Accounting principles 7th kieso kimel chapter 25

Uses and Limitations A static budget evaluates a manager’s effectiveness in controlling costs when: • Actual level of activity closely approximates the master budget activity level, an

Chapter 25

Budgetary Control and

Responsibility

Accounting

Accounting Principles, 7th Edition

Weygandt • Kieso • Kimmel

Prepared by Naomi Karolinski Monroe Community College

and Marianne Bradford Bryant College

CHAPTER 25 Budgetary Control and

Responsibility

Accounting

After studying this chapter, you should be able to:

1 Describe the concept of budgetary control.

2 Evaluate the usefulness of static budget reports.

3 Explain the development of flexible budgets and the usefulness of flexible budget reports.

4 Describe the concept of responsibility

accounting.

5 Indicate the features of responsibility reports

for cost centers.

After studying this chapter, you should be able to:

6 Identify the content of responsibility

reports for profit centers.

evaluating performance in investment

centers.

Budgetary Control

Budgetary Control

A formalized reporting system should :

• Identify the name of the budget report:

overhead budget

• Frequency of the report

• Purpose of the report

• Recipient(s) of the report

Budgetary Control Reporting System

The schedule above illustrates a partial budgetary control

system for a manufacturing company Note the frequency of

Static Budget Reports

• Projection of budget data at one level of activity

• Data for different levels of activity are ignored.

• Actual results are always compared with the

budget data at the activity level in the master

budget.

Budget and Actual Sales

Data

To illustrate the role of a static budget in budgetary

control, we will use selected data for Hayes

Company prepared in Chapter 24

Budget and actual sales data for the Kitchen-mate

product in the first and second quarters of 2005 are as

follows:

$1,000 $10,500 $11,500

The report shows that sales are $1,000 under budget - an

unfavorable result This difference is less that 1% of budgeted

sales ($1,000/$180,000 =.0056), we will assume that top

management of Hayes Company will view the difference as

immaterial and take no specific action.

Sales Budget Report:

First Quarter

The sales budget report for Hayes Company’s 1st quarter is shown below.

$1,000 U

Sales Budget Report:

Uses and Limitations

A static budget evaluates a manager’s effectiveness

in controlling costs when:

• Actual level of activity closely approximates the master

budget activity level, and/or

• Behavior of the costs in response to changes in activity is

fixed.

A static budget is useful in controlling costs when cost behavior is:

a mixed.

b fixed.

c variable.

d linear.

A static budget is useful in controlling costs when cost behavior is:

a mixed.

b fixed.

c variable.

d linear.

Flexible Budgets

STUDY OBJECTIVE 3

• A flexible budget projects budget data for various levels of activity

• The flexible budget recognizes that the

budgetary process is more useful if it is

adaptable to changed operating conditions

Static Overhead Budget

Barton Steel prepares the above static budget for manufacturing overhead based on a production volume of 10,000 units of steel ingots

(Budget based on 10,000 units of production)

If demand for steel

ingots has increased

and 12,000 units are

produced during the

year, rather than

10,000, the budget

report will show

very large variances.

This is because the

$132,000

Variable Costs per Unit

/10,000 units $25 /10,000 units 26 /10,000 units 19 $70

Comparing actual variable costs with budgeted costs

is meaningless (due to different levels of activity),

variable per unit costs must be isolated, so the budget can be adjusted An analysis of the budget data for

these costs at 10,000 units produces the above

per unit results:

The budgeted variable costs at 12,000

units, therefore, are shown above

Because FIXED costs do not change in

total as activity changes, the budgeted

amounts for these costs remain the same.

Illustration 25-9

Budgeted Variable Costs

( 12,000 units )

$300,000 312,000 228,000

$840,000

Flexible Overhead Budget

-0-

-0- -0- -0-

$8,000 F

Developing the Flexible

Budget

• Identify the activity index and the relevant range of

activity.

• Identify the variable costs, and determine the

budgeted variable cost per unit of activity for each cost.

• Identify the fixed costs, and determine the budgeted

amount for each cost.

• Prepare the budget for selected increments of

activity within the relevant range.

Flexible Budget -A Case Study

Master Budget Data

Fox Company wants to use a flexible budget for monthly

comparisons of actual and budgeted manufacturing

overhead costs The master budget for the year ended

December 31, 2005 is prepared using 120,000 direct

labor hours and the following overhead costs.

STEP 1: Identify the activity index and the relevant range of activity:

The activity index is direct labor hours and management concludes that the relevant range is 8,000-12,000 direct labor hours.

Flexible Budget-A Case Study

Computation of variable costs per direct labor

hour

STEP 2: Identify the variable costs and determine the budgeted variable cost per unit of activity for each cost.

There are 3 variable costs and the per unit variable cost is found by

dividing each total budgeted cost by the direct labor hours used in

preparing the master budget (120,000 hours).

Flexible Budget

A Case Study

• Step 3: Identify the fixed costs and determine the

budgeted amount for each cost.

• There are three fixed costs and since Fox desires monthly

budget data, the budgeted amount is found by dividing each annual budgeted cost by 12 ($180,000/12 =$15,000).

• Step 3: Identify the fixed costs and determine the

budgeted amount for each cost.

• There are three fixed costs and since Fox desires monthly

budget data, the budgeted amount is found by dividing each annual budgeted cost by 12 ($180,000/12 =$15,000).

Flexible Budget - A Case Study

Flexible Monthly Overhead

Budget

Step 4: Prepare the budget for selected increments of activity within

Flexible Budget - A Case Study

Formula for Total Budgeted

Costs

Variable Costs

Total Budgeted Costs

Fixed

• From the budget, the following formula may be used

to determine total budgeted costs at any level of activity.

• For Fox Manufacturing, fixed costs are $30,000, and

total variable costs per unit is $4.00

• Thus, at 8,622 direct labor hours, total budgeted costs

are:

EX AM

PL E

$30,000 $4.00 x 8,622 $64,488

Flexible Budget Reports

Another type of internal report produced

by managerial accounting Two sections:

Flexible budgets are used to evaluate a manager’s performance in production control and cost control.

Graphic Flexible Budget Data

Flexible Overhead Budget

Report

$ 13,500

18,000 4,500

36,000

15,000 10,000 5,000 30,000 $66,000

FOX MANUFACTURING COMPANY Flexible Manufacturing O verhead Budget Report

Finishing Department For the Month Ended January 31, 2005

Expected 8,800

Actual 9,000

Budget at 9,000 DLH

Actual Costs 9,000 DLH

Favorable F Unfavorable U

Management by Exception

Review of a budget report

• Focus on differences between actual results and

– more restrictive for controllable items than for

items that are not controllable by the manager

The Concept of Responsibility Accounting

accumulating and reporting costs (and

revenues, where relevant) on the basis of the manager who has the authority to make the day-to-day decisions about the items

• A manager's performance is evaluated on the matters directly under the

manager's control.

Responsibility Accounting

Used at every level of management in which the following conditions exist:

• Costs and revenues associated with the specific

level of management responsibility.

• The costs and revenues are controllable at the

level of responsibility with which they are associated.

• Budget data can be developed for evaluating the

manager's effectiveness in controlling the costs and revenues.

Responsibility Accounting

• Valuable in a decentralized company.

• Decentralization

– control of operations delegated to many managers

throughout the organization

• Segment

– an identified area of responsibility in

decentralized operations

Responsibility Accounting

vs Budgetary Control

Responsibility accounting differs from

budgeting in two respects:

• Distinction between controllable and

noncontrollable items

• Performance reports

– either emphasize or include only items controllable by

the individual manager

Controllable versus Noncontrollable Revenues

and Costs

• Controllable

– manager has the power to incur it within a

given period of time

• Noncontrollable

– Costs incurred indirectly and allocated to a

responsibility level.

Responsibility Reporting

System

• Involves preparation of a report for each

level of responsibility in the company's

organization chart

• Permits management by exception at

each level of responsibility.

Responsibility Reporting System

Types of Responsibility Centers

Examples of Responsibility

$ 500 U 1,000 F

100 U Supervision 4,000 4,000 -0-

$400 F

Top management may want an explanation

of these variance

Responsibility Accounting

for Profit Centers

• Profit center

– the operating revenues and variable expenses are controllable

by the manager of the profit center

• Necessary to distinguish between direct and indirect

fixed costs.

• Direct fixed costs or traceable costs

– costs that relate specifically to a responsibility center and are

incurred for the sole benefit of the center

• Indirect fixed costs

– pertain to a company's overall operating activities

– incurred for the benefit of more than one profit center

– most indirect costs are not controllable by the profit center

manager.

Responsibility Report

• Shows budgeted and actual controllable

revenues and costs for a profit center

• Prepared using the cost-volume-profit income

Responsibility Report for

a Profit Center

Controllable fixed costs

Note that this report does not show

noncontrollable fixed costs

This manager was below budgeted expectations by approximately 10% ($36,000/

$360,000)

Responsibility Accounting

for Investment Centers

• Investment center

– the manager can control or significantly influence the

investment funds available for use.

• Return on investment (ROI)

– Basis for evaluating the performance of a manger of an

investment center

– considered superior to any other performance

measurement

– shows the effectiveness of the manager in utilizing the

assets at his or her disposal

ROI Formula

Investment

Center Controllable

Margin /

Average Investment Center Operating

Return on Investment (ROI)

• Operating assets

– Current assets and plant assets used in operations by the

center (Nonoperating assets such as idle plant assets and land held for future use are excluded)

• Average operating assets

– usually based on the beginning and ending cost or book values of the

assets

$1,000,000 / $5,000,000 = 20%

Responsibility Report for

Investment Center

Other fixed costs 60,000 60,000

Controllable margin $300,000 264,000 $36,000 U

Since an investment center is an

independent entity for operating purposes,

all fixed costs are controllable by the investment center manager Assume

in this example that the manager can control $60,000

of fixed costs that were not

controllable when the division was a profit center.

Responsibility Report for

Investment Center

Assuming actual average operating assets are $2,000,000

actual and budgeted ROI is calculated as follows:

Return on Investment 15% 13.2% 1.8%

Top management would likely want an explanation of the reasons for actual ROI being 12% below budgeted ROI (1.8% / 15%).

Assumed Data for Marine

Division

• A manager can improve ROI by:

– Increasing controllable margin or

– Reducing average operating assets.

• Assume the following data for the Marine Division

of Mantle Manufacturing:

If sales increased by 10%, or $200,000 ($2,000,000 x 10) and there was no change

in the contribution margin percentage of 45%, contribution margin will increase

$90,000 ($200,000 x 45) Controllable margin will increase by the same amount because controllable fixed costs will not change Thus, controllable

margin becomes $690,000 ($600,000 +$90,000) The new ROI is 13.8%, computed

as follows:

ROI computation increase in Sales

-13.8%

$690,000 / $5,000,000 =

New controllable margin / Average operating assets

ROI computation decrease in costs

14.8%, computed as follows:

New Controllable margin / Average operating assets

ROI Computation decrease in operating

-assets

13.3%

A manager can also improve ROI by reducing average operating

assets Assume that average operating assets are reduced 10% or

$500,000 ($5,000,000 x 10) Average operating assets become

$4,500,000 ($5,000,000 - $500,000), Since controllable margin remains unchanged at $ 600,000 , the new ROI is 13.3%, computed as follows:

$600,000 / $4,500,000 =

Controllable margin / New average operating assets

Judgmental Factors in

ROI

The return on investment approach

includes two judgmental factors:

Operating assets may be valued at acquisition

cost, book value, appraised value, or market

value.

This measure may be controllable margin, income from operations, or net income.

Principles of Performance

Evaluation

Performance evaluation

• a management function that compares

actual results with budget goals

• includes both behavioral and reporting

principles.

Responsibilities centers include:

Responsibilities centers include:

Copyright © 2005 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written consent of the copyright owner

is unlawful Request for further information should be addressed to the

Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused

by the use of these programs or from the use of the information contained

herein.

Copyright © 2005 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written consent of the copyright owner

is unlawful Request for further information should be addressed to the

Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused

by the use of these programs or from the use of the information contained

herein.