer
A. Forecasting is a basis for planning.
B. Both forecasting and planning may be short or long term.
C. *Correct Answer* Planning is the determination of what is
to be done, and of how, when, where, and by whom it is to be
done. Plans serve to direct the activities that all organizational
members must undertake to move the organization from
where it is to where it wants to be. Forecasting is the basis of
planning because it projects the future. A variety of
quantitative methods are used in forecasting.
D. Forecasting is probably more technical than planning. It can
involve the use of a variety of mathematical models
SU 8.8 - Question 2
Strategy is a broad term that usually means the selection of
overall objectives. Strategic analysis ordinarily excludes the
A. Trends that will affect the entity’s markets.
B. Target product mix and production schedule to be
maintained during the year.
C. Forms of organizational structure that would best serve the
entity.
D. Best ways to invest in research, design, production,
distribution, marketing, and administrative activities.
SU 8.8 - Question 2 Answer
A. Strategic analysis includes examining marketing
trends.
B. *Correct Answer* Strategic analysis is the
process of long-range planning. Such tasks as
setting the target product mix and production
schedule for the current year are short-term
activities.
C. Strategic analysis evaluates organizational
structure.
D. Strategic analysis includes evaluation of the best
ways to invest in research, design, etc.
SU 8.8 - Question 3
An organization’s policies and procedures are part of its overall
system of internal controls. The control function performed by
policies and procedures is
A.
B.
C.
D.
Feedforward control.
Implementation control.
Feedback control.
Application control.
SU 8.8 - Question 3 Answer
A. *Correct Answer* Feedforward control anticipates and
prevents problems. Policies and procedures serve as
feedforward controls because they provide guidance on
how an activity should be performed to best ensure that
an objective is achieved.
B. Implementation controls are controls applied during
systems development.
C. Policies and procedures provide primary guidance
before and during the performance of some task rather
than give feedback on its accomplishment.
D. Application controls apply to specific applications, e.g.,
payroll or accounts payable.
Part 1
Study Unit 9
Budgeting Concepts & Forecasting
Techniques
Patricia Burnett, CMA
SU 5 - Introduction
• The Budget is a planning tool, a control tool, a
communication tool and a motivational tool
• For the CMA exam, budget is a composite of
theory and calculations
• Exam questions require calculations that have
many steps, and therefore are the most
missed questions of the CMA exam
• It is very important to pay attention to detail
as you work the calculations.
SU 9.1 -Role of Budget and the
Budgeting Process
• Planning tool: set clear goals for the
Organization and clear metrics of Performance
(Revenue Forecast, investments, CAPEX,
Headcount, Production Capacity, purchases…)
– A written plan for the future
– A way to anticipate problems and hopefully
means to deal with them before they
happen
– Quantifies operational steps
SU 9.1 -Role of Budget and the
Budgeting Process
• Control tool:
–
–
–
–
–
–
–
–
Setting cost guidelines (financial limitations)
Reveal efficiency (or inefficient) of resources usage
Accountability of controllable costs and rational for exceeding
Reveal things that are done correctly; it can be positive thing
Budget can also be a way for self-evaluation tool for Managers
Employees should not view the budget negatively
Budgetary slack = overestimation of expenses
Consider budgetary slack and the motivation behind it
Continued
SU 9.1 -Role of Budget and the
Budgeting Process
• Control tool:
– To control costs
– A way to discover efficiency and inefficiency
– Budget process must be integrated into the Accounting Process
(Actuals), that way variances can be assigned correctly
Do you see any other way that it is a control tool?
SU 9.1 -Role of Budget and the
Budgeting Process
• Motivational tool:
• Helps employees to do a good job and manage
• Employees get motivated when they are involved in the
preparation of it
• Budget must be realistic and not seen as a restriction = flexible
• Budget is not always viewed in a positive manner
• Communication tool:
• help to communicate clear objectives/goals
• Can communicate what goals the firm is attempting to
accomplish
SU 9.1 -Role of Budget and the
Budgeting Process
• Goal congruence = make sure all the Departments are
working toward the same goals (inventory, sales,
profits, margins, hiring, savings…)
• Starting point for an organization  Mission
Statement
• Next is the Strategic Plan (10 years)  set priorities
and long-term vision
• Awareness is crucial for allocation of limited
resources
• Shot-term objectives and specific action plans (3 years)
SU 9.1 -Role of Budget and the
Budgeting Process
• How to evaluate “progress”? Budget is one way to
measure this progress
• Comparing Actuals / Budget / Historical and new
Forecast
• Month over month seasonality of some businesses
(Monthly Budget)
• Importance of the phasing of expenses and activities
(Commitment)
• Study Unit 10 = variances
Role of the budget is to measure favorable/unfavorable variances
Coordination of the activities in the entire Organization
SU 9.1 -Role of Budget and the
Budgeting Process
• Budgeting as:
– Quantification of Management’s Plans
– Role in the overall Planning and Evaluation Process
– To Evaluate progress
– Formulating and Controlling Short-term objectives
– Measuring against established goals
– Monitoring and Controlling
– Enhancing Coordination
SU 9.1 -Role of Budget and the
Budgeting Process
• Budgeting’s Role in Formulating and
Controlling Short-term Objectives
⁻ Goal of increasing market share
⁻ Making a steady dividend payout
⁻ Only be achieved through the completion of
incremental steps
⁻ Lays out specific revenue targets and expense
limitations on a month-to-month basis
SU 9.1 -Role of Budget and the
Budgeting Process
• Role of Budgets in Measuring Performance Against
Established Goals
⁻ Provide guideposts for the assessment of success
or failure
• The Role of Budgets Monitoring and Controlling
Expenditures
⁻ Budget reports are produced periodically during
the year
⁻ Variance: reveals the efficient or inefficient use of
company resources
SU 9.1 -Role of Budget and the
Budgeting Process
• Characteristics of a successful Budgeting
Process
⁻ Sufficient lead time
⁻ Budget must be finalized when the fiscal year
begins
⁻ Budge planning calendar: schedule of activities
for the development and adoption of the budget
⁻ Budget manual
⁻ Buy-in at all levels
SU 9.1 -Role of Budget and the
Budgeting Process
• Participation in the Budget Process
⁻ Begins with the mission statement formulated by
the board of directors
⁻ Senior management
⁻ Budget committee/department
⁻ Middle and lower management
⁻ Top-down (authoritative) budgeting
⁻ Bottom-up (participative) budgeting
SU 9.1 -Role of Budget and the
Budgeting Process
• Time Framers for Budgets- each phase of the
organization’s planning cycle has its own
budget with an appropriate time frame
⁻ Strategic: senior managers with time frames of up
to 10 years or more
⁻ Intermediate: middle managers with time frames
of up to 2 years
⁻ Operational: lower-level managers with time
frames of 1 month – 1 year
SU 9.1 -Role of Budget and the
Budgeting Process
• Effects of External Factors on the budgeting Process
⁻ General economic decisions based on firm’s strategy
and budget
⁻ Expected trends
⁻ Availability of financial resources
• The concept of Controllability
⁻ Key concept in the use of budgets and other standards
to evaluate performance
⁻ Can be difficult to isolate because few costs or
revenues are under the sole influence of one manager
SU 9.1 Question 1
All of the following are advantages of
the use of budgets in a management
control system except that budgets
A.
Force management planning.
B.
Provide performance criteria.
C.
Promote communication and
coordination within the organization.
D.
Limit unauthorized expenditures.
SU 9.1 Question 1 Answer
Correct Answer: D
Budgets serve many roles. They force management to plan ahead,
communicate organizational goals throughout the organization, and
provide criteria for future performance evaluations.
Incorrect Answers:
A: Forcing management planning is an advantage of using budgets.
B: Providing performance criteria is an advantage of using budgets.
C: Promoting communication and coordination within the
organization is an advantage of using budgets.
SU 9.1 Question 2
Ineffective budget control systems
are characterized by
A.
Use of budgets as a planning but not a
control tool.
B.
Use of budgets for harassment of
individuals rather than motivation.
C.
Lack of timely feedback in the use of
the budget.
D.
All of the answers are correct.
SU 9.1 Question 2 Answer
Correct Answer: D
Ineffective budget control systems are characterized by each of the items noted. The
use of budgets for planning only is a problem that must be resolved through the
education process. Management must be educated to use the budget documents for
control, not just planning. Management must learn that budgets can motivate and
help individuals achieve professional growth as well as the goals of the firm. Ignoring
budgets obviously contributes to the ineffectiveness of the budget system. Finally,
feedback must be timely or lower management and employees will soon recognize
that budget feedback is so late it provides no information, making the budget a
worthless device.
Incorrect Answers:
A: This is not the only item listed that characterizes ineffective budget control
systems.
B: This is not the only item listed that characterizes ineffective budget control
systems.
C: This is not the only item listed that characterizes ineffective budget control
systems.
SU 9.1 Question 3
When comparing performance report information for top management with that for
lower-level management,
A
Top management reports are more
detailed.
B
Lower-level management reports are
typically for longer time periods.
C
Top management reports show control
over fewer costs.
D
Lower-level management reports are
likely to contain more quantitative data
and less financial data.
SU 9.1 Question 3 Answer
Correct Answer: D
Information sent to top management is ordinarily more highly aggregated and less timely than that
communicated to managers at operational levels. Top managers are concerned with the organization’s
overall financial results and long-term prospects and are responsible for the strategic planning function.
Lower-level reports contain more quantitative information of an operational nature, e.g., production
data.
Incorrect Answers:
A
Top management reports are less detailed. Top
management usually practices management by
exception.
B
Lower-level reports are typically more timely.
Rapid feedback is necessary to solve operating
problems.
C
Top management is responsible for all costs
incurred within the organization, including those
incurred in lower level departments.
SU 9.1 Question 4
Each organization plans and budgets its operations for slightly different reasons.
Which one of the following is not a significant reason for planning?
A
Providing a basis for controlling
operations.
B
Forcing managers to consider expected
future trends and conditions.
C
Ensuring profitable operations.
D
Checking progress toward the objectives
of the organization.
SU 9.1 Question 4 Answer
Correct Answer: C
This question is apparently directed toward budgeting. A budget is a realistic plan for the
future that is expressed in quantitative terms. It is a planning, control, motivational, and
communications tool. A budget promotes goal congruence and coordination among
operating units. Unfortunately, a budget does not ensure profitable operations.
Incorrect Answers:
A
Control of operations is a goal of planning.
B
Forcing managers to consider expected
future trends and conditions is a goal of
planning.
D
Checking progress toward objectives is a
goal of planning.
SU 9.2 – Budgeting and Standard
Costing
• Predetermined expectations
– Of input, output or given activity (should cost)
– Provide an alert to differences
– May be based on accounting, engineering or
statistical
• Activity analysis identifies, describes, and
evaluates the activities to go into product
– Historical data may be a surrogate for companies
lacking resources to study the activities
SU 9.2 – Budgeting and Standard
Costing
• Direct Materials – direct relationship between
unit price and quality.
– Inferior (cheaper) products (input) = higher
consumption, higher labor use
• Direct Labor – difficult to est. standard cost for
labor
– May rely on a team development approach
SU 9.2 – Budgeting and Standard
Costing
• Theoretical vs. Practical Standards
– Ideal (theoretical) standards – optimal conditions,
also ref. as perfection or maximum efficiency
standards.
•
•
•
•
Most skilled labor, no waste or spoilage
Also call “tight” standards
Sometimes used in a continuous improvement process
Usually replaced by attainable standards for most
budgets and estimates (i.e. product cost)
Continue
SU 9.2 – Budgeting and Standard
Costing
• Currently attainable (practical) standards –
expected to be achieved
– Reasonably well trained workers
– Allowance for spoilage, waste and downtime
– Alternative is “difficult-to-attain” results.
SU 9.2 – Budgeting and Standard
Costing (not in text)
• Controllability is a key concept to evaluate
performance
• Budget can be flexible to allow for changes
– Establishing standards of performance (KPIs)
– Measuring actual performance
– Analyzing and comparing with standards
(variances)
– Devising and implementing corrective actions
– Reviewing and revising the standards
• Use of Standard costing  baseline (t =0)
SU 9.2 – Budgeting and Standard
Costing
• Remember, to develop standards:
– Activity analysis: ABC step 1
– Review of historical data to assess trend or
base
– Calculate estimated cost: for example direct
materials, there is a relationship between
price and quality
SU 9.2 – Budgeting and Standard
Costing (not in text)
• Incorporate potential cost savings based on
assumptions
• Identify risks and opportunities on realizable
events
• Ideal (theoretical) standards / Practical
standard
SU 9.2 - Question 1
All of the following statements concerning standard costs are correct except
that
A
Time and motion studies are often
used to determine standard costs.
B
Standard costs are usually set for one
year.
C
Standard costs can be used in costing
inventory accounts.
D
Standard costs are usually stated in
total, while budgeted costs are
usually stated on a per-unit basis.
SU 9.2 - Question 1 Answer
Correct Answer: D
Standard costs can be used at the per-unit level and any level of aggregation
above.
Incorrect Answers:
A
Time and motion studies are often
used to determine standard costs.
B
Standard costs are usually set for one
year.
C
Standard costs can be used in costing
inventory accounts.
SU 9.2 - Question 2
Jura Corporation is developing standards for the next year. Currently XZ-26, one
of the material components, is being purchased for $36.45 per unit. It is
expected that the component’s cost will increase by approximately 10% next
year and the price could range from $38.75 to $44.18 per unit, depending on the
quantity purchased. The appropriate standard for XZ-26 for next year should be
set at the
A
Current actual cost plus the forecasted
10% price increase.
B
Lowest purchase price in the
anticipated range to keep pressure on
purchasing to always buy in the lowest
price range.
C
Highest price in the anticipated range
to ensure that there are only favorable
purchase price variances.
D
Price agreed upon by the purchasing
manager and the appropriate level of
company management.
SU 9.2 - Question 2 Answer
Correct Answer: D
Standard prices are designed for internal
performance measurement. Standards should be
attainable, but not so easily as to not provide
motivation. Management should decide its
objectives and set a standard that will achieve that
objective when the standard is met. For example,
the lowest price might not be selected if the
company is using a JIT system, for which the
primary objective is the minimization of inventories.
SU 9.2 - Question 3
After performing a thorough study of Michigan Company’s operations, an
independent consultant determined that the firm’s labor standards were
probably too tight. Which one of the following facts would be inconsistent with
the consultant’s conclusion?
A
A review of performance reports
revealed the presence of many
unfavorable efficiency variances.
B
Michigan’s budgeting process was welldefined and based on a bottom-up
philosophy.
C
Management noted that minimal
incentive bonuses have been paid in
recent periods.
D
Production supervisors found several
significant fluctuations in
manufacturing volume, with short-term
increases on output being followed by
rapid, sustained declines.
SU 9.2 - Question 4 Answer
Correct Answer: B
It is highly unlikely that workers familiar with their own processes would set tootight standards.
Incorrect Answers:
A
Many unfavorable efficiency variances
would be an indicator of too-tight
standards.
C
The widespread failure for expected
bonuses to be earned would be an
indicator of too-tight standards.
D
The situation described is indicative of
rush jobs being too common, which is a
result of poor production planning, not
tight labor standards.
SU 9.2 Question 5
Jura Corporation is developing standards for the next year. Currently XZ-26, one of
the material components, is being purchased for $36.45 per unit. It is expected that
the component’s cost will increase by approximately 10% next year and the price
could range from $38.75 to $44.18 per unit, depending on the quantity purchased.
The appropriate standard for XZ-26 for next year should be set at the
A. Current actual cost plus the forecasted 10% price increase.
B. Lowest purchase price in the anticipated range to keep pressure on purchasing to
always buy in the lowest price range.
C. Highest price in the anticipated range to ensure that there are only favorable
purchase price variances.
D. Price agreed upon by the purchasing manager and the appropriate level of
company management.
SU 9.2 Question 5 Answer
Correct Answer
D. Standard prices are designed for internal performance measurement. Standards
should be attainable, but not so easily as to not provide motivation. Management
should decide its objectives and set a standard that will achieve that objective when
the standard is met. For example, the lowest price might not be selected if the
company is using a JIT system, for which the primary objective is the minimization of
inventories.
Incorrect Answer Explanations:
A. The actual cost could be more or less depending in the quantity purchased.
B. The lowest price may not always be in the company’s best interests if the quantity
required to obtain the lowest price would lead to much higher carrying costs.
C. Standards should be set tightly enough to provide motivation to purchasing
management.
SU 9.2 Question 6
When compared with ideal standards, practical
standards
A. Produce lower per-unit product costs.
B. Result in a less desirable basis for the development of
budgets.
C. Incorporate very generous allowance for spoilage and
worker inefficiencies.
D. Serve as a better motivating target for manufacturing
personnel.
SU 9.2 Question 6 Answer
Correct Answer
D. Practical standards, also called attainable standards, are more likely to
meet with worker acceptance than standards based on an unachievable ideal.
Incorrect Answer Explanations:
A. The effect of one type of standard over another cannot guarantee lower
costs.
B. Practical standards are more appropriate in most cases than ideal
standards in the development of budgets.
C. An acceptance of high levels of spoilage and worker inefficiencies cannot
be overcome through the use of standards.
SU 9.2 Question 7
All of the following statements concerning standard
costs are correct except that
A. Time and motion studies are often used to determine
standard costs.
B. Standard costs are usually set for one year.
C. Standard costs can be used in costing inventory
accounts.
D. Standard costs are usually stated in total, while
budgeted costs are usually stated on a per-unit basis.
SU 9.2 Question 7 Answer
Correct Answer
D. Standard costs can be used at the per-unit level and any
level of aggregation above.
Incorrect Answer Explanations:
A. Time and motion studies are often used to determine
standard costs.
B. Standard costs are usually set for one year.
C. Standard costs can be used in costing inventory accounts.
SU 9.2 Question 8
Granger Company is reviewing its standard machine hours per unit to
use in its budget for the upcoming year. The machine manufacturer’s
specifications indicated a unit could be made in 0.75 hours, and a
benchmarking study showed a competitor produced at a speed of
0.78 machine hours per unit. Granger’s actual results from last year
averaged 0.83 machine hours per unit even though a standard of 0.80
machine hours per unit had been established using engineering
studies. The standard Granger should use in its upcoming budget is
A.
B.
C.
D.
0.75 machine hours per unit.
0.78 machine hours per unit.
0.80 machine hours per unit.
0.83 machine hours per unit.
SU 9.2 Question 8 Answer
Correct Answer
C. Standard costs are predetermined expectations about how much a given activity
should cost. Standards should be based on accounting, engineering, or statistical
control studies.
Incorrect Answer Explanations:
A. The machine manufacturer’s specifications are the ideal standards set for
production under optimal conditions. This is not the best alternative for setting
Granger’s standard costs.
B. While benchmarking can be a useful tool in helping companies with productivity
management and business process reengineering, it is unrealistic for setting Granger’s
standard costs.
D. A standard cost is not just an average of pasts costs but an objectively determined
estimate of what a cost should be. Historical data may be used to set standards by
firms that lack the resources to engage in the complex task of activity analysis.
However, it is not the best option in this case.
SU 9.3 – The Master Budget
• Annual Profit Plan
• Operating Budget – emphasis is on current
resources
–
–
–
–
–
–
Sales budget
Production budget
Direct material budget
Manufacturing overhead budget
Ending finished goods inventory budget
Cost of goods sold budget
Continued
SU 9.3 – The Master Budget
– Nonmanufacturing budget
•
•
•
•
•
•
Research and development budget
Design budget
Marketing budget
Distribution budget
Customer service budget
Administrative budget
– Pro forma income statement
SU 9.3 – The Master Budget
• Financial Budget – emphasis on funds needed
to purchase operating assets.
• Sales Budget
• Production Budget
• Purchase Budget
• Expense Budget
Continued
SU 9.3 – The Master Budget
• Capital budget
• Cash budget
– Projected cash disbursement
– Projected cash collection schedule
• Pro forma income statement
• Pro forma balance sheet
• Pro forma statement of cash flows
SU 9.3 – Question 1
Pro forma financial statements are part of the budgeting process. Normally,
the last pro forma statement prepared is the
A
Capital expenditure plan.
B
Income statement.
C
Statement of cost of goods sold.
D
Statement of cash flows.
SU 9.3 – Question 1 answer
Correct Answer: D
The statement of cash flows is usually the last of
the listed items prepared. All other elements of
the budget process must be completed before it
can be developed.
SU 9.3 – Question 2
Which one of the following may be considered an independent item in the
preparation of the master budget?
A
Ending inventory budget.
B
Capital investment budget.
C
Pro forma income statement.
D
Pro forma statement of financial
position.
SU 9.3 – Question 2 answer
Correct Answer: B
The capital investment budget may be prepared
more than a year in advance, unlike the other
elements of the master budget. Because of the
long-term commitments that must be made for
some types of capital investments, planning must
be done far in advance and is based on needs in
future years as opposed to the current year’s
needs.
SU 9.3 – Question 3
The Yummy Dog Bone Company is anticipating that a major supplier might
experience a strike this year. Because of the nature of the product and
emphasis on quality, extra production cannot be stored as finished goods
inventory. When developing a contingency budget that would anticipate a
direct materials buildup, the two most significant items that will be affected
are
A
Production volume and direct
material.
B
Sales and ending inventory.
C
Production and cash flow.
D
Direct materials and cash flow.
SU 9.3 – Question 3 answer
Correct Answer: D
The most significant items are those that will vary
between the contingency budget and the regular
budget. The company cannot increase its finished
goods inventory, but it can increase its inventory of
the direct materials provided by the supplier. Thus,
the items most affected will be direct materials and
cash. The cash budget will be affected because of
the need to pay for direct materials prior to their
usage.
9.3 - Budgeting Process
Let’s review the process again!
Master Budget
Operational Budget
Financial Budget
9.3 The Master Budget
• Also called comprehensive budget or annual
profit plan (operating + financial)
• Operating Budget (Sales, Production, DM, DL,
MOH, COGS, R&D, Marketing…)
• Financial Budget (Capital or CAPEX, Cash
flows, Pro-Forma B/S, Pro-Forma CF)
Budgeting Process (not in text)
• Sufficient lead time
• Budget planning calendar
• Detailed procedures for preparing and
submitting the budget
• Buy-in at all levels: support and transparency of
Top management is crucial
• Top-down Vs. Bottom-up budgeting
– Authoritative vs. participative approach
Strategic/10
Intermediate/2
Operational/1
Budgeting Process (not in text)
• Time Frames for Budgets
– Strategic – up to 10 yrs.
– Intermediate – up to 2 yrs.
– Operational – 1 mo. – 1 yr.
Budgeting Process (not in text)
• External Factors
– General Economic environment
– Competitors (Review Michael Porter)
– Regulation and Governmental initiatives
– Industry specific situation
• Input cost rising
Continued
Budgeting Process (not in text)
• External Factors
– Shareholders = merger & acquisition
– R&D: different stage of product develop.
– Technology / Software / Applications
Budgeting Process (not in text)
• Controllability
– Key concept in the use of budgets
– Under the discretion of a particular manager
– Can be difficult to isolate
Budgeting Process (not in text)
• Revisions to the Budget
– Significant internal and external changes since the
original budget was created
– Control loop:
•
•
•
•
•
The budget
Measurement
Analyzing and comparing
Development and implementing corrective actions
Reviewing and revising the standards
Budgeting Process - Question 1
A planning calendar in budgeting is
the
A.
Calendar period covered by the budget.
B.
Schedule of activities for the
development and adoption of the
budget.
C.
Calendar period covered by the annual
budget and the long-range plan.
D.
Sales forecast by months in the annual
budget period.
Budgeting Process - Question 1
Answer
Correct Answer: B
The budget planning calendar is the schedule of activities for the development and adoption of the
budget. It should include a list of dates indicating when specific information is to be provided by each
information source to others. The preparation of a master budget usually takes several months. For
instance, many firms start the budget for the next calendar year some time in September in hopes of
having it completed by December 1. Because all of the individual departmental budgets are based on
forecasts prepared by others and the budgets of other departments, it is essential to have a planning
calendar to ensure the proper integration of the entire process.
Incorrect Answers:
A: The period covered by the budget precedes the events in the planning calendar.
C: The period covered by the budget precedes the events in the planning calendar.
D: The planning calendar is not associated with sales.
Budgeting Process - Question 2
The primary role of the budget
director and the budgeting
department is to
A.
B.
C.
D.
Settle disputes among operating
executives during the development of
the annual operating plan.
Develop the annual profit plan by
selecting the alternatives to be adopted
from the suggestions submitted by the
various operating segments.
Justify the budget to the executive
committee of the board of directors.
Compile the budget and manage the
budget process.
Budgeting Process - Question 2
Answer
Correct Answer: D
The budget department is responsible for compiling the budget and managing the budget process. The
budget director and department are not responsible for actually developing the estimates on which the
budget is based. This role is performed by those to whom the resulting budget will be applicable. The
budget director has staff, not line, authority. (S)he has a technical and advisory role. The final decisionmaking responsibility rests with line management.
Incorrect Answers:
A: The budget director has staff, not line, authority. (S)he has a technical and advisory role. The final
decision-making responsibility rests with line management.
B: The budget director has staff, not line, authority. (S)he has a technical and advisory role. The final
decision-making responsibility rests with line management.
C: The budget director has staff, not line, authority. (S)he has a technical and advisory role. The final
decision-making responsibility rests with line management.
Budgeting Process - Question 3
1.The following sequence of steps is employed by a company to
develop its annual profit plan: Planning guidelines are disseminated
downward by top management after receiving input from all levels of
management.
2.A sales budget is prepared by individual sales units reflecting the
sales targets of the various segments. This provides the basis for
departmental production budgets and other related components by
the various operating units. Communication is primarily lateral with
some upward communication possible.
3.A profit plan is submitted to top management for coordination and
review. Top management’s recommendations and revisions are acted
upon by middle management. A revised profit plan is resubmitted for
further review to top management.
4.Top management grants final approval and distributes the formal
plan downward to the various operating units.
This outline of steps best describes which one of the following
approaches to budget development?
A.
B.
C.
D.
Imposed budgeting by top
management.
Bottom-up approach.
Top-down approach.
Total justification of all
activities by operating units.
Budgeting Process - Question 3
Answer
Correct Answer: B
A bottom-up approach is characterized by general guidance from the highest
levels of management, followed by extensive input from middle and lower
management. This sequence of steps aptly describes this process.
Incorrect Answers:
A: Top management has received extensive input and cooperation from
lower levels through performing these steps.
C: These steps describe the opposite of a top-down approach.
D: Top management is not demanding justification of all activities in the
steps described; such a demand would be consistent with a system known as
zero-based budgeting.
Budgeting Process - Question 4
The budgeting technique that is most likely to motivate managers is
A
Top-down budgeting.
B
Zero-based budgeting.
C
Program budgeting and review
technique.
D
Bottom-up budgeting.
Budgeting Process - Question 4
Answer
Correct Answer: D
Bottom-up budgeting is the best way of motivating managers to meet budget
estimates because it permits participation in the budget process. Lower level
managers who take part in budgeting decisions are more likely to support the
result and less likely to feel that the budget has been imposed from above.
Incorrect Answers:
A
A top-down budget is less likely to
motivate lower level managers who
have not participated in its formation.
B
Zero-based budgeting is a means of
adding objectivity to the budget
process; employee motivation is not a
particular goal.
C
Program budgets are formulated by
objective rather than function.
SU 9.4 - Budget Methodologies
• Project Budget
• Activity-Based Budget p. 297
• Zero-Based Budget (Manager must justify the
entire budget every year/cycle)
• Different from Incremental budgeting
• Continuous budgeting
– More accurate and keep Managers thinking ahead
– time consuming
9.4 – Budget Methodologies
• Remember Static & Flexible Budgeting:
– Static Budget = based on only one level of sales or
production
– Flexible Budget = series of budgets prepared for
many levels of activity
• Also remember – You must know how to both
apply and select a specific budgeting method,
as well explain why it should be selected.
SU 9.4 – Question 1
Which one of the following is not an advantage
of activity-based budgeting?
A.
B.
C.
D.
Better identification of resource needs.
Linking of costs to outputs.
Identification of budgetary slack.
Reduction of planning uncertainty.
SU 9.4 – Question 1 Answer
Answer Explanations for Question 1:
A. Better identification of resource needs is an advantage of
any kind of budgeting.
B. Linking costs to outputs is a feature of a cost accumulation
system, such as job-order or process costing.
C. Identification of budgetary slack can be built into any
budget system, not just an activity-based one.
D. *Correct Answer* Activity-based budgeting applies
activity-based costing principles to budgeting. It focuses on
the numerous activities necessary to produce and market
goods and services and requires analysis of cost drivers.
Activity-based budgeting cannot reduce the level of
uncertainty to which any large organization is subject.
SU 9.4 – Question 2
An advantage of incremental budgeting when
compared with zero-based budgeting is that
incremental budgeting
A. Encourages adopting new projects quickly.
B. Accepts the existing base as being satisfactory.
C. Eliminates functions and duties that have
outlived their usefulness.
D. Eliminates the need to review all functions
periodically to obtain optimum use of resources.
SU 9.4 – Question 2 Answer
Answer Explanations for Question 2:
A. Both types of budgets treat new projects in the same manner.
B. *Correct Answer* Incremental budgeting simply adjusts the current
year’s budget to allow for changes planned for the coming year; a
manager is not asked to justify the base portion of the budget. ZBB,
however, requires a manager to justify the entire budget for each year.
Incremental budgeting offers to managers the advantage of requiring
less managerial effort to justify changes in the budget.
C. Reexamining functions and duties that may have outlived their
usefulness is an advantage of ZBB.
D. Periodic review of functions is essential regardless of the budgetary
system used.
SU 9.4 – Question 3
A systemized approach known as zero-based budgeting
(ZBB)
A. Presents the plan for only one level of activity and
does not adjust to changes in the level of activity.
B. Presents a statement of expectations for a period of
time but does not present a firm commitment.
C. Divides the activities of individual responsibility
centers into a series of packages that are prioritized.
D. Classifies budget requests by activity and estimates
the benefits arising from each activity.
SU 9.4 – Question 3 Answer
Answer Explanations for Question 3:
A. A static budget does not adjust for changes in activity levels.
B. ZBB does present a firm commitment.
C. *Correct Answer* Zero-based budgeting is a planning process in
which each manager must justify a department’s entire budget every
year (or period). Different levels of service (work effort) are evaluated
for each activity, measures of work and performance are established,
and activities are ranked (prioritized) according to their importance to
the entity. For each budgetary unit, decision packages are prepared
that describe various levels of service that may be provided, including
at least one level lower than the current one.
D. Each activity is prepared as a series of packages.
SU 9.4 – Question 4
Medico has found that its annual budgets are quickly
outdated once actual data is recorded. Sometimes actual
preparations have already begun for the period being
budgeted by the time the annual budget is finished, which
leaves no time to react to changing factors. Medico wants
the budget to be as up-to-date as possible, and management
is willing to revise budgets as needed. Which budgeting
solution would be most appropriate for Medico?
A.
B.
C.
D.
Flexible budgeting.
Activity-based budgeting.
Zero-based budgeting.
Continuous budgeting.
SU 9.4 – Question 4 Answer
Answer Explanations for Question 4:
A. Flexible budgeting is the calculation of the quantity and cost of inputs that should
have been consumed given the achieved level of production. These are primarily used
at the end of a period to compare actual results with expected (budgeted) results.
B. Activity-based budgeting applies activity-based costing principles to budgeting. It
focuses on the numerous activities necessary to produce and market goods and
services and requires analysis of cost drivers. Activity-based budgeting is used
primarily used to properly allocate indirect costs, not to manage costs.
C. Zero-based budgeting requires a manager to justify the entire budget for each year.
The major limitation of zero-based budgeting is that it requires more time and effort
to prepare than a traditional budget. This would not meet the needs of Medico.
D. *Correct Answer* A continuous (rolling) budget is one that is revised monthly or
quarterly by dropping one period and adding a new one. Thus, a company desiring a
budget that is always as up-to-date as possible will benefit from using this type of
budget.
SU 9.5 - Operating Budget Calculation
• Sales Budget: Sales forecast x Selling
Price
• Production Budget: concerned with
Units only (no impact from Pricing
strategy)
– Projected Units (Volume)
– Desired Ending Inventory (Safety Stock)
– Projection on BGN Inventory
–  Units to be produced (include % spoilage)
SU 9.5 - Operating Budget Calculation
• Direct Materials Budget
– Follow directly from the production budget
– Concerned with units and input prices
– Objective is to minimize raw inventory carrying
cost, obsolesces
– Closely
SU 9.5 Question 1
Wellfleet Company manufactures
recreational equipment and prepares
annual operational budgets for each
department. The Purchasing Department
is finalizing plans for the fiscal year ending
June 30, Year 2, and has gathered the
information regarding two of the
components used in both tricycles and
bicycles. Wellfleet uses the first-in, firstout inventory method.
A19
B12
Tricycles
Beginning inventory, July 1, Year 1
3,500
1,200
800
2,150
Ending inventory, June 30, Year 2
2,000
1,800
1,000
900
Unit cost
Projected fiscal year unit sales
Component usage:
Tricycles
Bicycles
$1.20
--
$4.50
--
$54.50
96,000
$89.60
130,000
2/unit
2/unit
1/unit
4/unit
---
Bicycles
---
SU 9.5 Question 1 (cont.)
If the economic order quantity of
Component B12 is 70,000 units, the
number of times that Wellfleet Company
should purchase this component during
the fiscal year ended June 30, Year 2, is
A.
B.
C.
D.
Four times.
Five times.
Eight times.
Nine times.
SU 9.5 Question 1 Answer
Correct Answer: D
The number of tricycles to be produced is 96,200. Each requires one unit of B12. The number of bicycles
to be produced is 128,750. Each requires four units of B12, a total of 515,000. Combining the 96,200
units needed for tricycles with the 515,000 units needed for bicycles results in a total demand of
611,200 units. An additional 600 units (1,800 – 1,200) will have to be ordered to permit the increase in
the inventory of B12. Dividing the annual requirement of 611,800 units by the 70,000-unit EOQ results
in 8.74 orders per year. Because partial orders are not possible, nine orders will have to be placed.
Incorrect Answers:
A: Ordering four times will meet the need for tricycle but not bicycle production.
B: Ordering five times will meet the need for tricycle but not bicycle production.
C: Eight orders will suffice only for the bicycles.
SU 9.5 Question 2
Rokat’s sales budget in
units for the next quarter is
as follows:
Rokat Corporation is a manufacturer of tables sold to
schools, restaurants, hotels, and other institutions.
The table tops are manufactured by Rokat, but the
table legs are purchased from an outside supplier.
The Assembly Department takes a manufactured
table top and attaches the four purchased table legs.
It takes 20 minutes of labor to assemble a table. The
company follows a policy of producing enough tables
to ensure that 40% of next month’s sales are in the
finished goods inventory. Rokat also purchases
sufficient direct materials inventory to ensure that
direct materials inventory is 60% of the following
month’s scheduled production.
July
August
September
Finished goods
Direct materials (legs)
2,300
2,500
2,100
Rokat’s ending inventories in
units for June 30 are
1,900
4,000
SU 9.5 Question 2 Answer
Correct Answer: A
The August production of 1,600 units will require 6,400 table legs. September’s
production of 1,800 units will require 7,200 table legs. Thus, inventory at the end of
August should be 4,320 legs (7,200 legs × 60%). The total of legs needed during August
is 10,720 (6,400 + 4,320), of which 4,200 are available from the July 31 ending
inventory. The remaining 6,520 legs must be purchased during August.
Incorrect Answers:
B: The figure of 9,400 legs is based on an ending inventory of 100% of September’s
production.
C: Failing to consider the legs needed for the ending inventory results in 2,200 legs.
D: The amount needed for August production is 6,400 legs.
SU 9.6 – Operating Budget Calculations
• Direct Labor Budget
• Employee Fringe Benefits
• Variable OH: Manufacturing OH budget
reflects the nature of OH as a mixed cost (VC +
FC)
• VOH contains elements that vary with level of production:
indirect materials, indirect labor, variable factory operating
costs
• Fixed OH: real estate taxes, insurance,
depreciations = easy to project
SU 9.6 – Operating Budget Calculations
•
•
•
•
•
Ending Finished Goods Inventory Budget
COGS Budget (materials, labor, overhead)
Variable Costing & Contribution Margin
Nonmanufacturing Budget
Pro Forma Operating Income
9.6 - Question 1
Which one of the following statements regarding selling and
administrative budgets is most accurate?
A. Selling and administrative budgets are usually optional.
B. Selling and administrative budgets are fixed in nature.
C. Selling and administrative budgets are difficult to allocate
by month and are best presented as one number for the
entire year.
D. Selling and administrative budgets need to be detailed in
order that the key assumptions can be better understood.
9.6 - Question 1 Answer
A. Selling and administrative budgets are no more optional than any
other component of the master budget.
B. Selling and administrative budgets have both variable and fixed
components.
C. Selling and administrative budgets should be prepared on the same
basis as the remainder of the budget, typically on at least a monthly
basis.
D. *Correct Answer* Sales and administrative budgets are prepared
after the sales budget. Like the other budgets, they constitute
prospective information based on the preparer’s assumptions about
conditions expected to exist and actions expected to be taken.
9.6 - Question 2
Harvin Co. pays out sales commissions to its sales team in the month the
company receives cash for payment. These commissions equal 5% of total
(monthly) cash inflows as a result of sales. Harvin has budgeted sales of
$300,000 for August, $400,000 for September, and $200,000 for October.
Approximately half of all sales are on credit, and the other half are cash
sales. Experience indicates that 70% of the budgeted credit sales will be
collected in the month following the sale, 20% the month after that, and
10% of the sales will be uncollectible. Based on this information, what
should be the total amount of sales commissions paid out by Harvin in the
month of October?
A.
B.
C.
D.
$8,500
$13,500
$17,000
$22,000
9.6 - Question 2 Answer
A. Failure to consider the cash sales made during October results in
$8,500.
B. *Correct Answer* Cash sales for Harvin for the month of October
are budgeted at $100,000 (half of $200,000 overall sales). Projections
for collections of credit sales in August indicate that 20% will be cash
inflows in October, or ($150,000 × 20%) = $30,000. Projections for
collections of credit sales in September indicate that 70% will be cash
inflows in October, or ($200,000 × 70%) = $140,000. Therefore, total
cash inflows projected for the month of October equal $100,000 +
$30,000 + $140,000 = $270,000. Because sales commissions are set at
5% of monthly cash inflows, the sales commissions for October equal
($270,000 × 5%) = $13,500.
C. The amount of $17,000 is based on total sales for August and
September rather than credit sales.
D. Using total sales rather than credit sales results in $22,000.
SU 9.7 – Projecting Cash
Collections
• Capital Budget: CAPEX = major expenditures for
long-term assets (equipment, furniture,
software, hardware…)
• Ranking projects: NPV, IRR, Payback  Part 2
• Cash Collections Schedule: estimate the inflows
of cash from customer payments
• Cash Budget = Lynchpin of Budget Process
– It is the part of Financial budget cycle that ties
together all the schedules from the operating
budget
SU 9.7 Question 1
DeBerg Company has developed the following sales
projections for the calendar year.
May
$100,000
June
120,000
July
140,000
August
160,000
September
150,000
October
A.
B.
C.
D.
130,000
Normal cash collection experience has been that
50% of sales are collected during the month of sale
and 45% in the month following sale. The remaining
5% of sales is never collected. DeBerg’s budgeted
cash collections for the third calendar quarter are
$427,500
$422,500
$414,000
$450,000
SU 9.7 Question 1 Answer
Correct Answer: C
If 50% of sales are collected in the
month of sale and 45% in the next
month, with the balance
uncollectible, collections during
the third quarter will be based on
sales during June, July, August, and
September. As calculated below,
total budgeted collections are
$414,000.
June:
$120,000 × 45%
=
$ 54,000
July:
140,000 × (50% + 45%)
=
133,000
August:
160,000 × (50% + 45%)
=
152,000
September:
150,000 × 50%
=
75,000
Total
$414,000
SU 9.7 Question 2
The forecast for both cash and
credit sales is as follows:
Historically, Pine Hill Wood Products has had no
significant bad debt experience with its customers.
Cash sales have accounted for 10% of total sales, and
payments for credit sales have been received as
follows:
40% of credit sales in the month of the sale
30% of credit sales in the first subsequent month
25% of credit sales in the second subsequent month
5% of credit sales in the third subsequent month
Month
January
February
March
April
May
Sales
$95,000
65,000
70,000
80,000
85,000
SU 9.7 Question 2 (cont.)
What is the forecasted cash inflow for
Pine Hill Wood Products for May?
A.
$70,875
B.
$76,500
C.
$79,375
D.
$83,650
SU 9.7 Question 2 Answer
Correct Answer: C
The cash inflows for May will come from May cash sales of $8,500 ($85,000 ×
10%), May credit sales of $30,600 ($85,000 × 90% × 40%), April sales of
$21,600 ($80,000 × 30% × 90%), March sales of $15,750 ($70,000 × 25% ×
90%), and February sales of $2,925 ($65,000 × 5% × 90%). The total is
$79,375.
Incorrect Answers:
A: The amount of $70,875 omits May cash sales.
B: May credit sales equals $76,500.
D: The amount of $83,650 includes 5% of January’s credit sales.
SU 9.8 – Cash Budget
• Cash budget projects cash receipts and
disbursements for planning and control
purposes. It helps prevent not only cash
emergencies but also identifies excessive idle
cash.
– Part of the financial budget cycle that ties together
all the schedules from the operating budget.
– Vital because an organization must have adequate
cash.
• Particularly important for seasonal organizations
• Must consider collection policies, bad debt est., changes
in the economy, etc.
SU 9.8 – Cash Budget
• Cash Disbursements Schedule (example page
307*)
• Cash Budget Preparation (example page 308*)
9.8 - Question 1
Monroe Products is preparing a cash forecast based on the following information:
Monthly sales: December, $200,000; January, $200,000; February, $350,000; March,
$400,000.
All sales are on credit and collected the month following the sale.
Purchases are 60% of next month’s sales and are paid for in the month of purchase.
Other monthly expenses are $25,000, including $5,000 of depreciation.
If the January beginning cash balance is $30,000, and Monroe is required to maintain
a minimum cash balance of $10,000, how much short-term borrowing will be required
at the end of February? Loans are repaid in the following month, even though that
might require additional borrowing at the end of the month.
• A. $60,000
• B. $70,000
• C. $75,000
• D. $80,000
9.8 - Question 1 Answer
Beginning cash balance
$ 30,000
Collections on December sales (in January)
200,000
Collections on January sales (in February)
200,000
Disbursements for inventory (in January)
(210,000)
Disbursements for inventory (in February)
(240,000)
Disbursements for other expenses (in
January)
(20,000)
Disbursements for other expenses (in
February)
(20,000)
Minimum balance requirement
(10,000)
Shortfall
$ (70,000)
9.8 - Question 2
Which one of the following best represents a
factor that should be considered for mediumand long-term cash forecasting?
A.
B.
C.
D.
Pre-tax cost of capital projects.
Current monthly depreciation.
Impact of stock split.
Non-routine property sales.
9.8 - Question 2 Answer
A. The pre-tax cost of capital projects represents a sunk cost
and is not relevant to medium- and long-term cash
forecasting.
B. The current monthly depreciation represents a sunk cost
and is not relevant to medium- and long-term cash
forecasting.
C. A stock split does not impact cash. Thus, it is not relevant to
medium- and long-term cash forecasting.
D. *Correct Answer* Non-routine property sales could result
in large fluctuations of cash and should be considered for
medium- and long-term forecasting.
9.9 – Sales Forecast and Pro Forma Financial
Statements
• Sales Forecast
– Begin by looking at historical trends
• Using regression analysis to forecast next year’s sales
• Determining the AAGR (Average Annual Growth Rate)
– See example on page 308
SU 9.9 – Sales Forecasts
• Percent of sales method
– After sales are forecasted, future financial
statements must be forecasted
– Common method is the percent of sales method
• Items on the income statement and balance sheets
assumed to increase proportionately to sales
• Other items based off historical data and forecasted net
sales
SU 9.9 – Pro Forma Financial
Statements
• Pro forma: Latin phrase meaning “according
to form.”
– Referred to when financial statements reflect
projected, rather than actual, results
– Used to decide whether budget activities will
result in acceptable level of income
– Also observed is target gross margin percentage
and the interest coverage ratio
SU 9.9 – Pro Forma Financial
Statements
• Pro Forma Balance Sheet:
– Using cash and capital budgets
– And the pro forma income statement
– Beginning-of-the-period balance sheet
SU 9.9 – Pro Forma Financial
Statements
• Pro Forma Statement of Cash Flow
– Normally last statement prepared
– Classifies cash receipts and disbursements
– Direct presentation reports the major classes of
gross cash operating receipts, payments, and
difference between them
– Indirect presentation reconciles net income with
net operating c ash flow
SU 9.9 – Pro Forma Financial
Statements
• Financial Projections and Ratio Analysis
– Help the bank asses debt covenants
– To see whether company anticipates satisfying
requirements
– Typically debt ratio < than a certain threshold
– Coverage ratio > than a threshold
– Satisfactory levels of these ratios provide the bank
assurance
9.9 – Question 1
In November, a company finalized its budget for the upcoming
calendar year. In December, the decision was made to acquire new
equipment in January by trading in old equipment and financing the
amount due by a loan with principal and interest due at the end of 3
years. Out-of-pocket costs to operate the machinery would not
change. This decision would change which of the company’s
budgeted financial statements for the upcoming year?
A. The budgeted balance sheet only.
B. Both the budgeted balance sheet and the income statement.
C. The budgeted balance sheet, the income statement, and the
statement of cash flows.
D. Both the budgeted income statement and the statement of cash
flows.
9.9 – Question 1 Answer
A. The budgeted balance sheet is not the only statement
that would change.
B. The budgeted balance sheet and the income statement
are not the only statements that would change.
C. *Correct Answer* The budgeted balance sheet, the
income statement, and the statement of cash flows
would all change.
D. The budgeted income statement and the statement of
cash flows are not the only statements that would
change.
9.9 – Question 2
A production plan should be based on
A. A sales forecast adjusted for projected inventory
levels.
B. Economic order quantities and reorder points.
C. Exponential smoothing.
D. Linear regression.
9.9 – Question 2 Answer
A. *Correct Answer* A production plan depends on the sales
budget and anticipated inventory levels. Inventory serves to
balance seasonal fluctuations in sales with the need for stable
and efficient use of productive resources.
B. EOQs and reorder points are considered only after it has
decided how many units are needed.
C. Exponential smoothing is a technique used to level or
smooth variations encountered in a forecast. A production
plan should be based on the variations expected.
D. Regression analysis explains the correlation of a dependent
variable with one or more independent variables. It is based
on linearity of costs.
9.9 – Question 3
One of the final steps in completing a master budget is
the preparation of a pro forma cash flow statement.
This statement is intended to help users of financial
statements
A. Evaluate a firm’s economic resources and obligations.
B. Evaluate a firm’s liquidity, solvency, and financial
flexibility.
C. Determine a firm’s components of income from
operations.
D. Determine whether or not accounts receivable are
collectible.
9.9 – Question 3 Answer
A. The pro forma balance sheet, not the pro forma statement of cash
flows, will better evaluate a firm’s economic resources and obligations.
B. *Correct Answer* The pro forma statement of cash flows classifies
cash receipts and disbursements depending on whether they are from
operating, investing, or financing activities. Thus, it will help users
evaluate a firm’s liquidity, solvency, and financial flexibility by analyzing
the different cash disbursements and receipts.
C. A pro forma statement of income, not the pro forma statement of
cash flows, will better determine a firm’s components of income from
operations.
D. The pro forma statement of cash flows is not intended to determine
whether or not accounts receivables are collectible. This is best
determined by performing ratio analysis.