10
Chapter
Budgetary Control and
Responsibility Accounting
BUDGETARY CONTROL
 A major function of management is to control
operations
 One element is the use of budget reports which
compare actual results with planned objectives
 Provides management with feedback on operations
BUDGETARY CONTROL
 Schedule below illustrates a partial budgetary control
system for a manufacturing company.
 Note the frequency of reports and their emphasis on
control
Static Budgets and Performance
Reports
Hmm! Comparing
Static budgets are
prepared for a single,
planned level of
activity.
Performance
evaluation is difficult
when actual activity
differs from the
planned level of
activity.
static budgets with
actual costs is like
comparing apples
and oranges.
Let’s look at CheeseCo.
Static Budgets and Performance
Reports
CheeseCo
Static
Budget
Machine hours
Variable costs
Ind irect labor
Indirect materials
Power
Fixed costs
Depreciation
Insurance
Total overhead costs
Actual
Results
10,000
8,000
$ 40,000
30,000
5,000
$ 34,000
25,500
3,800
12,000
2,000
12,000
2,050
$ 89,000
$ 77,350
Variances
Static Budgets and Performance
Reports
CheeseCo
Static
Budget
Machine hours
10,000
Actual
Results
Variances
8,000
2,000 U
Variable costs
U = Unfavorable
variance
Ind irect labor
$ 40,000
$ 34,000
was30,000
unable to achieve
Indirect CheeseCo
materials
25,500
the budgeted 5,000
level of activity.
Power
3,800
Fixed costs
Depreciation
Insurance
Total overhead costs
$6,000 F
4,500 F
1,200 F
12,000
2,000
12,000
2,050
0
50 U
$ 89,000
$ 77,350
$11,650 F
Static Budgets and Performance
Reports
CheeseCo
Static
Budget
Machine hours
Variable costs
Ind irect labor
Indirect materials
Power
Actual
Results
Variances
10,000
8,000
2,000 U
$ 40,000
30,000
5,000
$ 34,000
25,500
3,800
$6,000 F
4,500 F
1,200 F
F = Favorable variance that occurs when
Fixed costs
actual
costs are less than
budgeted12,000
costs.
Depreciation
12,000
Insurance
2,000
2,050
Total overhead costs
$ 89,000
$ 77,350
0
50 U
$11,650 F
Static Budgets and Performance
Reports
CheeseCo
Static
Budget
Machine hours
Variable costs
Ind irect labor
Indirect materials
Power
Actual
Results
Variances
10,000
8,000
2,000 U
$ 40,000
30,000
5,000
$ 34,000
25,500
3,800
$6,000 F
4,500 F
1,200 F
Since cost variances are favorable, have
Fixed costs
we
done a good job controlling
costs?
Depreciation
12,000
12,000
Insurance
2,000
2,050
Total overhead costs
$ 89,000
$ 77,350
0
50 U
$11,650 F
Static Budgets and Performance
Reports
I don’t think I
can answer the
question using
a static budget.
Actual activity is below
budgeted activity which
is unfavorable.
So, shouldn’t variable costs
be lower if actual activity
is lower?
Static Budgets and Performance
Reports
 The relevant question is . . .
“How much of the favorable cost variance is
due to lower activity, and how much is due
to good cost control?”
 To answer the question,
we must
the budget to the
actual level of activity.
Flexible Budgets
Show revenues and expenses
that should have occurred at the
actual level of activity.
May be prepared for any activity
level in the relevant range.
Reveal variances due to good cost
control or lack of cost control.
Improve performance evaluation.
Flexible Budgets
Central Concept
If you can tell me what your activity was
for the period, I will tell you what your costs
and revenue should have been.
Management by Exception
Focus of top management’s review of a budget
report:
differences between actual and planned results
Able to focus on problem areas
Investigate only material and controllable
exceptions
Express materiality as a
percentage difference from budget either over or under budget
Controllability relates to those items
controllable by the manager
Preparing a Flexible Budget
To
a budget we need to know that:
Total variable costs change
in direct proportion to
changes in activity.
Total fixed costs remain
unchanged within the
relevant range.
Fixed
Preparing a Flexible Budget
Preparing a Flexible Budget
CheeseCo
Cost
Formula
Per Hour
Total
Fixed
Cost
Flexible Budgets
8,000
10,000
Hours
Hours
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
8,000
$
4.00
3.00
0.50
7.50
12,000
Hours
10,000
12,000
Variable costs are expressed as
$ 32,000 amount per hour.
a constant
24,000
$40,000
4,000 ÷ 10,000 hours
$ 60,000
$4.00 per hour.
$12,000
2,000
is
Fixed costs are
expressed as a
total amount.
Preparing a Flexible Budget
CheeseCo
Cost
Formula
Per Hour
Total
Fixed
Cost
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Flexible Budgets
8,000
10,000
Hours
Hours
8,000
$
Fixed costs
Depreciation $4.00
Insurance
Total fixed cost
Total overhead costs
4.00
3.00
0.50
7.50
10,000
$ 32,000
24,000
4,000
$ 60,000
per hour
× 8,000 hours = $32,000
$12,000
2,000
12,000
Hours
12,000
Preparing a Flexible Budget
CheeseCo
Cost
Formula
Per Hour
Total
Fixed
Cost
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
$
4.00
3.00
0.50
7.50
$12,000
2,000
Flexible Budgets
8,000
10,000
Hours
Hours
12,000
Hours
8,000
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
$ 48,000
36,000
6,000
$ 90,000
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 89,000
$ 12,000
2,000
$ 14,000
$ 104,000
Preparing a Flexible Budget
CheeseCo
Cost
Formula
Per Hour
Total
Fixed
Cost
Machine hours
Variable costs
Indirect
labor fixed costs
4.00
Total
Indirect material
3.00
do
not
change
in
Power
0.50
the relevant
Total variable
cost
$ range.
7.50
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
$12,000
2,000
Flexible Budgets
8,000
10,000
Hours
Hours
12,000
Hours
8,000
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
$ 48,000
36,000
6,000
$ 90,000
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 89,000
$ 12,000
2,000
$ 14,000
$ 104,000
Trepid Manufacturing Company prepared a
static budget of 40,000 direct labor hours,
with estimated overhead costs of $200,000
for variable overhead and $60,000 for fixed
overhead. Trepid then prepared a flexible
budget at 38,000 labor hours. How much is
total overhead costs at this level of activity?
a
$247,000
b
$250,000
c
$260,000
d
$190,000
Flexible Budget Performance Reports
Monthly comparisons of actual and budgeted
manufacturing overhead costs
A type of internal report
Consists of two sections:
Production data for a selected activity
index, such as direct labor hours
Cost data for variable and fixed costs
Widely used in production and service departments
to evaluate a manager’s performance in production
control and cost control
Flexible Budget
Performance Report
CheeseCo
Cost
Total
FlexibleFormula
budget
is
Fixed
prepared
for theCosts
Per Hour
same activity level
Machine hours
(8,000 hours) as
Variable costs
actually$achieved.
Indirect labor
4.00
Indirect material
Power
Total variable costs
Fixed Expenses
Depreciation
Insurance
Total fixed costs
Total overhead costs
$
3.00
0.50
7.50
$ 12,000
2,000
Flexible
Budget
Actual
Results
8,000
8,000
$ 32,000
24,000
4,000
$ 60,000
$ 34,000
25,500
3,800
$ 63,300
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,050
$ 14,050
$ 77,350
Variances
0
Flexible Budget
Performance Report
CheeseCo
Cost
Formula
Per Hour
Total
Fixed
Costs
Machine hours
Variable costs
Indirect labor
Indirect material
Power
Total variable costs
Fixed Expenses
Depreciation
Insurance
Total fixed costs
Total overhead costs
$
$
4.00
3.00
0.50
7.50
$ 12,000
2,000
Flexible
Budget
Actual
Results
8,000
8,000
$ 32,000
24,000
4,000
$ 60,000
$ 34,000
25,500
3,800
$ 63,300
$ 2,000 U
1,500 U
200 F
$ 3,300 U
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,050
$ 14,050
$ 77,350
0
50 U
50 U
$ 3,350 U
Variances
0
Flexible Budget
Performance Report
Static Budgets and Performance
How much of the $11,650 is due to activity
and how much is due to cost control?
Static
Budget
Machine hours
Variable costs
Indirect labor
Indirect materials
Power
Fixed costs
Depreciation
Insurance
Total overhead costs
Actual
Results
Variances
10,000
8,000
2,000 U
$ 40,000
30,000
5,000
$ 34,000
25,500
3,800
$6,000 F
4,500 F
1,200 F
12,000
2,000
12,000
2,050
0
50 U
$ 89,000
$ 77,350
$11,650 F
Flexible Budget
Performance Report
Overhead Variance Analysis
Static
Overhead
Budget at
10,000 Hours
$
89,000
Let’s place
the flexible
budget for
8,000 hours
here.
Actual
Overhead
at
8,000 Hours
$
77,350
Difference between original static budget
and actual overhead = $11,650 F.
Flexible Budget
Performance Report
Overhead Variance Analysis
Static
Overhead
Budget at
10,000 Hours
$
89,000
Flexible
Overhead
Budget at
8,000 Hours
$
Activity
This $15,000F variance is
due to lower activity.
74,000
Actual
Overhead
at
8,000 Hours
$
77,350
Cost control
This $3,350U flexible
budget variance is due
to poor cost control.
Flexible Budget
Performance Report
There are two primary
reasons for unfavorable
variable overhead variances:
What causes
the cost
control variance?
1. Spending too much for
resources.
2. Using the resources
inefficiently.
THE CONCEPT OF
RESPONSIBILITY ACCOUNTING
 Involves accumulating and
reporting costs on the basis of
the manager who has the
authority to make the day-today decisions about the items
 Means a manager's
performance is evaluated on
the matters directly under the
manager's control
CONTROLLABLE vs. NONCONTROLLABLE
REVENUES AND COSTS
 All costs can be controlled at some level within
the company.
 Fewer costs controllable as one moves down to
lower levels of management
 Critical issue:
Whether the cost or revenue is
controllable at the level of responsibility
with which it is associated
THE CONCEPT OF
RESPONSIBILITY ACCOUNTING
 Conditions for using responsibility accounting:
 Costs and revenues can be directly associated
with the specific level of management
responsibility.
 The costs and revenues are controllable by
those responsible.
 Budget data can be developed to evaluate the
manager's effectiveness in controlling costs
and revenues.
THE CONCEPT OF
RESPONSIBILITY ACCOUNTING
 Responsibility center - any
individual who has control and
is accountable.
 May extend from the lowest
levels of management to the top
strata of management.
 Responsibility accounting is
especially valuable in a
decentralized company
 where control of operations is
delegated to many managers
throughout the organization.
THE CONCEPT OF
RESPONSIBILITY ACCOUNTING
 Two differences from budgeting in reporting costs
and revenues:
 Distinguishes between controllable and noncontrollable
costs
 Performance reports emphasize or include only items
controllable by the individual manager.
 Applies to both profit and not-for-profit entities
 Profit entities: maximize net income
 Not-for-profit: minimize cost of providing services
RESPONSIBILITY REPORTING SYSTEM
 Involves preparation of a
report for each level of
responsibility in the
company's organization
chart
 Begins with the lowest level
of responsibility and moves
upward to higher levels
 Permits management by
exception at each level of
responsibility
RESPONSIBILITY REPORTING SYSTEM
 Also permits comparative evaluations
 Plant manager can rank the department
manager’s effectiveness in controlling
manufacturing costs
 Comparative ranking provides incentive
a manager to control costs
for
RESPONSIBILITY REPORTING SYSTEM
TYPES OF
RESPONSIBILITY CENTERS
 Three basic types:
 Cost centers
 Profit centers
 Investment centers
 Indicates degree of
responsibility that
managers have for the
performance of the center
TYPES OF
RESPONSIBILITY CENTERS
TYPES OF RESPONSIBILITY CENTERS
RESPONSIBILITY ACCOUNTING FOR
COST CENTERS
 Based on a manager’s ability to meet budgeted goals
for controllable costs
 Results in responsibility reports which compare actual
controllable costs with flexible budget data
 Include only controllable costs in reports
 No distinction between variable and fixed costs
RESPONSIBILITY ACCOUNTING FOR COST
CENTERS
Example – Fox Manufacturing Co.
 Assumes department manager can control all manufacturing overhead costs
except depreciation, property taxes, and his own monthly salary of $4,000
RESPONSIBILITY ACCOUNTING FOR
PROFIT CENTERS
 Based on detailed information
about both controllable
revenues and controllable costs
 Manager controls operating
revenues earned, such as sales,
 Manager controls all variable
costs (and expenses) incurred
by the center because they vary
with sales
PROFIT CENTERS
Responsibility Reports
 Shows budgeted and actual controllable revenues
and costs
 Prepared using the cost-volume-profit income
statement format:
 Deduct controllable fixed costs from the
contribution margin
 Controllable margin - excess of contribution
margin over controllable fixed costs – best
measure of manager’s performance in
controlling revenues and costs
 Do not report noncontrollable fixed costs
PROFIT CENTER -RESPONSIBILITY REPORTS
Example – Marine Division
$60,000 of indirect fixed costs are not controllable by manager not shown
RESPONSIBILITY ACCOUNTING FOR
INVESTMENT CENTERS
 Controls or significantly
influences investment funds
available for use
 ROI (return on investment) -
primary basis for evaluating
manager performance in an
investment center
 ROI shows the effectiveness of
the manager in utilizing the
assets at his or her disposal
RESPONSIBILITY ACCOUNTING FOR
INVESTMENT CENTERS - ROI
 ROI is computed as follows:
 Operating assets include current assets and plant
assets used in operations by the center.
Exclude nonoperating assets such as idle plant assets and
land held for future use
 Base average operating assets on the beginning and
ending cost or book values of the assets
INVESTMENT CENTER - RESPONSIBILITY REPORT
Example – Marine Division
All fixed costs are controllable by the manager
JUDGMENTAL FACTORS IN ROI
 Valuation of operating
assets
 May be valued at
acquisition cost, book value,
appraised value, or market
value
 Margin (income) measure
 May be controllable margin,
income from operations, or
net income
IMPROVING ROI
 ROI can be improved by
 Increasing controllable margin or
 Reducing average operating assets
 Assume the following data for Laser Division of
Berra Manufacturing:
IMPROVING ROI
Increasing Controllable Margin
 Increased by increasing sales or by reducing
variable and controllable fixed costs
Increase sales by 10%
Sales increase $200,000 and contribution margin
increases $90,000 ($200,000 X 45%)
Thus, controllable margin increases to $690,000
($600,000 + $90,000)
New ROI is 13.8%
IMPROVING ROI
Increasing Controllable Margin
Decrease variable and fixed costs 10%
Total costs decrease $140,000 [($1,100,000 + $300,000) X
10%]
Controllable margin becomes $740,000 ($600,000 +
$140,000 )
New ROI becomes 14.8%
IMPROVING ROI
Reducing Average Operating Assets
 Reduce average operating assets by 10% or
$500,000
Average operating assets become $4,500,000
($5,000,000 X 10%)
Controllable margin remains unchanged at
$600,000
New ROI becomes 13.3%
YES!!!