6 - 1 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Chapter 6 Master Budget and Responsibility Accounting Mar 7, 2005

6 - 2 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Budgeting l A tool companies use for planning and controlling what they must do to succeed in the marketplace l Show financial results expected from planned activities l Anticipate potential problems and how to avoid them, i.e., running out of cash l Focus energy on exploiting opportunities l “Failing to plan is a plan to fail’

6 - 3 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Understand what a master budget is and explain its benefits. Learning Objective 1

6 - 4 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Budgeting Cycle Performance planning Providing a frame of reference Investigating variations from plan Taking corrective action Planning again based on feedback

6 - 5 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster The Master Budget Master Budget Operating Decisions (Focus on use of scare resources) Operating Decisions (Focus on use of scare resources) Financial Decisions (How to obtain funding to acquire resources) Financial Decisions (How to obtain funding to acquire resources)

6 - 6 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Describe the advantages of budgets. Learning Objective 2

6 - 7 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster What are the Advantages of Budgets? Compels strategic planning (Identify objectives, markets, form of organization, financial structure, alternative and contingency plans) Provides a framework for judging performance (so you don’t repeat past mistakes, and plan for changing conditions) #1 #2

6 - 8 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster What are the Advantages of Budgets? Motivates employees and managers (Never used as a “club”, set challenging but achievable goals) Promotes coordination and communication (Coordinating all facets of the firm, Communicating goals, gaining acceptance #3 #4

6 - 9 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Time Coverage of Budgets Budgets typically have a set time period (month, quarter, year). This time period can itself be broken into subperiods. The most frequently used budget period is one year. Businesses are increasingly using rolling budgets, i.e. next four quarters

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 3 Prepare the operating budget and its supporting schedules.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Overview of Master Budget l See Exhibit 6-2, page 181 l Operating budget – income statement items l Financial Budget – includes capital budget, cash budget, balance sheet and statement of cash flow l Key to process is the revenue budget What are sources of information?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Revenue Budget l Marketing department l Sales force l Customers l New products l Competitors l State of economy l Suppliers (availability of resources)

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Operating Budget Example Hawaii Diving expects 1,100 units to be sold during the month of August Selling price is expected to be $240 per unit. How much are budgeted revenues for the month? 1,100 × $240 = $264,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Operating Budget Example Two pounds of direct materials are budgeted per unit at a cost of $2.00 per pound, $4.00 per unit. Three direct labor-hours are budgeted per unit at $7.00 per hour, $21.00 per unit. Variable overhead is budgeted at $8.00 per direct labor-hour, $24.00 per unit. Fixed overhead is budgeted at $5,400 per month.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Operating Budget Example Variable nonmanufacturing costs are expected to be $0.14 per revenue dollar. Fixed nonmanufacturing costs are $7,800 per month.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Production Budget Example Budgeted sales (units) Target ending finished goods inventory (units) Beginning finished goods inventory (units) Budgeted production (units) + – =

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Production Budget Example Assume that target ending finished goods inventory is 80 units. Beginning finished goods inventory is 100 units. How many units need to be produced?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Production Budget Example Hawaii Diving Production Budget for the Month of August 2004 Units required for sales1,100 Add ending inv. of finished units 80 Total finished units required1,180 Less beg. inv. of finished units 100 Units to be produced1,080

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Direct Materials Usage Budget Each finished unit requires 2 pounds of direct materials at a cost of $2.00 per pound. Desired ending inventory equals 15% of the materials required to produce next month’s sales. September sales are forecasted to be 1,600 units. What is the ending inventory in August? 480 pounds

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Direct Materials Usage Budget September sales: 1,600 × 2 pounds per unit = 3,200 pounds 3,200 × 15% = 480 pounds (the desired ending inventory) What is the beginning inventory in August? 1,100 units × 2 × 15% = 330 units

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Direct Materials Usage Budget How many pounds are needed to produce 1,080 units in August? 1,080 × 2 = 2,160 pounds

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Material Purchases Budget Hawaii Diving Direct Material Purchases Budget for the Month of August 2004 Units needed for production 2,160 Target ending inventory 480 Total material to provide for 2,640 Less beginning inventory 330 Units to be purchased 2,310 Unit purchase price$ 2.00 Total purchase cost$4,620

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Direct Manufacturing Labor Budget Hawaii Diving Direct Labor Budget for the Month of August 2004 Units produced: 1,080 Direct labor-hours/unit 3 Total direct labor-hours: 3,240 Total $7.00/hour:$22,680 Each unit requires 3 direct labor-hours at $7.00 per hour.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Manufacturing Overhead Budget Variable overhead is budgeted at $8.00 per direct labor-hour. Fixed overhead is budgeted at $5,400 per month.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Manufacturing Overhead Budget Hawaii Diving Manufacturing Overhead Budget for the Month of August 2004 Variable Overhead: (3,240 × $8.00)$25,920 Fixed Overhead 5,400 Total$31,320

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Ending Inventory Budget Cost per finished unit: Materials$ 4 Labor 21 Variable manufacturing overhead 24 Fixed manufacturing overhead 5* Total$54 *$5,400 ÷ 1,080 = $5

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Ending Inventory Budget What is the cost of the target ending inventory for materials? 480 × $2 = $960 What is the cost of the target finished goods inventory? 80 × $54 = $4,320

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Cost of Goods Sold Budget Direct materials used: 2,160 × $2.00$ 4,320 Direct labor 22,680 Total overhead 31,320 Cost of goods manufactured$58,320

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Cost of Goods Sold Budget Ending finished goods inventory is $4,320. What is the cost of goods sold? Assume that the beginning finished goods inventory is $5,400.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Cost of Goods Sold Budget Beginning finished goods inventory$ 5,400 + Cost of goods manufactured$58,320 = Goods available for sale$63,720 – Ending finished goods inventory$ 4,320 = Cost of goods sold$59,400

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Nonmanufacturing Costs Budget Hawaii Diving Other Expenses Budget for the Month of August 2004 Variable Expenses: ($0.14 × $264,000)$36,960 Fixed expenses 7,800 Total$44,760

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Cost of Goods Sold Budget Cost of goods sold are budgeted at $59,400. What is the budgeted gross margin? Hawaii Diving has budgeted sales of $264,000 for the month of August.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Budgeted Statement of Income Hawaii Diving Budgeted Income Statement for the Month ending August 31, 2004 Sales$264,000100% Less cost of sales 59,400 22% Gross margin$204,600 78% Other expenses 44,760 17% Operating income$159,840 61%

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 4 Use computer-based financial planning models in sensitivity analysis.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Financial Planning Models Financial planning models are mathematical representations of the interrelationships among operating activities, financial activities, and other factors that affect the master budget.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Software Software packages are now readily available to reduce the computational burden and time required to prepare budgets.( These packages assist managers to do sensitivity analysis.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Sensitivity Analysis Consider Hawaii Diving. What if some parameters in the budget model were to change? For example, what if the selling price is expected to be $230 instead of $240? What are expected revenues? 1,100 × $230 = $253,000 instead of $264,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Sensitivity Analysis What if the materials cost is expected to increase to $2.50 per pound instead of $2.00. What is the cost of goods sold? 1,100 × $55 = $60,500 instead of $59,400 Why the increase? Because materials cost per unit become $5.00 instead of $4.00.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Cash Budget Hawaii Diving has the following collection pattern: In the month of sale:50% In the month following sale:27% In the second month following sale:20% Uncollectible: 3%

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Cash Budget Budgeted charge sales are as follows: June$200,000 July$250,000 August$264,000 September$260,000 What are the expected cash collections in August?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Cash Budget Budgeted Cash Receipts for the Month Ending August 31, 2004 August sales:$264,000 × 50%$132,000 July sales:$250,000 × 27% 67,500 June sales:$200,000 × 20% 40,000 Total$239,500

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Cash Budget Budgeted Cash Disbursements for the Month Ending August 31, 2004 August purchases$ 4,620 Direct labor 22,680 Total overhead 31,320 Other expenses 9,760* Total$68,380 *Other expenses exclude depreciation

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Cash Budget for the Month Ending August 31, 2004 Budgeted receipts$239,500 Budgeted disbursements 68,380 Net increase in cash$171,120

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 5 Explain kaizen budgeting and how it is used for cost management.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster What is Kaizen? The Japanese use the term “kaizen” for continuous improvement. Kaizen budgeting is an approach that explicitly incorporates continuous improvement during the budget period into the budget numbers.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Kaizen Budgeting It was previously estimated that it should take 3 labor-hours for Hawaii Diving to manufacture its product. A kaizen budgeting approach would incorporate future improvements.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Kaizen Budgeting Budgeted Hours/Item January – March April – June July – September October – December

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 6 Prepare an activity-based budget. SKIP

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 7 Describe responsibility accounting. Managers should only be responsible for costs they can control or influence

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster What is Controllability? It is the degree of influence that a specific manager has over costs, revenues, or other items in question. A controllable cost is any cost that is primarily subject to the influence of a given responsibility center manager for a given time period.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Controllability Responsibility accounting focuses on information and knowledge, not control. A responsibility accounting system could exclude all uncontrollable costs from a manager’s performance report. In practice, controllability is difficult to pinpoint.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Appendix, p l The Cash Budget l Preparation of budgets the cash budget the income statement the balance sheet

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster End of Chapter 6