Planning and Budgeting: Solutions to Review Questions

REVIEW QUESTIONS 13 Planning and Budgeting Solutions to Review Questions 13-1. Which has more detail, the budget for the coming period or a long-range forecast? Why? Next period’s budget has more detail because it is closer in time than the longer-range forecasts. The budget plan is a blueprint for operations in the coming period. It must be sufficiently detailed so that it provides adequate direction to the various people responsible for operations. 13-2. What is the purpose of the cash budget if the budgeted income statement will indicate whether the firm expects to be profitable? Cash receipts and disbursements often take place in different time periods from when items are recognized in the income statement and balance sheet. Thus, a company needs to prepare a cash budget to ensure that cash needs will be met. 13-3. Describe four methods used to estimate sales for budgeting purposes. Answers will vary, but examples include: a. Econometric methods—using economic data to forecast using statistical models; b. Delphi technique—collecting and synthesizing the opinion of experts; c. Estimates from salespeople and other knowledgeable personnel; d. Trend analysis—statistical analysis of historical data; e. Market research—collecting information on the macroeconomic trends in the industry and in the local markets. 13-4. What role does the master budget play in the planning and budgeting exercise? The master budget links long-term objectives and short-term, tactical plans. Organization goals are broad-based statements of purpose. Strategic plans take the broad-based statements and expresses them in terms of detailed steps needed to attain those goals. Budgets are the short-term plans used to implement the steps included in the strategic plans. For example, a company might have a goal of "Becoming the number 1 company in the industry." The strategic plans would include such statements as: "Increase sales volume by 20% per year." The master budget would state the number of units that are needed to be produced and sold in the coming period to meet the 20% volume increase as well as the production and marketing costs necessary to attain that objective. The master budget would also include estimates of the levels of cash, accounts receivable, inventories, and fixed assets needed to support the budgeted level of activity. 13-5. What problems might arise if a firm relies solely on management estimates in preparing the master budget? Because middle management has better knowledge about operations at lower levels in the organization, and because budgets are usually used to evaluate performance or compute bonuses for middle management, middle management might have a tendency to underestimate revenues and overestimate costs. This bias arises because if the biased plans are adopted, middle management will find it easier to meet targets and to achieve bonus awards. Of course, if upper management always "tightens" the budget plans suggested by middle management, gaming might result. The disadvantage of this gaming is that the planning effectiveness might be reduced. 13-6. What is the coordinating role of budgeting? Budgeting aids in coordination in a number of ways. By relating sales forecasts to production activities it is possible to reduce the likelihood of over- or under-production. It coordinates production so that plants making subassemblies are making the appropriate number at the right time as needed by the plant making the final assemblies. In addition, the budget process is used to make certain that adequate cash is on hand to finance company activities for the coming period. Guidelines are set for administrative and selling departments so that their costs are commensurate with the company’s income and output goals. 13-7. What is participative budgeting? What are some advantages of participative budgeting? What are some disadvantages? Participative budgeting is a process that uses inputs from lower- or middle-management employees. The advantages include enhanced motivation, acceptance of goals, increased information. The primary disadvantage is the time taken away from other activities. 13-8. Write out the inventory equation that is used to determine required production in the production budget for a manufacturing firm. Required production (units) = Budgeted sales (units) + Ending inventory (units) – Beginning inventory (units) 13-9. What makes creating budgets for marketing and administration more difficult than creating, for example, the production cost budget? It is often more difficult to create the marketing and administration budget, because the managers have more discretion about both the amount and timing of the spending. 13-10. What does the phrase, “use it or lose it,” mean in the context of budgeting? “Use it or lose it” in the context of budgeting refers to the incentive managers have to spend any unused funds prior to the end of the budget year. If they fail to do this, they will lose the money and, possibly, see reduced budgets in the future.