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1

Which of the following is not a true statement:

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A budget is an action plan for allocating resources and expenditures.

Not the best choice. This actually is a true statement: a budget serves as an action plan for allocating resources and expenditures. It's also a planning tool, as well as a yardstick for measuring performance. The statement that is not true is: "A budget is a historical record of the company's financial results." While historical information may be used in developing a budget, the budget itself is forward-looking.

A budget is a historical record of a company's financial results.

Correct choice. A budget is not a historical document but rather a forward-looking action plan that guides managers' allocation of resources and expenditures based on their assumptions about the future.

A budget is a yardstick for measuring performance.

Not the best choice. This actually is a true statement: a budget is a yardstick for measuring performance. It also serves as a planning tool and as an action plan for allocating resources and expenditures.

The statement that is not true is: "A budget is a historical record of the company's financial results." While historical information may be used in developing a budget, the budget itself is forward-looking.

2

The most important element of the budgeting process is:

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The assessment of variances

Not the best choice. Though analyzing variances between what a budget says and what actually happens is eventually useful, it's not as important as the communication and planning that occur as managers formulate budgets. That's because creating a budget requires managers to consider longer-term goals, challenges, and opportunities facing the organization—all of which shape major decisions about how to respond.

The communication and planning that occur in formulating the budget

Correct choice. The planning and communication activities that take place in formulating a budget require managers to consider longer-term goals, challenges, and opportunities facing the organization—all of which shape major decisions about how to respond.

The end result

Not the best choice. Though analyzing the end result of a budget is eventually useful, it's not as important as the communication and planning that occur as managers formulate budgets. That's because creating a budget requires managers to consider longer-term goals, challenges, and opportunities facing the organization—all of which shape major decisions about how to respond.

3

One significant disadvantage associated with zero-based budgeting is:

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Its in-depth analysis

Not the best choice. The in-depth analysis that characterizes a zero-based budget is actually an advantage, not a disadvantage. It means that the budget is typically more accurate than an incremental budget because of the additional consideration each element receives. The significant disadvantage associated with zero-based budgeting is the additional time required to justify each line item during every budgeting period.

Its overall accuracy

Not the best choice. The overall accuracy that characterizes a zero-based budget is actually an advantage, not a disadvantage. This accuracy (which is greater than that of an incremental budget) stems from the additional consideration each element receives. The significant disadvantage associated with zero-based budgeting is the additional time required to justify each line item during every budgeting period.

Its time costs

Correct choice. One problem that occurs with zero-based budgeting is that the time involved in the budget preparation process can overwhelm planners, making implementation difficult. Managers have to balance the need for increased accuracy with the time required to collect further information.

4

An expense that stays the same when there is an increase in the volume of product produced is categorized as a:

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Fixed cost

Correct choice. Fixed costs, such as rent, administrative costs, and insurance, do not vary with incremental changes in production volumes.

Variable cost

Not the best choice. Variable costs do not stay the same when production levels change. Instead, they typically rise or fall in step with changes in production. Examples of variable costs include direct labor, raw materials, and packaging and shipping. Fixed costs, such as rent, interest expense, and administrative costs remain the same when there are incremental changes in production volumes.

5

Your company's marketing department is forecasting a 15% increase in sales revenue next year. What assumptions should you, the production department manager, make from this forecast as you prepare your budget for next year?

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That sales volume will increase 15%

Not the best choice. You can't actually make any assumptions to inform your own budget until you've identified the assumptions behind the marketing department's revenue forecast. For example, the marketing manager may assume that the projected growth in revenue will come from a lower selling price and a dramatic increase in volume; a higher selling price and a decline in the number of units sold; or a jump in sales volume due to other factors such as increased spending on advertising. Each of these assumptions will have different implications for your budget. Only after you've clarified marketing's assumptions can you then begin preparing your own budget.

No assumptions can be made from this forecast.

Correct choice. Before you can make assumptions that inform your own budget, you must identify the assumptions behind the marketing department's revenue forecast. For example, the marketing manager may assume that the projected growth in revenue will come from a lower selling price and a dramatic increase in volume; a higher selling price and a decline in the number of units sold; or a jump in sales volume due to other factors such as increased spending on advertising. Each of these assumptions will have different implications for your budget. Only after you've clarified marketing's assumptions can you then begin preparing your own budget.

That sales volume will remain the same next year.

Not the best choice. You can't actually make any assumptions to inform your own budget until you've identified the assumptions behind the marketing department's revenue forecast. For example, the marketing manager may assume that the projected growth in revenue will come from a lower selling price and a dramatic increase in volume; a higher selling price and a decline in the number of units sold; or a jump in sales volume due to other factors such as increased spending on advertising. Each of these assumptions will have different implications for your budget. Only after you've clarified marketing's assumptions can you then begin preparing your own budget.

6

It is October 1, and your department's year-to-date revenue is 20% less than what you had budgeted year-to-date. The run rate has jumped sharply since July, while your total expenses are right on budget. One-half of your annual bonus depends on achieving budgeted revenues by the end of the year, and one-half on achieving budgeted gross margin. What action should you take?

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Reduce prices and increase spending on advertising and marketing

Not the best choice. You shouldn't change prices or increase spending unless you've identified what has caused the revenue shortfall. A better move would be to look at the rising run rate and consider its implications. The rising run rate indicates that sales are increasing at current prices, suggesting that the revenue shortfall is due to events in prior months. For example, perhaps sales are seasonal or were affected by other external factors. However, expenses did not decline along with revenue, and as a result you may not be able to achieve the budgeted gross margin even if sales recover. By reviewing expense items, you may be able to identify adjustments you can make to bring expenses into line with the reduced revenue.

Increase prices as well as spending on advertising and marketing

Not the best choice. You shouldn't change prices or increase spending unless you've identified what has caused the revenue shortfall. A better move would be to look at the rising run rate and consider its implications. The rising run rate indicates that sales are increasing at current prices, suggesting that the revenue shortfall is due to events in prior months. For example, perhaps sales are seasonal or were affected by other external factors. However, expenses did not decline along with revenue, and as a result you may not be able to achieve the budgeted gross margin even if sales recover. By reviewing expense items, you may be able to identify adjustments you can make to bring expenses into line with the reduced revenue.

Examine expense items to see if there are any adjustments to spending that you should make

Correct choice. The rising run rate indicates that sales are increasing. And if this continues, sales may come in on budget by the end of the year. The greater risk, and one over which you have more control, is that you will not meet the budgeted gross margin unless you reduce expenses to match the shortfall in revenue.

7

Capital budgeting is the process of:

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Identifying the potential return on a given investment to determine whether the investment makes sense and to compare alternative investment options

Correct choice. Capital budgeting involves evaluating the financial soundness of a proposed capital investment and choosing among alternatives.

Estimating future outlays for property, equipment, and capital assets

Not the best choice. Estimating future outlays for property, equipment, and capital assets is actually the process of preparing a capital budget, not capital budgeting. By contrast, capital budgeting is the process of identifying the potential return on a given investment to determine whether the investment makes sense and to compare alternative investment options.

Plotting the expected cash balances that the organization will experience during the forecast period

Not the best choice. Plotting the expected cash balances that the organization will experience during the forecast period is actually a description of cash budgeting, not capital budgeting. By contrast, capital budgeting is the process of identifying the potential return on a given investment to determine whether the investment makes sense and to compare alternative investment options.

8

You want to determine the potential impact on your division's operating income if the number of product units sold increases by 10%, if the number of product units sold decreases by 5%, and if material costs decrease by 5%. What would you do?

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Estimate costs associated with expected revenues (the cost of goods sold and the estimated SG&A) and calculate expected operating income

Not the best choice. Estimating costs associated with expected revenues (the cost of goods sold and the estimated SG&A) and calculating expected operating income are what you do when you're preparing an operating budget. When you want to determine the potential ramifications of different scenarios, you would conduct a sensitivity analysis, which applies a "what-if" situation to the budget model to see the effect of potential changes on the original data. Using sensitivity analysis, you can see the possible impact of a change in your assumptions about sales, costs, and so forth—without having to generate new forecasts for each budget item, such as raw materials.

Differentiate between fixed and variable costs and then allocate costs using Activity-Based Costing (ABC)

Not the best choice. Differentiating between fixed and variable costs and then allocating costs are steps you take while categorizing expenses as you prepare a budget. When you want to determine the potential ramifications of different scenarios, you would conduct a sensitivity analysis, which applies a "what-if" situation to the budget model to see the effect of potential changes on the original data. Using sensitivity analysis, you can see the possible impact of a change in your assumptions about sales, costs, and so forth—without having to generate new forecasts for each budget item, such as raw materials.

Conduct a sensitivity analysis comparing the units sold, material costs, and operating income shown in your budget against those you would see under the three proposed scenarios

Correct choice. A sensitivity analysis applies a "what-if" situation to the budget model to see the effect of the potential change on the original data. Using sensitivity analysis, you can see the possible impact of a change in your assumptions, without having to generate new forecasts for each budget item, such as raw materials.

9

Which of the following goals might be appropriate for the vice president of Purchasing?

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Reduce material costs by 15%

Correct choice. The purchasing department can make a significant contribution to reducing materials costs by controlling what the company pays for raw materials, and packaging.

Reduce overhead by 10%

Not the best choice. Overhead includes many variables—such as corporate office rents and salaries of corporate managers and administrative employees—that fall outside of the purchasing department's domain. Therefore, reducing overhead by 10% would not be an appropriate goal for the VP of Purchasing. The more appropriate goal would be "Reduce materials costs 15%." The purchasing department can make a significant contribution to reducing materials costs by controlling what the company pays for raw materials and packaging.

Increase sales revenue by 10%

Not the best choice. The purchasing department has little control over sales revenue, so increasing sales revenue by 10% would not be appropriate goal for this VP. The more appropriate goal would be "Reduce materials costs by 15%." The purchasing department can make a significant contribution to reducing materials costs by controlling what the company pays for raw materials and packaging.

10

True or false: The balanced scorecard is linked to the budget process by highlighting the financial results that the company intends to achieve through its competitive strategy.

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True

Not the best choice. This statement is actually false. The balanced scorecard does not link to a company's budgeting process by favoring the organization's intended financial performance. Rather, it is linked to the budget process by (1) highlighting leading indicators; (2) balancing the company's financial, customer, internal process, and innovation and improvement perspectives; and (3) helping managers communicate strategic goals to all stakeholders.

False

Correct choice. The balanced scorecard does not favor the financial perspective; rather, it is linked to the budget process by (1) highlighting leading indicators; (2) balancing the financial, customer, internal process, and innovation and improvement perspectives; and (3) helping managers communicate strategic goals to all stakeholders.

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