Understanding Budgets and Variances

What is a budget?

• A detailed plan for the future expressed in quantitative terms.

• A list of expenses incurred in the past month.

• A summary of past financial performance.

• A document outlining company policies.

Answer explanation

A budget is primarily a detailed plan for the future expressed in quantitative terms, outlining expected income and expenses, which helps in financial planning and management.

What is the primary purpose of a budget?

• To record past financial transactions.

• To provide a forecast of revenues and expenditures.

• To determine the value of a company.

• To calculate taxes owed.

Answer explanation

The primary purpose of a budget is to provide a forecast of revenues and expenditures, helping individuals or organizations plan their financial future effectively.

How can budgets benefit a business?

• By eliminating all financial risks.

• By providing a framework for financial decision-making.

• By ensuring profits are maximised.

• By reducing the need for financial reporting.

Answer explanation

Budgets provide a framework for financial decision-making by outlining expected revenues and expenses, helping businesses allocate resources effectively and make informed choices.

Which of the following is a stakeholder that might be interested in a company's budget?

• Competitors

• Customers

• Employees

• All of the above

Answer explanation

All of the listed groups—competitors, customers, and employees—have a vested interest in a company's budget. Competitors may analyze it for strategic insights, customers may be affected by pricing, and employees may be concerned about job security and resources.

What is an adverse variance?

• When actual performance is better than budgeted performance.

• When actual performance is worse than budgeted performance.

• When actual performance matches budgeted performance.

• When there is no budget set.

Answer explanation

An adverse variance occurs when actual performance is worse than budgeted performance, indicating negative financial impact. This is the correct choice, as it highlights a shortfall compared to expectations.

What is a favourable variance?

• When actual performance is worse than budgeted performance.

• When actual performance is better than budgeted performance.

• When actual performance matches budgeted performance.

• When there is no budget set.

Answer explanation

A favourable variance occurs when actual performance exceeds budgeted performance, indicating better efficiency or profitability. This is the desired outcome for businesses, as it reflects positive financial results.

Calculate the variance: Budgeted cost = £500, Actual cost = £450.

• £50 adverse

• £50 favourable

• £450 adverse

• £450 favourable

Answer explanation

Variance is calculated as Budgeted Cost - Actual Cost. Here, £500 - £450 = £50. Since the actual cost is less than the budgeted cost, this is a £50 favourable variance.

Calculate the variance: Budgeted revenue = £1,000, Actual revenue = £900.

• £100 adverse

• £100 favourable

• £900 adverse

• £900 favourable

Answer explanation

Variance is calculated as Actual Revenue - Budgeted Revenue. Here, £900 - £1,000 = -£100, indicating a shortfall. Since the actual revenue is less than budgeted, this is £100 adverse.

Which of the following is NOT a benefit of budgeting for a business?

• Improved financial control

• Enhanced communication within the organisation

• Guaranteed increase in profits

• Better resource allocation

Answer explanation

The correct choice is 'Guaranteed increase in profits' because budgeting helps in planning and control but does not ensure profits. It improves financial management, communication, and resource allocation.

How can budgets help in performance evaluation?

• By setting benchmarks for comparison.

• By eliminating the need for performance reviews.

• By ensuring all employees receive the same salary.

• By reducing the workload of managers.

Answer explanation

Budgets help in performance evaluation by setting benchmarks for comparison, allowing organizations to measure actual performance against planned targets, thus identifying areas for improvement.