ICAEW BIP · Chapter 6
Budgeting: purposes and approaches MCQs with Answers
11 multiple-choice questions on Budgeting: purposes and approaches for ICAEW BIP Business Insight and Performance. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
What is a fixed budget?
- A) A budget that includes fixed costs only
- B) A budget prepared for several different levels of activity
- C) A budget prepared for a single, planned level of activity, which is not adjusted when actual activity differs
- D) A budget that cannot be revised once approved by the board
Show answer & explanation
Answer: C) A budget prepared for a single, planned level of activity, which is not adjusted when actual activity differs
A fixed budget is set for one planned level of activity. It is useful for planning but can be misleading for control, because comparing actual results at a different activity level with it mixes up volume effects and efficiency effects. A budget designed to change with activity is a flexible budget.
Question 2
Which of the following is NOT normally a purpose of budgeting?
- A) To co-ordinate the activities of different departments
- B) To guarantee that the organisation will achieve its profit target
- C) To provide a benchmark for controlling actual performance
- D) To communicate plans and targets to managers
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Answer: B) To guarantee that the organisation will achieve its profit target
Budgets help to plan, co-ordinate, communicate, motivate, control and authorise. A budget is a plan expressed in financial terms; it cannot guarantee results, because actual conditions may differ from the assumptions it was built on.
Question 3
A company can sell all it produces, but the supply of a specialist component is restricted. In this situation, what is the principal budget factor?
- A) Sales demand
- B) Cash available for capital expenditure
- C) The availability of the specialist component
- D) Labour hours available
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Answer: C) The availability of the specialist component
The principal (or key) budget factor is the factor that limits the organisation's activities, so it must be budgeted first and all other budgets built around it. Sales demand is often the principal budget factor, but here the company can sell everything it makes, so the limit is the supply of the component.
Question 4
What is the main weakness of incremental budgeting?
- A) It requires every activity to be justified from a zero base
- B) It cannot be used where costs are stable from year to year
- C) It takes far longer to prepare than any other budgeting method
- D) It tends to carry forward past inefficiencies because existing activities are not challenged
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Answer: D) It tends to carry forward past inefficiencies because existing activities are not challenged
Incremental budgeting takes last year's budget or actual results and adjusts them for expected changes such as inflation. It is quick and simple, but builds in any slack and waste from earlier periods and does not ask whether activities are still needed. Justifying every activity from zero describes zero-based budgeting.
Question 5
Which of the following best describes zero-based budgeting?
- A) Budgets are set at zero profit so that managers concentrate on controlling costs
- B) The budget starts from the previous year's actual results, with nothing added for inflation
- C) Each activity must be justified as if it were being started for the first time, and resources are allocated according to ranked decision packages
- D) The budget is updated each quarter by adding a new quarter as the most recent one ends
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Answer: C) Each activity must be justified as if it were being started for the first time, and resources are allocated according to ranked decision packages
Zero-based budgeting starts from a base of zero. Managers identify decision packages for each activity, assess their costs and benefits, and rank them so that limited resources go to the most worthwhile activities. It is especially suited to discretionary costs such as training or marketing, but it is time-consuming to carry out.
Question 6
A company prepares a 12-month budget and, at the end of each quarter, adds a further quarter so that a 12-month budget always exists. What is this approach called and what is its main advantage?
- A) A rolling budget; it reduces the time managers spend on budgeting
- B) A rolling budget; it keeps the budget relevant and realistic as circumstances change
- C) A flexible budget; it adjusts allowed costs to the actual level of activity
- D) An incremental budget; it is quick to prepare from last year's figures
Show answer & explanation
Answer: B) A rolling budget; it keeps the budget relevant and realistic as circumstances change
A rolling (continuous) budget is regularly extended by a further period as each period ends, so it always covers the same length of time ahead and reflects up-to-date conditions. It is useful in fast-changing environments. Its main drawback is that it needs more management time and effort, not less.
Question 7
Which of the following is a recognised disadvantage of participative (bottom-up) budgeting?
- A) Managers may build budgetary slack into their budgets to make targets easier to achieve
- B) Managers are less motivated because targets are imposed on them
- C) The budget is prepared too quickly to be accurate
- D) Local knowledge of operating managers is ignored
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Answer: A) Managers may build budgetary slack into their budgets to make targets easier to achieve
Participative budgeting involves managers in setting their own budgets, which uses their local knowledge and tends to improve motivation and acceptance. The drawbacks are that it takes longer and that managers may deliberately overstate costs or understate revenues to create slack. The other options describe drawbacks of imposed (top-down) budgets.
Question 8
Activity-based budgeting (ABB) differs from traditional budgeting mainly because it:
- A) sets every budget at zero and requires each cost to be justified
- B) budgets revenue first and treats all costs as fixed
- C) uses only direct labour hours as the basis for budgeting overheads
- D) budgets overhead costs by reference to the activities that drive them and the expected level of each cost driver
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Answer: D) budgets overhead costs by reference to the activities that drive them and the expected level of each cost driver
ABB applies ABC principles to budgeting. Expected demand for each activity (such as the number of set-ups or purchase orders) is estimated, and the resources and costs needed are budgeted from it. This gives managers a better understanding of what causes overhead costs and helps them control those costs.
Question 9
Which document sets out the instructions, procedures, timetable and responsibilities for preparing the budget?
- A) The principal budget factor schedule
- B) The budget manual
- C) The cash budget
- D) The master budget
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Answer: B) The budget manual
The budget manual is a collection of instructions for the budget process, covering responsibilities, timetables, procedures and the forms to use. The master budget is the end result of the process (budgeted statement of profit or loss, statement of financial position and cash budget). The budget committee co-ordinates the process.
Question 10
A manager compares forecast results for the rest of the year with the budget and takes action now to correct an expected shortfall before it happens. This is an example of:
- A) feedforward control
- B) feedback control
- C) negative variance analysis
- D) zero-based budgeting
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Answer: A) feedforward control
Feedforward control compares forecast results with targets so that action can be taken before deviations happen. Feedback control compares actual results with budget after the event and responds to variances. Feedforward control is proactive, but it relies on reliable forecasts.
Question 11
In which situation is an imposed (top-down) budget most likely to be appropriate?
- A) A newly formed business in which operational managers have little experience of budgeting
- B) A decentralised group in which divisional managers have full autonomy
- C) A mature business whose managers have detailed local knowledge
- D) An organisation that wants to maximise managers' commitment to targets
Show answer & explanation
Answer: A) A newly formed business in which operational managers have little experience of budgeting
Imposed budgets are more suitable where operational managers lack budgeting skills, in very small or new businesses, in times of crisis, or where senior management needs tight control. Where managers have good local knowledge and commitment matters, or in decentralised organisations, participative budgeting is usually preferred.