CMA® > CMA® Part 1 > B.2. Budgeting Concepts and Standard Setting > Flashcards

B.2. Budgeting Concepts and Standard Setting Flashcards

Learn core budgeting principles, the development process, and how to establish cost standards. (49 cards)

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1
Q

What is the primary purpose of a budget in a business context?

A

A budget is intended as a planning tool and guideline for achieving the company’s planned goals and objectives.

While budgets are often seen as restrictive, their main function is to guide and plan for future business activities.

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2
Q

How are planning, budgeting, and performance evaluation related?

A
  1. Management develops the strategic plan.
  2. The strategic plan leads to the formulation of the annual budget (profit plan), expressing management’s plans in quantitative terms.
  3. The budget quantifies the likely effects of the strategic plan and provides feedback to the planning process.
  4. The master budget is the document the organization relies on as its operating plan.
  5. The profit plan functions as a control tool because it expresses what measures will be used to evaluate progress.
  6. Comparison of actual results to the profit plan may result in the revision of prior plans and goals or the formulation of new ones, changes in operations, and revisions to the budget.
  7. Changed conditions during the year are used in planning for the next period.

Planning involves setting goals and objectives, budgeting quantifies these plans, and performance evaluation measures the outcomes against the budget.

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3
Q

What is a profit plan also known as?

A

Budget

The terms “profit plan” and “budget” are used interchangeably to express management’s plans in quantitative terms.

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4
Q

What are the advantages of properly developed and administered budgets?

A
  • Promote coordination and communication
  • Provide a framework for measuring performance
  • Provide direction and motivation
  • Promote efficient allocation of resources
  • Provide a means for controlling operations
  • Provide a means to check on progress toward goals
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5
Q

What is the role of variance analysis?

A

It is used to determine whether variances between actual and budgeted results are favorable or unfavorable and to determine the causes of the variances.

It helps in understanding the reasons for variances and in making necessary adjustments.

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6
Q

What is a rolling budget?

A

A budget that covers a set number of months, quarters, or years into the future at all times, with new periods added as old ones are completed.

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7
Q

What are the methods of developing a budget?

A
  • Participative process
  • Authoritative process
  • Consultative process

Participative process: developed from the bottom up

Authoritative process: developed from the top down

Consultative process: senior management asks for input from lower-level managers but then develops the budget with no joint decision-making or negotiation involved

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8
Q

What is budgetary slack?

A
  • It is the difference between the amount budgeted and the amount the manager really expects.
  • It involves underestimating planned revenues and overestimating planned costs to make the overall budgeted profit more achievable.
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9
Q

What is the benefit of a participative budget development process?

A

It is more likely to gain employee commitment and be achievable because it involves input from those responsible for achieving it.

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10
Q

What is a limitation of participative budget development?

A

It can lead to budget targets that are too easy to achieve, known as budgetary slack.

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11
Q

What is the benefit of an authoritative budget development process?

A
  • It gives senior management better control over the decision-making process and emphasizes the achievement of strategic plans.
  • It can be done more rapidly and with greater flexibility than participative budgeting can because it eliminates the need to meet with lower-level managers to negotiate their budgets.

Authoritative budgeting emphasizes the achievement of strategic plans and can be done more rapidly than participative budgeting.

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12
Q

What is a limitation of authoritative budget development?

A

Lower-level managers and employees have no input, leading to less commitment and acceptance, morale problems, and lack of communication between senior management and lower-level managers.

This lack of input can result in objectives that may not be practical or achievable.

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13
Q

What is a benefit of consultative budget development?

A

Management maintains control, and senior management’s strategic plans are integrated into the budget. Budgetary slack is not a problem.

Consultative budgeting requires less time than participative budgeting and can increase acceptance if lower-level input is incorporated.

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14
Q

What is a limitation of consultative budget development?

A
  • It requires more time than authoritative budgeting.
  • If lower-level managers feel their input has been disregarded, they may be even more resentful than if they had never been asked to provide input in the first place.

If lower-level input is disregarded, it can lead to resentment and reduced future participation.

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15
Q

Who should participate in the budgeting process?

A

A combination of:

  • senior management
  • budget committees
  • department heads

Effective budgeting involves bottom-up, top-down, and negotiation approaches.

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16
Q

What is the first step in the budget development process?

A

Setting and communicating budget guidelines.

Guidelines are based on strategic objectives, economic outlook, and other relevant factors.

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17
Q

What is the purpose of variance reporting?

A

To compare actual results to planned results and identify causes of variances.

Variance reporting helps monitor and control operations to meet strategic objectives.

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18
Q

What is a responsibility center, and what role does it play in budgeting?

A
  • A subset of a business with its own staff, policies, procedures, and financial reporting.
  • Budgeting must be done at the responsibility center level so that each responsibility center’s financial results can be compared to the budgeted amounts.

Managers of responsibility centers may be accountable for revenues, expenses, and funds invested, as applicable to the type of responsibility center.

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19
Q

What are controllable costs?

A

Costs for which a manager has the authority to make spending decisions.

Costs that are non-controllable by a given manager are typically controllable costs at a higher organizational level.

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20
Q

What is the role of a manager in relation to non-controllable costs?

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A
  • Costs that are non-controllable by a given manager are not the responsibility of the manager, even though they may appear on the manager’s budget report.
  • Each budgeted cost assigned to a responsibility center should be identified as either controllable or non-controllable by that responsibility center’s management.

Costs that are non-controllable by a manager are controllable at some level. They are typically controlled by higher-level management.

21
Q

What is a standard cost as used in manufacturing?

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A
  • The estimated manufacturing costs for direct materials, direct labor, and manufacturing overhead that are predetermined or estimated as they would occur under the conditions in the budget.
  • The cost allowed for producing one unit of output. It is the sum of the products of each standard direct input multiplied by its standard price, plus allocated overhead.
22
Q

What is a standard input?

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A

The quantity of an input (such as the number of units of direct material or hours of direct labor) allowed to produce one unit of output.

23
Q

What is a standard price?

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A

The price the company expects to pay for one unit of an input.

24
Q

How is the standard direct material cost per unit of output calculated?

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A

The standard material input allowed for one unit of output multiplied by the standard price per unit of that direct material input.

25
What is the **purpose** of standard costing in manufacturing?
To apply costs to production and develop **budgeted costs per unit** for manufactured goods.
26
What is a **static budget**?
A budget that is developed for **one activity level** using the standard or budgeted cost per unit of activity (production level or sales volume, as appropriate). It is not adjusted for actual activity levels that differ from the originally planned activity levels. ## Footnote Comparing actual results to a static budget can be misleading when activity levels change significantly. Static budgets can create unfavorable variances simply due to volume changes rather than operational inefficiencies.
27
What is a **flexible budget**?
A budget prepared using the standard or budgeted costs per unit of activity (production level or sales volume, as appropriate) and the **actual level of activity**.
28
List **methods** used to establish standard costs.
* Activity analysis * Historical data * Target costing * Strategic decisions * Benchmarking ## Footnote **Activity analysis**: identifying and evaluating all the input factors and activities required to complete a job, a project, or an operation efficiently. **Historical data**: using data on costs involved in the manufacture of a similar product in prior periods if accurate data are available. **Target costing**: the target cost is the cost that yields the required profit margin for the product, given a set selling price. **Strategic decisions**: such as a strategic decision to pursue kaizen, the Japanese term for continuous improvement, or a management decision to replace an obsolete piece of equipment with a new machine. **Benchmarking**: industry information about current practices of other companies of similar size and sales or current practices of the best-performing divisions within the same company.
29
What is **activity analysis** when used as a method of establishing standard costs?
Identifying and evaluating all **input factors and activities** required to complete a job, project, or operation efficiently.
30
What is **target costing** when used as a method of establishing standard costs?
A method used when a company needs to sell its product at a **specific price to be competitive**, determining standards that allow the product to be manufactured at the target cost.
31
What is **benchmarking** when used as a method of establishing standard costs?
Using **industry information** about current practices of other companies or best-performing divisions within the same company to set standards.
32
What are the **benefits** of an authoritative standard-setting process, where management sets the standards and they are handed down to those charged with their execution?
* All factors affecting costs receive proper consideration. * Management's expectations are reflected in the standards. * The process is handled more expeditiously than is possible when more individuals are involved.
33
What are the **limitations** of a participative standard-setting process, which involves the lower-level managers and other employees who will be affected by the standards and involves negotiation?
The resulting standards may not support achievement of the company's **strategic goals** or operating objectives.
34
What are the **benefits** of a consultative standard-setting process, where senior management asks for recommendations from lower-level managers but then sets the standards on its own and presents them to those affected by them?
* All cost factors are considered. * Input from employees provides added perspectives for management to consider. * Management's expectations are incorporated. * Supports strategic goals and objectives. * Less time required than participative process.
35
What are the **three considerations** for establishing direct materials standards?
* Required **quality** of materials * **Quantity** needed per unit of output * **Price** per unit of materials ## Footnote **Required quality of materials**: the quantity that will be required, the time required for processing, and the amount of supervision needed during the production process **Quantity needed per unit of output**: based on each product's design, the cost drivers of the manufacturing activities, the quality of the direct materials, and the condition of the plant and equipment **Price per unit of materials**: considerations in addition to price are quality, timing of the purchases, quantity purchased at one time, and vendors' records of reliability for delivering the product on time The involvement of multiple departments, including marketing, engineering, production, and management accountants, is crucial to assess trade-offs and determine the optimum quality that produces the lowest overall cost while meeting market demands.
36
What areas of the organization need to be involved in developing the **quantity standards** for direct materials?
* Industrial engineering department * Production department * Management accountants ## Footnote The quantity standards are based on each product's design, cost drivers, material quality, and the condition of plant and equipment.
37
What factors determine the standards for **direct labor**?
* Type of work * Nature of the manufacturing process * Type of equipment used * Required skill level of employees ## Footnote The quantity standards for direct labor are determined by industrial engineers, the production departments, the labor union, the personnel department, and management accountants.
38
What do the **cost standards** for labor include?
* Hourly wage or salary * Employee benefits * Payroll taxes ## Footnote Employee benefits may include medical insurance, life insurance, pension plan contributions, and paid vacation. Payroll taxes include unemployment taxes and the employer portion of Social Security and Medicare taxes.
39
What are the components of **manufacturing overhead**?
* Indirect materials * Indirect labor * Other indirect costs - for example, depreciation on manufacturing equipment, utilities, and other non-traceable costs ## Footnote Overhead can be variable, fluctuating with production volume, or fixed, remaining constant regardless of production volume.
40
How is the **predetermined overhead rate** calculated?
Budgeted factory overhead costs divided by a predetermined level of activity (traditionally machine hours or direct labor hours)--the standard level of activity allowed for the budgeted production level. ## Footnote The predetermined activity level is the number of machine hours or direct labor hours that are allowed as standard inputs for the number of units planned to be produced. The predetermined rate is used to allocate overhead costs to production based on standard levels of activity allowed **for the actual production**.
41
What are the **steps** in calculating the predetermined overhead allocation rate to be used in standard costing?
* Budget the costs for fixed and variable overhead * Determine appropriate allocation base(s) to use for fixed and for variable overhead * Plan output and how many inputs used as the allocation base(s) will be allowed for the planned production during the year * Divide budgeted overhead by the predetermined activity level of the allocation base(s), usually direct labor hours or machine hours. ## Footnote The predetermined (standard) rate is the amount of overhead that will be allocated for each hour of the allocation base (usually direct labor hours or machine hours) **allowed** for the production of each unit actually produced.
42
What is the **difference** between variable and fixed manufacturing overhead?
* **Variable overhead** varies with production volume, but cost per unit remains constant. It includes costs such as supplies used in manufacturing or the electricity required to operate the equipment. * **Fixed overhead** does not vary with production volume within the relevant range, but standard cost per unit varies with planned volume. Two examples are salaries for plant supervisors and depreciation on plant equipment.
43
What are the **four choices** for determining the budgeted output or activity level?
* Theoretical or ideal capacity * Practical (or currently attainable) capacity * Master budget capacity utilization * Normal capacity utilization ## Footnote **Theoretical or ideal capacity**: the level of activity that will occur if the company produces at its absolutely most efficient level at all times (not achievable). **Practical (or currently attainable) capacity**: the theoretical level reduced by allowances for idle time and downtime but not reduced for any expected decrease in sales demand. **Master budget capacity utilization**: the amount of output expected during the next budget period based on expected demand. **Normal capacity utilization**: the level of activity that will be achieved in the long run, taking into account seasonal changes in the business and cyclical changes. These are called **denominator-level capacity concepts** because they are used as the denominator in calculating standard per-unit fixed overhead costs.
44
What is the best **activity level** to use for the denominator in calculating budgeted fixed cost per unit for developing standards?
Master budget capacity utilization ## Footnote This level is considered applicable to the period for which the standards are being developed, simplifying variance reporting.
45
Which **capacity level** does U.S. GAAP specify for use in external financial reporting?
U.S. GAAP, in ASC 330, specifically prescribes that **normal capacity** is to be used for external financial reporting. Other denominator-level concepts can be used for other purposes.
46
How does an increase in planned production affect the total budgeted variable manufacturing overhead?
It increases in proportion to the higher production level. ## Footnote This increase is due to the planned production level rising while the per-unit cost remains unchanged.
47
Does the total budgeted fixed manufacturing overhead change with increased production within the relevant range?
No ## Footnote The total budgeted fixed manufacturing overhead remains constant if planned production increases as long as the production level remains within the relevant range.
48
What is the "**relevant range**" in manufacturing?
* The range of activity over which a certain cost behavior holds true. * The term is used most often to refer to fixed costs. Fixed costs do not vary in response to changes in activity as long as the activity level remains within a certain range--the relevant range. ## Footnote If the activity level drops below or rises above the relevant range, the fixed cost can change in total.
49
What happens to the standard fixed manufacturing cost per output unit when planned production increases?
It decreases. ## Footnote This decrease occurs because the total fixed overhead is spread over a larger number of units.
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