3.9 Budgets (HL)

Day 1: Cost and Profit Centres, Creating a Budget, and Variances

Review 3.9 Powerpoint

• Exam Practice Question - Ed Jaen Toys Inc.

Activity 1: Cost and Profit Centres: School or Business of your choice 

1. Choose either a School, Business of your choice, or yourself

2. What cost centres does the school/business/you have?

3. What profit centres does the school/business/you have?

4. What are the benefits and possible disadvantages of splitting up different profit and cost centres? 

5. How can we split them up?

Activity 2: Create a budget:  

• • Using either the School, Business, or yourself from Activity 1:

    • What goals and strategies does the school, business, or you have?

    • Revenues: Make up potential revenues 

      • How much money will you have?

    • Expenses: What expenses will you have 

      • How much will each expense be? 

  • Construct a budget (Put into a table)

  • Calculate Excess of Revenues Over (under) Costs

• Fill in "Actual Figures" 

Surprise! 

• • • 1) Revenues or Money available is 10% less than expected, 

    • 2) Expenses are higher by 5%

  • Complete a Variance Analysis (Favourable, Adverse)

• Questions:

  • How useful are budgets?

  • What determines a good or not good budget?

Day 2: Budget Exam Practice

3.9 Case Study Questions - Case Study 27. Jupiter Doors 

• Questions A - G

Read Kognity + Do 1) Exam Practice Question - Ed Jaen Toys Inc. + 2) Exam Practice Question from above

Option 1: 3.8 IBDB Google Slides

• Complete all practice questions in the slides as well

Option 2: 3.8 Case Study Questions

• Complete all practice questions except for the 10 mark questions

What you should know 

By the end of this subtopic, you should be able to:

• define the following terms: (AO1)

  • budget 

  • profit centres

  • cost centres

  • variance analysis

  • favourable variance

  • adverse variance

• distinguish between cost centres and profit centres (AO2)

• explain the roles of cost centres and profit centres (AO2)

• explain and construct a budget (AO2, AO4)

• explain and calculate variances (AO2, AO4)

• explain the importance of budgets and variances in decision-making (AO2)

https://quizlet.com/_d58tmo?x=1qqt&i=4jrhob

https://www.gimkit.com/view/65c0efc881d8ff0032addb19 

3.7-3.9 Gimkit https://www.gimkit.com/view/67beabd5b964fd7370b37c1a  

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.

• Monitoring and control – allows better control over the different parts of their operations. 

  1. • Cost and profit centres enable large organizations in particular to monitor and control costs and revenues more effectively. 

     • Data from cost and profit centres of the business enable benchmarking to take place, i.e., comparing the financial performances of  the various divisions of the business to assess their financial efficiency. 

     • This monitoring and control of individual parts of the organization can help improve the overall financial efficiency in the business.

• Autonomy – Budget holders are empowered to make autonomous decisions for their respective cost and profit centres. 

  1. • The quality of the decisions made is improved as the budget holders are more aware of the realities and needs of the department. 

     • The operational decisions can be taken quickly, without have to refer to or get permission from head office. The speed of decision making also improves as a result.

• Motivating – Empowering budget holders to be in charge of cost and profit centres also serves to motivate these people to make better decisions for the organization. 

  1. • The organization can reward managers who operate efficiently and control their operating costs, and managers of profit centres who generate high levels of revenue and profits.

• Accountability – The use of cost and profit centres makes managers and budget holders accountable for their designated responsibilities. 

  1. • They are held accountable for all costs incurred by the centre (such as a subsidiary of a larger company) and their ability to control these costs. 

     • Similarly, managers of profit centres are accountable for the amount of revenue and profit made.

Cost centres are departments that only have costs. 

Profit centres on the other hand are departments that have both revenues and costs. 

Variance is the difference between actual and budgeted outcomes. 

Variance = Actual Results – Budgeted Results

Variances may be favourable (when they are in favour of the organisation) and adverse (when they are not in favour of the organisation). You may also call adverse variances "unfavourable".

Why do Variance Analysis?

• Helps business managers to monitor and control budgets as well as to review the annual budget against original targets.

• Budgetary control measures require managers to also investigate the cause or causes of any variance.

• Planning - The budgeting process helps decision makers to plan their operations based on the amount of money they have been allocated in the budget per time period.

• Forecasting - Budgets help businesses to plan the timing of their expenditure based on the planned revenue streams. This can help the organization to improve its cash flow forecasts and liquidity position.

• Prioritizing - It forces budget holders to prioritize their activities, e.g., which members of staff to send on training and which courses to send them on.

• Controlling - Enables managers to identify and analyse differences in planned and actual revenues and expenditure. This helps them to better understand possible financial problems and to devise corrective actions.

• Target setting - Budgets help departments within a business to set financial goals, thereby preventing costs spiralling out of control.

• Motivating - Empowering budget holders can act as a form of motivation (see Unit 2.4), especially if there are financial rewards linked to the attainment of financial targets such as sales revenue.

• Accountability - Budgets make people accountable for their actions and spending. Formally monitoring this through budgetary control is important, especially in organizations with a laissez-faire management or leadership style (see Unit 2.3).

• Benchmarking - They provide a basis for measuring the degree of success or failure (see section on variance analysis below). Managers can see if cost and/or revenue targets are met and to and take corrective actions if need be.

• Costs and time - Preparing, constructing, setting, and updating budgets may be expensive and time-consuming.

• Demotivational - If budgets are inflexible and unrealistic, regardless of changes in circumstances, staff may become highly demotivated.

• Changes in the external environment - Similarly, setting realistic budgets may be difficult in a dynamic business exposed to the constant forces of change. Hence, budgets could be a waste of time and resources.

• Sub-cultures and conflict - The culture of many organizations is that budgets are often related more to power and status, than to the needs of the business. Department budget holders may exaggerate budgets to elevate their position in the organization.

• Inaccuracies - Budgeting is only based on forecast costs and revenues, so may turn out to be rather inaccurate.

• Profligacy - This refers to reckless expenditure or wastefulness in the use of resources. In organizations that do not allow budgets to be carried over to the financial year (to prevent overspending), budget holders may feel the need to spend towards the end of the financial year rather than having the money taken away by the master budget holder.

3.9 Case Study Questions

https://docs.google.com/document/d/1LrXS2vJo4PmrutXBnyRchtjYYecLKcxKksm7OuC7tEc/edit?usp=sharing 

3.9 Case Study Answers

https://docs.google.com/document/d/1HDkkdFR5VBXXvtHWswbSxWs5mPxYKzY1MM1RuxDOXN4/edit?usp=sharing