Richard E. McDermott, Ph.D.

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Budgetary Control and Responsibility Accounting

• Chapter 10
• Richard E. McDermott, Ph.D.

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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.

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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

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Flexible Budget Formula

• A formula that Professor McDermott has found to
  be useful 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

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Example Problem

• The controller of XYZ Company has provided you
  with the following cost information on the
  companys 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

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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.

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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.

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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.
• Lets see an example!

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Responsibility Report Format
Everything here is under control of one manager!
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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

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Exercise 10-1

• Identify each of the statements on the following
  slide as true or false.
• If false, indicate how to correct the statement.

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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.

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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.

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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.

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Exercise 10-1

• 9. Top managements reaction to unfavorable
  differences is not influenced by the materiality
  of the difference
• False. Top managements reaction to unfavorable
  differences is often influenced by the
  materiality of the difference.
• 10.A static budget is not appropriate in
  evaluating a managers effectiveness in
  controlling costs unlessthe actual activity level
  approximates the static budget level or the
  behavior of the cost is fixed.
• True.

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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

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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.

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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.
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Exercise 10-3
Now multiply in the variable costs per activity
level by the budgeted number of activities to get
total variable costs.
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Exercise 10-3
Now insert fixed costs. Then total variable and
fixed costs to give a total budget at each level
of activity.
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Exercise 10-4

• Using the information from exercise 10-3, assume
  that in 2008, the company incurs the following
  manufacturing overhead costs.

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RANEY
COMPANY Manufacturing Overhead Flexible Budget
Report For the Month Ended July 31, 2008
Prepare a flexible budget at 9,000 hours.
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RANEY
COMPANY Manufacturing Overhead Flexible Budget
Report For the Month Ended July 31, 2008
Prepare a flexible budget at 8,500 hours.
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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.

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Exercise 10-8

• As 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.

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Original Report
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Corrected Variable Cost Report
Then we multiply per unit cost by actual activity
We calculate per unit cost first by dividing
budget by units of activity.
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Exercise 10-8

• Terry should not have been reprimanded. As shown
  in the flexible budget report, variable costs
  were 1,250 below budget.

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Exercise 10-9

• XYZ 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.

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Exercise 10-9
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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

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Responsibility ReportFor the Quarter Ended March
31, 2008
Calculate the contribution margin first
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Responsibility ReportFor the Quarter Ended March
31, 2008
Then subtract controllable fixed expenses
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Exercise 10-9

• Write a memo to the president discussing the
  principles that should be used when preparing a
  performance report.

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Exercise 10-9

• Points to be covered
• When evaluating the performance of a companys
  segments, the performance reports should
• Contain only data that are controllable by the
  segments 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.

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The End