Budgetary Control
The use of budgets in controlling operations is known as
budgetary control.
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
Takes place by means of budget reports which compare
actual results with planned objectives.

Provides management with feedback on operations.

Budget reports can be prepared as frequently as needed.

Analyze differences between actual and planned results
and determines causes.
Budgetary Control
Budgetary control involves the following activities.
Illustration 24-1
24-2
Static Budget Reports
Static
Budget: budget data at one level of activity.

Ignores data for different levels of activity.

Compares actual results with budget data at
the activity level used in the master budget.
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Static Budget Reports
Illustration: Budget and actual sales data in the first and
second quarters of 2014 are:
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Static Budget Reports
Illustration: Sales budget report for HCo’s first quarter.
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Static Budget Reports
Illustration: Budget report for the second quarter contains one
new feature: cumulative year-to-date (YTD) information.
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Static Budget Reports
Uses and Limitations

Appropriate for evaluating a manager’s effectiveness in
controlling costs when:
►
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Actual level of activity close to
master budget activity level.

Appropriate for fixed costs.

Not appropriate for variable costs.
ximates
Flexible Budgets
Flexible
Budget: projects budget data for various levels of activity.
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
Budget is more useful if it is adaptable
to changes in operating conditions.

Essentially a series of static budgets
at different activity levels.

Can be prepared for each type of
budget in the master budget.
Flexible Budgets
Why Flexible Budgets?
Illustration: Barton Robotics, static budget based on a production
volume of 10,000 units of robotic controls.
Illustration 24-6
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Flexible Budgets
Illustration: Static Budget based on 10,000 units
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Flexible Budgets

Over budget in three of six overhead costs.

Comparison based on budget data for 10,000 units which is not relevant.
►
Meaningless to compare actual variable costs for
12,000 units with budgeted variable costs for 10,000.
►
Variable cost increase with production.
Budgeted variable amounts should increase
proportionately with production
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Flexible Budgets
Illustration: Analyzing the budget data for these costs at 10,000
units, you arrive at the following per unit results.
Illustration 24-8
Variable costs
per unit
Budgeted variable costs at 12,000 units.
Illustration 24-9
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Flexible Budgets
Illustration: flexible budget for 12,000 units of production.
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Flexible Budgets
Flexible Budget – A Case Study
Illustration: Fox Company’s management uses a flexible budget for
monthly comparisons of actual and budgeted manufacturing overhead
costs of the Finishing department. The master budget for the year
ending December 31, 2014, shows expected annual operating capacity
of 120,000 direct labor hours and the following overhead costs.
Illustration 24-11
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Flexible Budgets
Four steps for developing the flexible budget.
 Identify the activity index and the relevant range.
►
Activity index: direct labor hours.
►
Relevant range: 8,000 – 12,000 direct labor hours per
month.
 Identify variable costs and determine the budgeted variable
cost per unit of activity for each cost.
Illustration 24-12
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Flexible Budgets
Four steps for developing the flexible budget.
 Identify the fixed costs and determine the budgeted amount
for each cost.
►
Three fixed costs per month:

Depreciation $15,000.

Supervision $10,000.

Property taxes $5,000.
 Prepare the budget for selected increments of activity within
the relevant range.
►
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Prepared in increments of 1,000 direct labor hours.
Flexible Budgets
Monthly overhead flexible budget
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Lawler Company expects to produce 40,000 units of product
CV93 during the current year.
Budgeted variable manufacturing costs per unit are direct
materials $6, direct labor $15, and overhead $24.
Annual budgeted fixed manufacturing overhead costs are
$120,000 for depreciation and $60,000 for supervision.
In the current month, Lawler produced 5,000 units and incurred
the following costs:
Were costs controlled?
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Prepare a flexible budget report. Were costs controlled?
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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.
Conditions:
1. Costs and revenues can be directly associated with the specific
level of management responsibility.
2. Costs and revenues can be controlled by employees at the
level of responsibility with which they are associated.
3. Budget data can be developed for evaluating the manager’s
effectiveness in controlling the costs and revenues.
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Responsibility Accounting
Levels of responsibility for controlling costs.
Illustration 24-17
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Responsibility Accounting

Different from budgeting:
1. Distinguishes between controllable versus
noncontrollable costs.
2. Emphasizes only items controllable by the
individual manager in performance reports.
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Responsibility Accounting
Controllable Versus Noncontrollable
Revenues and Costs
Critical issue is whether the cost or revenue is controllable at the
level of responsibility with which it is associated. A cost over
which a manager has control is called a controllable cost.
1. All costs are controllable by top management.
2. Fewer costs are controllable as one moves down to each
lower level of managerial responsibility.
Costs incurred indirectly and allocated to a responsibility level are
noncontrollable costs.
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Principles of Performance Evaluation
Management by Exception
Management by exception means that top management’s
review of a budget report is focused primarily on differences
between actual results and planned objectives.

Materiality - Without quantitative guidelines, management
would have to investigate every budget difference
regardless of the amount.

Controllability of the item - Exception guidelines are
more restrictive for controllable items than for items the
manager cannot control.
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Responsibility Accounting
Illustration 24-18
Partial organization chart
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Responsibility
Accounting
Illustration 24-19
Responsibility reporting system

Permits comparative
evaluations.

Plant manager can rank
each department
manager’s effectiveness
in controlling
manufacturing costs.

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Comparative rankings
provide incentive for a
manager to control costs.
Report A
President sees
summary
data of vice
presidents.
Report B
Vice president sees
summary of controllable
costs in his/her functional
area.
Report C
Plant manager sees
summary of controllable
costs for each department
in the plant.
Report D
Department manager sees
controllable costs of his/her
department.
Types of Responsibility Centers
Three basic types:

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Cost centers
►
Incurs costs but does not directly generate revenues.
►
Managers have authority to incur costs.
►
Managers evaluated on ability to control costs.
►
Usually a production or a service department.

Profit centers

Investment centers
Types of Responsibility Centers
Illustration: The following report is adapted from the flexible
budget report for Fox Manufacturing Company in Illustration 24-16.
Illustration 24-21
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Types of Responsibility Centers
Three basic types:

Cost centers

Profit centers

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►
Incurs costs and generates revenues.
►
Managers judged on profitability of center.
►
Ex: individual departments of a retail store or
branch bank offices.
Investment centers
Types of Responsibility Centers
Illustration 24-22
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The Marine Division also had $60,000 of indirect fixed costs that were not
controllable by the profit center manager.
Types of Responsibility Centers
Three basic types:
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
Cost centers

Profit centers

Investment centers
►
Incurs costs, generates revenues, and has
investment funds available for use.
►
Manager evaluated on profitability of the center and
rate of return earned on funds.
►
Often a subsidiary company or a product line.
►
Manager able to control or significantly influence
investment decisions such as plant expansion.
Types of Responsibility Centers
Illustration: The
Marine Division is an
investment center.
It has operating
assets of $2,000,000.
The manager can
control $60,000 of fixed
costs.
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Types of Responsibility Centers
Responsibility Accounting for Investment
Centers
Return on investment (ROI) is the primary basis for evaluating
the performance of a manager of an investment center.
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
Shows the effectiveness of the manager in using the assets
at his/her disposal.

Useful performance measure.

Factors in ROI formula are controllable by manager.
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