Budgetary Control and Responsibility
Accounting
Chapter 10
Richard E. McDermott, Ph.D.
Presentation Approach
 As 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 Budgets
 Static 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, or
 If the company cannot identify variable costs
Flexible Budget Formula
 A formula that Professor McDermott has found to be useful
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to students in working flexible budgeting problems is:
Y = a + bX
Where
Y = total flexible budget
a = total fixed costs
b = variable costs per unit
X = production or sales volume
Example Problem
 The controller of XYZ Company has provided you with the
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following cost information on the company’s product line.
Total fixed costs equals $200,000
Variable cost per unit is $10
Next year the company anticipates manufacturing 25,000
units
What should be the flexible budget for the year?
Y = 200,000 + 10(25,000)
Y = $450,000
Responsibility Accounting
 Involves 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 Centers
 Cost 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 Report
 Prepared 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
Everything here is under control of one manager!
Budget
Actual
Variance
Sales
$xxx
$xxx
$xxx
Less variable
costs
Contribution
margin
Less controllable
fixed costs
Controllable
margin
$xxx
$xxx
$xxx
$xxx
$xxx
$xxx
$xxx
$xxx
$xxx
$xxx
$xxx
$xxx
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 10-1
1.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 causes
True.
Exercise 10-1
4. 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 10-1
6. 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 10-1
9. Top management’s reaction to unfavorable
differences is not influenced by the materiality of
the difference
False. 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 10-3
 XYZ 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 $1.00
 indirect material $0.50
 utilities $0.40
Exercise 10-3
 Fixed overhead costs per month are:
 Supervision $4000
 Depreciation the $1500
 Property 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
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.
Activity level
Direct labor hours
7,000
8,000
9,000
10,000
Exercise 10-3
Now multiply in the variable costs per activity level by the budgeted number of
activities to get total variable costs.
Activity level
Direct labor hours
Variable costs
Indirect labor ($1)
Indirect materials ($.50)
Utilities ($.40)
Total variable costs ($1.90)
7,000
8,000
9,000
10,000
$ 7,000
3,500
2,800
13,300
$ 8,000
4,000
3,200
15,200
$ 9,000
4,500
3,600
17,100
$10,000
5,000
4,000
19,000
Exercise 10-3
Now insert fixed costs.Then total variable and fixed costs to give a total budget at
each level of activity.
Activity level
Direct labor hours
Variable costs
Indirect labor ($1)
Indirect materials ($.50)
Utilities ($.40)
Total variable costs ($1.90)
Fixed costs
Supervision
Depreciation
Property taxes
Total fixed costs
Total costs
7,000
8,000
9,000
10,000
$ 7,000
3,500
2,800
13,300
$ 8,000
4,000
3,200
15,200
$ 9,000
4,500
3,600
17,100
$10,000
5,000
4,000
19,000
4,000
1,500
800
6,300
$19,600
4,000
1,500
800
6,300
$21,500
4,000
1,500
800
6,300
$23,400
4,000
1,500
800
6,300
$25,300
Exercise 10-4
 Using the information from exercise 10-3, assume that in
2008, the company incurs the following manufacturing
overhead costs.
Variable costs
Indirect labor
Fixed costs
$8,700 Supervision
Indirect materials
4,300 Depreciation
Utilities
3,200 Property taxes
$4,000
1,500
800
RANEY COMPANY
Manufacturing Overhead Flexible Budget Report
For the Month Ended July 31, 2008
Prepare a flexible budget at 9,000 hours.
Direct labor hours (DLH)
Variable costs
Indirect labor
Indirect materials
Utilities
Total variable costs
Fixed costs
Supervision
Depreciation
Property taxes
Total fixed costs
Total costs
Budget at
9,000 DLH
$ 9,000
4,500
3,600
17,100
Actual Costs
9,000 DLH
$ 8,700
4,300
3,200
16,200
4,000
1,500
800
6,300
$23,400
4,000
1,500
800
6,300
$22,500
Difference
$300 F
200 F
400 F
900 F
$900 F
RANEY COMPANY
Manufacturing Overhead Flexible Budget Report
For the Month Ended July 31, 2008
Prepare a flexible budget at 8,500 hours.
Direct labor hours (DLH)
Variable costs
Indirect labor
Indirect materials
Utilities
Total variable costs
Fixed costs
Supervision
Depreciation
Property taxes
Total fixed costs
Total costs
Budget at
8,500 DLH
$ 8,500
4,250
3,400
16,150
Actual Costs
8,500 DLH
$ 8,700
4,300
3,200
16,200
4,000
1,500
800
6,300
$22,450
4,000
1,500
800
6,300
$22,500
Difference
$200 U
50 U
200 F
50 U
$ 50 U
Exercise 10-4
 Comment 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 10-8
 As sales manager, Terry DeWitt was given the following
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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.
Original Report
Garber Company Budget Report for October 31, 2008
Sales in units
Variable expenses
Sales commissions
Advertising expenses
Travel expense
Free samples give amount
Total variable
Fixed expenses
Rent
Sales salaries
Office salaries
Depreciation
Total fixed
Total expenses
Budget
8000
Actual
10,000
Difference
-2,000
2000
800
3600
1600
8000
2600
850
4000
1300
8750
-600
-50
-400
300
-750
1500
1200
800
500
4000
12000
1500
1200
800
500
4000
12750
0
0
0
0
0
-750
Corrected Variable Cost Report
Then we
Garber Company Budget Report for October 31, 2008 multiply per
unit cost by
actual
Variable
activity
Cost per
Budget
unit
Actual Difference
Sales in units
10,000
10,000
-2,000
Variable expenses
Sales commissions
2,500
0.25
2,600
-100
Advertising expenses
1,000
0.10
850
150
Travel expense
4,500
0.45
4,000
500
Free samples give amount
2,000
0.20
1,300
700
Total variable
10,000
1.00
8,750
1,250
Fixed expenses
Rent
Sales salaries
Office salaries
Depreciation
Total fixed
Total expenses
1500
1200
800
500
4000
14000
We calculate per
unit cost first by 1500
dividing budget 1200
by units of
800
activity.
500
4000
12,750
0
0
0
0
0
1,250
Exercise 10-8
 Terry should not have been reprimanded. As shown
in the flexible budget report, variable costs were
$1,250 below budget.
Exercise 10-9
 XYZ Plumbing company is a newly formed company
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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
Service revenue
Allocated portion of:
Building depreciation
Advertising
Billing
Property taxes
Material and supplies
Supervisory salaries
Insurance
Wages
Gas and oil
Equipment depreciation
Budgeted
25,000
Actual
26,000
11,000
5000
3500
1200
1500
9000
4000
3000
2700
1600
11,000
4200
3000
1000
1200
9400
3500
3300
3400
1300
Exercise 10-9
 Prepare 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
Responsibility Report
For the Quarter Ended March 31, 2008
Calculate the contribution margin first:
Service revenue
Variable costs:
Material and supplies
Wages
Gas and oil
Total variable costs
Contribution margin
Budget
$25,000
Actual
$26,000
Difference
Favorable F
Unfavorable U
$1,000 F
1,500
3,000
2,700
7,200
17,800
1,200
3,300
3,400
7,900
18,100
300 F
300 U
700 U
700 U
300 F
Responsibility Report
For the Quarter Ended March 31, 2008
Then subtract controllable fixed expenses:
Service revenue
Variable costs:
Material and supplies
Wages
Gas and oil
Total variable costs
Contribution margin
Controllable fixed costs:
Supervisory salaries
Insurance
Equipment depreciation
Total controllable fixed costs
Controllable margin
Budget
$25,000
Actual
$26,000
Difference
Favorable F
Unfavorable U
$1,000 F
1,500
3,000
2,700
7,200
17,800
1,200
3,300
3,400
7,900
18,100
300 F
300 U
700 U
700 U
300 F
9,000
4,000
1,600
14,600
$ 3,200
9,400
3,500
1,300
14,200
$ 3,900
400 U
500 F
300 F
400 F
$ 700 F
Exercise 10-9
 Write a memo to the president discussing the principles that
should be used when preparing a performance report.
Exercise 10-9
 Points 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