3.9 Budgets (HL)

a) The difference between cost and profit centres AO2

b) The roles of cost and profit centres AO2

c) Constructing a budget AO2, AO4

d) Variances AO2, AO4

e) The importance of budgets and variances in decision-making AO2

Adverse variance

This discrepancy in the budget occurs when profit is lower than expected, due to costs being higher than expected and/or revenues being lower than predicted.

Budget

A detailed financial plan for the future, usually involving the expected costs and revenues or a cash flow forecast, for a pre-determined period of time.

Budgetary control

The financial methods used to attempt to balance actual outcomes with budgeted outcomes. This is achieved by systematic observations and corrective measures to minimize variances.

Cost centre

A section or division of a business that has responsibility for its own operational costs. It is held accountable for its departmental expenditure.

Favourable variance

This discrepancy in the budget occurs when profits are higher than expected, due to lower than expected costs and/or higher than predicted revenues.

Organization by function

Arranging the different cost centres of a business based on different functional departments of the organization.

Organization by geography

Arranging the different cost centres of a business based on the location of its operations domestically and/or overseas.

Organization by product

Arranging the different cost centres of a business based on what it produces, i.e. its range of different goods and/or services.

Profit

Refers to the positive difference between a firm’s total revenues and its total costs for any given period of time.

Profit centre

A section or division of a business that has responsibility for both costs and revenues generated within the department. It is held accountable for the amount of profit generated.

Variance

Refers to a discrepancy between the planned (budgeted) item of expenditure or revenue and the actual amount.

Variance analysis

This is the management process of comparing planned and actual costs and revenues, in order to measure and compare the degree of budgetary success.

Zero budgeting

A method of budgeting that requires all budget holders to justify each dollar of spending subject to management approved before the funds are released.