IB DP Business Management: Budgets (HL only) – Revision Notes

These notes condense section 3.9, Budgets, from Unit 3 of the IB Business management guide, first assessment 2024. The section is HL only. For full explanations and the longer worked examples, read the study guide first, then test yourself with the practice questions.

Other links: the course hub is IB DP Business Management, the printable list is the syllabus checklist, and the free diagnostics show which topics need work. Earlier Unit 3 material is in the Unit 3 overview and its revision summary, and the cost ideas are in costs and revenues.

The five content points

Guide content point	Depth of teaching	One-line reminder
Difference between cost and profit centres	AO2	Cost centres record costs only. Profit centres record costs and revenue.
Roles of cost and profit centres	AO2	Control and accountability. Performance judgment and investment decisions.
Constructing a budget	AO2, AO4	Forecast revenue, cost each item, find profit, total across the period.
Variances	AO2, AO4	Actual minus budget, then label favorable or adverse.
Importance of budgets and variances in decision-making	AO2	Plan, control, coordinate, review, but only as good as the assumptions.

Definitions to learn

Term	Meaning (standard working definition)
Budget	A financial plan for a future period, stated in money terms
Cost centre	A part of a business where costs are collected but no revenue is attributed
Profit centre	A part of a business where both costs and revenue are identified, so profit can be found
Variance	The difference between the actual figure and the budgeted figure
Favorable variance	A variance that increases profit compared with the budget
Adverse variance	A variance that reduces profit compared with the budget

Cost centre or profit centre?

Ask one question: does this part of the business earn revenue that can be traced to it?

• Yes: profit centre. Examples: a shop, an online store, a branch, a product line with its own sales.
• No: cost centre. Examples: human resources, IT support, finance, cleaning, security.

Roles in brief:

	Cost centre	Profit centre
Aim of the manager	Keep spending within the budget	Meet revenue, cost and profit targets
Main use to owners	Control and accountability	Judge performance, decide where to invest or review
Main risk	Cutting cost lowers the service others receive	Managers pursue their own profit and ignore the whole business

Method: constructing a budget

1. Choose the period and split it into months.
2. Forecast units and price, then work out sales revenue (units × price).
3. Calculate variable costs (cost per unit × units) and list fixed costs by month.
4. Calculate gross profit (sales revenue − cost of sales), then deduct other expenses.
5. Find profit or loss for each month and total each row.
6. Cross-check: the monthly totals across must equal the column totals down.
7. State your assumptions.

A cost centre budget is the same but stops after the cost lines.

Mini reminder with new numbers: a stall plans 450 units at a price of 14 dollars. Unit cost is 9 dollars and fixed costs are 1,200 dollars. Revenue is 6,300 and variable cost is 4,050. Profit is 6,300 − 4,050 − 1,200 = 1,050.

Method: variances

1. Write the budget figure and the actual figure for the same item and period.
2. Variance = actual − budget.
3. Percentage = variance ÷ budget × 100. Divide by budget, not actual. This is the standard form, as the guide’s formulae list does not give one.
4. Decide F or A using the rule below.
5. Suggest a reason that fits the case.

Item	Actual above budget	Actual below budget
Revenue	F	A
Profit	F	A
Cost	A	F

A memory aid: ask “did this make profit bigger than planned?” If yes, favorable.

Worked reminder: Kowhai Candles

Kowhai Candles budgets one month for its workshop profit centre. The actual figures are alongside.

US dollars	Budget	Actual	Variance	% of budget	F or A
Sales revenue	18,000	19,350	+1,350	+7.5	F
Wax and materials	6,400	7,040	+640	+10.0	A
Rent	2,500	2,500	0	0.0	none
Wages	3,100	3,380	+280	+9.0	A
Profit	6,000	6,430	+430	+7.2	F

The profit variance is favorable (+430) even though two cost variances are adverse. This is because the revenue gain of 1,350 outweighs the extra costs of 920. Check: 1,350 − 640 − 280 = 430.

Costs rose by 10.0% on materials while revenue rose by only 7.5%, so profit per unit of revenue is under pressure. A manager should ask whether the extra sales needed extra wax, or whether the wax supplier raised its price.

Causes to quote

Variance	Possible reasons
Revenue favorable	Higher demand, successful promotion, price increase, new customers
Revenue adverse	Discounts, weak demand, a competitor’s action, a poor forecast
Cost adverse	Supplier price rise, waste, overtime, inflation, extra volume
Cost favorable	Efficiency gain, supplier discount, lower volume, cuts in quality or maintenance (check these)

Tie the reason to the case. Quote a figure from the stem.

Budgets and decision-making

For each benefit, add one limit.

Benefit	Limit
Planning and setting targets	Forecasts can be wrong
Coordination between departments	Takes time and can become rigid
Control of spending	May stop useful, unplanned spending
Accountability of centre managers	Managers may pad costs or understate sales
Variances direct attention to problems	A variance shows what happened, not why
Better later forecasts	Fixing past variances may lead to short-term thinking

Conclusion template for “evaluate” or “justify” questions: budgets are most useful when assumptions are stated and realistic, variances are investigated rather than just reported, and managers take part in setting the targets. The guide’s theory of knowledge prompt asks what assumptions underlie the techniques used when budgeting, which fits that point well.

Quick self-test

1. State what a cost centre is.
2. State what a profit centre is.
3. Is a company’s IT support team normally a cost centre or a profit centre? Give a reason.
4. A budget for materials is 8,000 dollars. Actual spending is 7,600 dollars. Calculate the variance, the percentage, and say whether it is favorable or adverse.
5. Budgeted revenue is 25,000 dollars. Actual revenue is 21,750 dollars. Calculate the variance, the percentage, and label it F or A.
6. Budgeted profit is 4,000 dollars. Actual profit is 5,200 dollars. Calculate the variance and percentage.
7. In the Kowhai table, which two lines show adverse variances?
8. Give one reason why a favorable cost variance might be bad news.
9. Name two benefits of a budget for decision-making.
10. Give one limitation of using variances to judge a manager.

Answers

1. A part of a business where costs are identified and collected, but revenue is not attributed to it.
2. A part of a business where both costs and revenue are identified, so its profit can be measured.
3. A cost centre. It supports other parts of the business and does not earn revenue on its own.
4. 7,600 − 8,000 = −400, which is 400 below budget. The percentage is −400 ÷ 8,000 × 100 = −5.0%. It is a cost, so below budget is favorable (F).
5. 21,750 − 25,000 = −3,250. The percentage is −3,250 ÷ 25,000 × 100 = −13.0%. Revenue is below budget, so it is adverse (A).
6. 5,200 − 4,000 = +1,200, which is +30.0% of budget and favorable.
7. Wax and materials (+640), and wages (+280).
8. The saving may have come from cutting quality, delaying maintenance or buying fewer inputs than the sales needed, which could damage future sales.
9. Any two from: planning, control of spending, coordination, accountability, resource allocation, motivation, appraisal.
10. The manager may not control the cause, for example a supplier price rise or a market downturn, so the variance can be unfair as a measure of effort.

Where marks are usually lost

• Writing “favorable” for any positive number, even when the item is a cost.
• Calculating the percentage against the actual figure rather than the budget.
• Dropping the F or A label, or the sign of the variance.
• Defining a cost centre as a department that makes a loss. It is about recording costs only.
• Giving a list of benefits of budgeting with no link to the business in the case.
• Giving a reason for a variance that contradicts the data, such as “higher demand” for a revenue shortfall.
• Stopping an “evaluate” answer after the advantages, with no limits and no judgment.
• Forgetting to state assumptions or to total rows and columns twice.

Frequently asked questions

What is the difference between a cost centre and a profit centre? A cost centre is a part of a business to which costs can be charged but which earns no revenue of its own, such as human resources or IT support. A profit centre records both revenue and costs, so its profit can be measured.

How do you construct a budget in IB Business Management? Divide the period into months, forecast sales volume and price to find revenue, work out variable and fixed costs, subtract cost of sales and other expenses to reach profit or loss, then total each row and check the totals.

What is a variance? A variance is the difference between a budgeted figure and the actual figure for the same item and period, found as actual minus budgeted.

What layout do IB budget questions use? The guide’s appendix says budgets in case studies or examination questions follow the layout in its figure 11, “Budget: Profit and non-profit entity”.

Official syllabus

IB Diploma Programme Business management guide, first assessment 2024, published by the International Baccalaureate Organization. This page covers section 3.9, Budgets (HL only).