OM Financial Management & Budgeting 2 — Questions and Answers
Question 1: A manager discovers mid-year that actual expenses are running 15% above the approved budget. What is the MOST appropriate first step?
- Request an immediate budget amendment
- Conduct a variance analysis to identify root causes (Correct answer)
- Reduce all departmental spending by 15%
- Defer the issue to the next budget cycle
Correct answer: Conduct a variance analysis to identify root causes
Variance analysis identifies whether overruns stem from controllable issues, price changes, or scope increases before any corrective action is taken.
Question 2: Which budgeting approach requires managers to justify every expenditure from a zero base each period?
- Incremental budgeting
- Rolling budget
- Zero-based budgeting (Correct answer)
- Activity-based budgeting
Correct answer: Zero-based budgeting
Zero-based budgeting starts from zero each cycle, requiring justification for all costs rather than simply adjusting prior-year figures.
Question 3: The current ratio is calculated as current assets divided by current liabilities. A ratio of 0.8 indicates:
- Strong short-term liquidity
- The organization cannot cover short-term obligations with current assets (Correct answer)
- Efficient use of long-term capital
- Excess cash reserves
Correct answer: The organization cannot cover short-term obligations with current assets
A current ratio below 1.0 means current liabilities exceed current assets, signaling potential difficulty meeting short-term obligations.
Question 4: An organization uses a flexible budget. When actual production volume exceeds the budgeted volume, the flexible budget will:
- Remain unchanged from the static budget
- Show higher allowable variable costs (Correct answer)
- Show lower allowable fixed costs
- Show a smaller overall budget
Correct answer: Show higher allowable variable costs
A flexible budget adjusts variable cost allowances proportionally to actual activity levels, so higher volume yields higher allowable variable costs.
Question 5: Which financial statement shows the organization's revenues, expenses, and net income over a specific period?
- Balance sheet
- Statement of cash flows
- Income statement (Correct answer)
- Statement of retained earnings
Correct answer: Income statement
The income statement (also called the profit and loss statement) summarizes revenues and expenses to show net income or loss for a given period.
Question 6: A department head wants to purchase equipment costing $50,000 with a 5-year life. The organization uses a 10% hurdle rate. What capital budgeting technique compares the present value of cash inflows to the initial outlay?
- Payback period
- Net present value (NPV) (Correct answer)
- Return on equity
- Break-even analysis
Correct answer: Net present value (NPV)
NPV discounts future cash inflows at the hurdle rate and compares the result to the initial investment to determine value creation.
Question 7: Encumbrance accounting is PRIMARILY used to:
- Record depreciation on capital assets
- Reserve funds when a purchase order is issued before payment is made (Correct answer)
- Calculate accrued liabilities at period end
- Allocate overhead costs to departments
Correct answer: Reserve funds when a purchase order is issued before payment is made
Encumbrances earmark funds at the time of commitment (e.g., purchase order issuance), preventing overspending before the invoice is received.
OM Financial Management & Budgeting 2
A manager discovers mid-year that actual expenses are running 15% above the approved budget.
What is the MOST appropriate first step?