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Chapter 10Richard E. McDermott, Ph.D.
Budgetary Control and Responsibility Accounting
Presentation ApproachAs much of the material is self-explanatory,
this presentation will only focus on conceptual concepts that need additional explanation.
As always, students are responsible for all material in the chapter.
Static BudgetsStatic budgets are budgets that do not vary
with changes in production or sales volume.
Static budgets are of limited use for cost control or performance evaluation.
The only reason Professor McDermott can see for using a static budget (versus a flexible budget) is:If the company can forecast volume with
certainty, orIf the company cannot identify variable costs
Flexible Budget FormulaA formula that Professor McDermott has
found to be useful to students in working flexible budgeting problems is:
Y = a + bXWhereY = total flexible budgeta = total fixed costsb = variable costs per unitX = production or sales volume
Example ProblemThe controller of XYZ Company has provided
you with the following cost information on the company’s product line.
Total fixed costs equals $200,000Variable cost per unit is $10Next year the company anticipates
manufacturing 25,000 unitsWhat should be the flexible budget for the
year?Y = 200,000 + 10(25,000)Y = $450,000
Responsibility AccountingInvolves accumulating and reporting costs
(and revenues where relevant) on the basis of the manager who has authority to make day-to-day decisions about the items.
Is based on the concept that managers should not be held accountable for revenues and costs over which they have no control.
Types of Responsibility CentersCost Center. Incurs costs but does not
generate revenue.Profit Center. Incurs both costs and
revenues.Investment Center. Incurs both costs and
revenues. In addition has responsibility for assets used in generating revenues.Investment center managers are evaluated
on both the profitability of the center and the rate of return earned on the funds invested.
Responsibility ReportPrepared using the cost volume profit
income statement explained in chapter 5.Steps:
Contribution margin is calculated by subtracting variable costs from revenues.
Controllable fixed costs are subtracted from contribution margin.
The resulting balance is known as the controllable margin.
Let’s see an example!
Responsibility Report Format
Budget Actual Variance
Sales $xxx $xxx $xxx
Less variable costs
$xxx $xxx $xxx
Contribution margin
$xxx $xxx $xxx
Less controllable fixed costs
$xxx $xxx $xxx
Controllable margin
$xxx $xxx $xxx
Everything here is under control of one manager!
Return on Investment (ROI)ROI is used in evaluating managers of
investment centers because it measures the effectiveness of the manager and utilizing the assets at his or her disposal.
Formula:When using responsibility accounting, we
divide the controllable margin (instead of operating income) by average operating assets to calculate return on investments (ROI).
Controllable margin ÷ average operating assets = ROI
Exercise 10-1 Identify each of the statements on the
following slide as true or false.If false, indicate how to correct the
statement.
Exercise 10-11.Budget reports compare actual results
with planned objectives.True.
2. All budget reports are prepared on a weekly basis.False. Budget reports are prepared as frequently as needed.
3. Management uses budget reports to analyze differences between actual and planned results and determine their causesTrue.
Exercise 10-14. As a result of analyzing budget
reports, management may either take corrective action or modify future plans.True.
5. Budgetary control works best when the company has an informal reporting system.False. Budgetary control works best when a company has a formalized reporting system.
Exercise 10-16. The primary recipients of the sales
reporter the sales manager and the vice president of production.False. The primary recipients of the sales report are the sales manager and top management.
7. The primary recipient of the scrap report is production manager.
True.8. A static budget is a projection of budget
data at one level of activity.True.
Exercise 10-19. Top management’s reaction to
unfavorable differences is not influenced by the materiality of the differenceFalse. Top management’s reaction to unfavorable differences is often influenced by the materiality of the difference.
10.A static budget is not appropriate in evaluating a manager’s effectiveness in controlling costs unlessthe actual activity level approximates the static budget level or the behavior of the cost is fixed.True.
Exercise 10-3XYZ company uses a flexible budget for
manufacturing overhead based on direct labor hours.
Variable manufacturing overhead costs per direct labor hour are as follows:indirect labor $1.00indirect material $0.50utilities $0.40
Exercise 10-3Fixed overhead costs per month are:
Supervision $4000Depreciation the $1500Property taxes $800
The company believes it will normally operate in a range of 7,000 to 10,000 direct labor hours per month.
Prepare a monthly manufacturing overhead flexible budget for 2008 for the expected range of activity, using increments of 1,000 direct labor hours.
Exercise 10-3
Activity levelDirect labor hours 7,000 8,000 9,000 10,000
Since we are working with a flexible budget, we must first identify the activity level. The activity level is the cost driver – the activity that drives variable costs. In this problem it is direct labor hours.
Exercise 10-3
Activity levelDirect labor hours
Variable costsIndirect labor ($1)Indirect materials ($.50)Utilities ($.40)
Total variable costs ($1.90)
7,000
$ 7,000 3,500 2,800 13,300
8,000
$ 8,000 4,000 3,200 15,200
9,000
$ 9,000 4,500 3,600 17,100
10,000
$10,000 5,000 4,000 19,000
Now multiply in the variable costs per activity level by the budgeted number of activities to get total variable costs.
Exercise 10-3
Activity levelDirect labor hours
Variable costsIndirect labor ($1)Indirect materials ($.50)Utilities ($.40)
Total variable costs ($1.90)Fixed costs
SupervisionDepreciationProperty taxes
Total fixed costsTotal costs
7,000
$ 7,000 3,500 2,800 13,300
4,000
1,500 800 6,300$19,600
8,000
$ 8,000 4,000 3,200 15,200
4,000
1,500 800 6,300$21,500
9,000
$ 9,000 4,500 3,600 17,100
4,000
1,500 800 6,300$23,400
10,000
$10,000 5,000 4,000 19,000
4,000
1,500 800 6,300$25,300
Now insert fixed costs. Then total variable and fixed costs to give a total budget at each level of activity.
Exercise 10-4Using the information from exercise 10-3,
assume that in 2008, the company incurs the following manufacturing overhead costs.Variable costs Fixed costs
Indirect labor $8,700 Supervision $4,000
Indirect materials 4,300 Depreciation 1,500
Utilities 3,200 Property taxes 800
Direct labor hours (DLH)Variable costs
Indirect laborIndirect materialsUtilities
Total variable costsFixed costs
SupervisionDepreciationProperty taxes
Total fixed costsTotal costs
Budget at9,000 DLH
$ 9,000 4,500 3,600 17,100
4,000 1,500 800 6,300$23,400
Actual Costs9,000 DLH
$ 8,700 4,300 3,200 16,200
4,000 1,500 800 6,300$22,500
Difference
$300 F 200 F 400 F 900 F
$900 F
RANEY COMPANYManufacturing Overhead Flexible Budget ReportFor the Month Ended July 31, 2008
Prepare a flexible budget at 9,000 hours.
Direct labor hours (DLH)Variable costs
Indirect laborIndirect materialsUtilities
Total variable costsFixed costs
SupervisionDepreciationProperty taxesTotal fixed costs
Total costs
Budget at8,500 DLH
$ 8,500 4,250 3,400 16,150
4,000 1,500 800 6,300$22,450
Actual Costs
8,500 DLH$ 8,700 4,300 3,200 16,200
4,000 1,500 800 6,300$22,500
Difference
$200 U 50 U 200 F 50 U
$ 50 U
RANEY COMPANYManufacturing Overhead Flexible Budget ReportFor the Month Ended July 31, 2008
Prepare a flexible budget at 8,500 hours.
Exercise 10-4Comment on your findings.In case (a) the performance for the month
was satisfactory.In case (b) management may need to
determine the causes of the unfavorable differences for indirect labor and indirect materials, or since the differences are small, 2.4% of budgeted cost for indirect labor and 1.2% for indirect materials, they might be considered immaterial.
Exercise 10-8As sales manager, Terry DeWitt was given the
following static budget report for selling expenses in the clothing department of XYZ Company for the month of October.
As a result of this budget report, he was called in and congratulated on his fine sales performance.
He was reprimanded, however ,for allowing his cost to get out of control.
Terry was sure that something was wrong with the performance report that he had been given. However he was not sure what to do and comes to you for advice.
Prepare a budget report based on flexible budget data to help Terry.
Garber Company Budget Report for October 31, 2008
Budget Actual DifferenceSales in units 8000 10,000 -2,000Variable expensesSales commissions 2000 2600 -600Advertising expenses 800 850 -50Travel expense 3600 4000 -400Free samples give amount 1600 1300 300Total variable 8000 8750 -750
Fixed expensesRent 1500 1500 0Sales salaries 1200 1200 0Office salaries 800 800 0Depreciation 500 500 0Total fixed 4000 4000 0Total expenses 12000 12750 -750
Original Report
Garber Company Budget Report for October 31, 2008
Variable
BudgetCost per
unit Actual DifferenceSales in units 10,000 10,000 -2,000Variable expensesSales commissions 2,500 0.25 2,600 -100Advertising expenses 1,000 0.10 850 150Travel expense 4,500 0.45 4,000 500Free samples give amount 2,000 0.20 1,300 700Total variable 10,000 1.00 8,750 1,250
Fixed expensesRent 1500 1500 0Sales salaries 1200 1200 0Office salaries 800 800 0Depreciation 500 500 0Total fixed 4000 4000 0Total expenses 14000 12,750 1,250
Corrected Variable Cost Report
We calculate per unit cost first by dividing budget
by units of activity.
Then we multiply per unit cost by actual activity
Exercise 10-8Terry should not have been
reprimanded. As shown in the flexible budget report, variable costs were $1,250 below budget.
Exercise 10-9XYZ Plumbing company is a newly formed company
specializing in plumbing service for home and business.The owner has divided the company into two segments:
home plumbing services and business plumbing services.Each segment is run by its own supervisor, all basic selling
and administrative services are shared by both segments.The president has asked you to help him create a
performance reporting system that will allow them to measure each segments performance in terms of its profitability.
To that end following information has been collected on the home services segment for the first quarter of 2008.
Exercise 10-9
Budgeted ActualService revenue 25,000 26,000Allocated portion of:Building depreciation 11,000 11,000Advertising 5000 4200Billing 3500 3000Property taxes 1200 1000Material and supplies 1500 1200Supervisory salaries 9000 9400Insurance 4000 3500Wages 3000 3300Gas and oil 2700 3400Equipment depreciation 1600 1300
Exercise 10-9Prepare a responsibility report for the first
quarter of 2008 for the home plumbing service segment.
Remember the formula:Revenue – variable expenses – controllable
fixed expenses = controllable margin
Budget Actual
DifferenceFavorable F
Unfavorable UService revenue $25,000 $26,000 $1,000 FVariable costs:
Material and supplies 1,500 1,200 300 FWages 3,000 3,300 300 UGas and oil 2,700 3,400 700 U
Total variable costs 7,200 7,900 700 UContribution margin 17,800 18,100 300 F
Responsibility ReportFor the Quarter Ended March 31, 2008
Calculate the contribution margin first:
Budget Actual
DifferenceFavorable F
Unfavorable UService revenue $25,000 $26,000 $1,000 FVariable costs:
Material and supplies 1,500 1,200 300 FWages 3,000 3,300 300 UGas and oil 2,700 3,400 700 U
Total variable costs 7,200 7,900 700 UContribution margin 17,800 18,100 300 FControllable fixed costs:
Supervisory salaries 9,000 9,400 400 UInsurance 4,000 3,500 500 FEquipment depreciation 1,600 1,300 300 F
Total controllable fixed costs 14,600 14,200 400 FControllable margin $ 3,200 $ 3,900 $ 700 F
Responsibility ReportFor the Quarter Ended March 31, 2008
Then subtract controllable fixed expenses:
Exercise 10-9Write a memo to the president discussing
the principles that should be used when preparing a performance report.
Exercise 10-9Points to be covered:When evaluating the performance of a
company’s segments, the performance reports should:Contain only data that are controllable by the
segment’s manager. Provide accurate and reliable budget data to
measure performance.Highlight significant differences between actual
results and budget goals.Be tailor-made for the intended evaluation.Be prepared at reasonable intervals.
The End
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