Lecture Accounting principles (7th Edition): Chapter 25 – Weygandt, Kieso, Kimmel

Chapter 24 - Budgetary control and responsibility accounting. In this chapter, the learning objectives are: Describe the concept of budgetary control, evaluate the usefulness of static budget reports, explain the development of flexible budgets and the usefulness of flexible budget reports.

    John Wiley & Sons, Inc. © 2005

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

4   Describe the concept of responsibility 

accounting.

5   Indicate the features of responsibility reports 

for cost centers.

Budgetary Control

Budgetary Control Reporting

System

The schedule above illustrates a partial budgetary control

system for a manufacturing company Note the frequency of reports and their emphasis on control

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

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

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)

     $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

         ­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 8,000­12,000 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).

• 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  the relevant range.

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

Graphic Flexible Budget Data

Flexible Overhead Budget Report

    $ 13,500   

18,000           4,500 

36,00015,000 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  

Direct labor hours (DLH)       Difference   Expected 8,800  

Actual     9,000   9,000 DLH  Budget at   Actual Costs  9,000 DLH   Unfavorable U  Favorable  F 

• A manager's performance is evaluated on the 

manager's control.

• Segment

– an identified area of responsibility in      

decentralized operations

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

• Profit center: individual departments of retail stores and branch offices of banks.

• Investment center: subsidiary companies 

$ 500 U1,000 F

   100 U Supervision       4,000       4,000       ­0­

 $400 F

Top  management may want an explanation

of these  variance. 

• Direct fixed costs  or traceable costs 

– costs that relate specifically to a responsibility center and are  incurred for the sole benefit of the center.  

1) Controllable fixed costs 

2)C ontrollable margin

3) Noncontrollable fixed costs are not reported.

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

$360,000). 

• 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 (in dollars)

/

Average Investment Center Operating Assets

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%

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.

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%

$740,000 / $5,000,000 =

Controllable margin can also be increased by reducing variable andcontrollable fixed costs.  

If variable and fixed costs were decreased by 10%, total costs willdecrease $140,000[($1,000,000 + $300,000) x .10]. This reduction willresult in a corresponding increase in controllable margin. Thus, thismargin becomes $740,000 ($600,000 + $140,000), and the new ROI is

14.8%, computed as follows:

New Controllable margin / Average operating assets

ROI Computation decrease in operating assets

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

Controllable margin / New average operating assets

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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.