The use of budgets in controlling operations is known as budgetary control.

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Budgetary Control

• The use of budgets in controlling operations is
  known as budgetary control.
• 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.

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Budgetary Control

• Budgetary control involves the following
  activities.

Illustration 24-1
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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
Ex Budget actual sales data in the 1st 2nd
quarters of are
Difference often referred to as a Variance
or Exception
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Static Budget Reports
Uses and Limitations

• Appropriate for evaluating a managers
  effectiveness in controlling costs when
• Actual level of activity close to
  ximates master budget activity level.
• Appropriate for fixed costs.
• Not appropriate for variable costs.

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Flexible Budgets
Flexible Budget projects budget data for
various levels of activity.

• 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.

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Flexible Budgets
Why Flexible Budgets?
Illustration Barton Robotics, static budget
based on a production volume of 10,000 units of
robotic controls.
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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 Budget A Case Study
Ex Corp uses a flexible budget to compare
actual vs budgeted manufacturing overhead costs.
The master budget year ending 12/31/14, shows
expected annual operating capacity of 120,000
direct labor hours and these overhead costs.
These variable costs are based on 120,000 hours
(120,000 / 12 10,000 hours per month)
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Flexible Budget A Case Study 4 steps

• Identify the activity index and the relevant
  range.
• Activity index direct labor hours.
• Relevant range for the flexible budget
  96,000 144,000 labor
  hours per year
• (96,000 hrs yr / 12 months 8,000
  hours per month)
• (144,000 hrs yr / 12 months
  12,000 hours per month)

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Flexible Budget A Case Study 4 steps

• Identify variable costs and determine the
  budgeted variable cost per unit of activity for
  each cost.

Original budget based on 120,000 hours
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Flexible Budget A Case Study 4 steps

• Identify the fixed costs and determine the
  budgeted amount for each cost.
• Three fixed costs per month
• Depreciation 180,000 / 12 15,000 per mo.
• Supervision 120,000 / 12 10,000 per mo.
• Property taxes 60,000 / 12 5,000 per
  mo.

Original budget based on 120,000 hours (12 months)
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Flexible Budget A Case Study 4 steps

• Prepare the budget for selected increments of
  activity within the relevant range.
• Prepared for range of 8,000 12,000 direct labor
  hours per month in increments of 1,000 direct
  labor hours.

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Monthly overhead flexible budget
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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
• Costs and revenues can be directly associated
  with the specific level of management
  responsibility.
• Costs and revenues can be controlled by employees
  at the level of responsibility with which they
  are associated.
• Budget data can be developed for evaluating the
  managers 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
• Distinguishes between controllable versus
  noncontrollable costs.
• Emphasizes only items controllable by the
  individual manager in performance reports.

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Responsibility Accounting
Controllable vs 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 a controllable cost.
• All costs are controllable by top management.
• 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
  managements 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
Report A President sees summary data of vice
presidents.
Illustration 24-19 Responsibility reporting system
Report B Vice president sees summary of
controllable costs in his/her functional area.

• Permits comparative evaluations.
• Plant manager can rank each department managers
  effectiveness in controlling manufacturing costs.
• Comparative rankings provide incentive for a
  manager to control costs.

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.
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Types of Responsibility Centers

• Three basic types
• 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

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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
• Incurs costs and generates revenues.
• Managers judged on profitability of center.
• Ex individual departments of a retail store or
  branch bank offices.
• Investment centers

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Types of Responsibility Centers
Illustration 24-22
The Marine Division also had 60,000 of indirect
fixed costs that were not controllable by the
profit center manager.
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Types of Responsibility Centers

• Three basic types
• 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.

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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.
• 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.