1. 16-1 Activity- Based Budgeting Prepared by Douglas Cloud Pepperdine University Prepared by Douglas Cloud Pepperdine University

2. 16-2 1.Describe the shortcomings of the traditional master budgeting process. 2.Define flexible budgeting, and discuss its role in planning, control, and decision making. 3.Define activity-based budgeting, and discuss its role in planning, control, and decision making. ObjectivesObjectives After studying this chapter, you should be able to: ContinueContinue

3. 16-3 4.Identify and discuss the key features that a budgetary system should have to encourage managers to engage in goal-congruent behavior. 5.Describe budgets for merchandising and service firms and zero-base budgeting. ObjectivesObjectives

4. 16-4 Shortcomings of the Traditional Master Budgeting Process  department oriented and does not recognize the interdependencies among departments.  static, not dynamic.  results, not process, oriented. The traditional master budget is:

5. 16-5 A static budget is a budget for a particular level of activity. A flexible budget is a budget that provides a firm with the capability to compute expected costs for a range of activity. Static Budgets versus Flexible Budgets

6. 16-6 For the Year Ended December 31, 2004 Quarter 1 2 3 4 Year Unit sales2,0006,0006,0002,00016,000 Units to be produced2,4006,0005,6002,00016,000 Budgeted fixed OH: Supervision100100100100400 Depreciation200200200200800 Rent2020202980 Budgeted Information on ABT, Inc. (in thousands) ContinuedContinued

7. 16-7 For the Year Ended December 31, 2004 Quarter 1 2 3 4 Year Budgeted unit costs: Direct materials$0.26 Direct labor0.12 Variable overhead: Supplies0.03 Indirect labor0.07 Power0.02 Budgeted Information on ABT, Inc. (in thousands)

8. 16-8 Actual Budgeted Variance Actual Budgeted Variance Performance Report: Quarterly Production Costs (in thousands) (in thousands) Units produced3,0002,400600 F Direct materials cost$ 927.3$ 624.0$303.3 U Direct labor cost360.0288.072.0 U Overhead: Variable: Supplies80.072.08.0 U Indirect labor220.0168.052.0 U Power40.048.0-8.0 F Fixed: Supervision90.0100.0-10.0 F Depreciation200.0200.00.0 - Rent 30.0 20.0 10.0 U Total$1,947.3$1,520.0$427.3 U 2,400,000 x $0.26 2,400,000 x $0.12

9. 16-9 Flexible Production Budget (in thousands) Production costs: Variable: Direct materials$0.26$ 624$ 780$ 936 Direct labor0.12288360432 Variable overhead: Supplies0.037290108 Indirect labor0.07168210252 Power 0.02 48 60 72 Total variable costs$0.50$1,200$1,500$1,800 Variable Cost Per Unit Range of Production (units) 2,400 3,000 3,600 Continued

10. 16-10 Flexible Production Budget (in thousands) Production costs: Fixed overhead: Supervision$ 100$ 100$ 100 Depreciation200200200 Rent 20 20 20 Total fixed costs$ 320$ 320$ 320 Total production costs$1,520$1,820$2,120 Variable Cost Per Unit Range of Production (units) 2,400 3,000 3,600

11. 16-11 Actual versus Flexible Performance Report: Quarterly Production Costs (in thousands) Quarterly Production Costs (in thousands) Units produced3,0003,000---- Production costs: Direct materials$ 927.3$ 780.0$147.3U Direct labor360.0360.00.0 Variable overhead: Supplies80.090.0-10.0F Indirect labor220.0210.010.0U Power 40.0 60.0 -20.0F Total variable costs$1,627.3$1,500.0$127.3U Actual Budgeted Variance Actual Budgeted Variance Continued

12. 16-12 Actual versus Flexible Performance Report: Quarterly Production Costs (in thousands) Quarterly Production Costs (in thousands) Units produced3,0003,000---- Fixed overhead: Supervision$ 90.0$ 100.0$ -10.0F Direct labor200.0200.00.0 Rent 30.0 20.0 10.0U Total fixed costs$ 320.0$ 320.0$ 0.0 Total production costs$1,947.3$1,820.0$127.3U Actual Budgeted Variance Actual Budgeted Variance

13. 16-13 Budgets can be used to examine the efficiency and effectiveness of a company.

14. 16-14 Efficiency is achieved when the business process is performed in the best possible way, with little or no waste.

15. 16-15 Managerial Performance Report: Quarterly Production (in thousands) Quarterly Production (in thousands) Units produced3,0003,000---2,400600F Production costs: Direct materials$ 927.3$ 780.0$147.3U$ 624.0$156.0U Direct labor360.0360.00.0288.072.0U Supplies80.090.0-10.0F72.018.0U Indirect labor220.0210.010.0U168.042.0U Power40.060.0-20.0F48.012.0U Supervision90.0100.0-10.0F100.00.0 Depreciation200.0200.00.0200.00.0 Rent 30.0 20.0 10.0U 20.0 0.0 Total costs$1,947.3$1,820.0$127.3U$1,520.0$300.0U Actual Results (1) Flexible Budget (2) Flexible Budget Variance (3) Static Budget (4) Volume Variance (5)

16. 16-16 Drivers: Number of Orders Fixed Variable 1,5000 25,000 Purchasing$211,000$1$226,000$236,000 Activity Flexible Budget Drivers: Number of Batches Fixed Variable 25 30 Fixed Variable 25 30 Inspection$ 80,000$2,100$132,500$143,000 Setups 01,800 45,000 54,000 Subtotal$ 80,000$3,900$177,500$197,000 Driver: Machine Hours Formula Level of Activity Fixed Variable 8,000 16,000 Fixed Variable 8,000 16,000 Maintenance$ 20,000$5.50$ 64,000$108,000 Machining 15,000 2.00 31,000 47,000 Subtotal$ 35,000$7.50$ 95,000$155,000

17. 16-17 Activity-Based Performance Budget Maintenance$ 55,000$ 64,000$ 9,000F Machining29,00031,0002,000F Inspection125,500132,5007,000F Setups46,50045,0001,500U Purchases 220,000 226,000 6,000F Total$476,000$498,500$22,500F Actual Budgeted Budget Actual Budgeted Budget Costs Costs Variance Costs Costs Variance

18. 16-18 Salaries and benefits: Brad$110,000 Administrative assistants70,000 Receptionist 30,000$210,000 Rent36,000 Supplies10,000 PCs and Internet4,000 Travel3,000 Investigative services6,000 Telephone 4,800 Total$273,800 Traditional Budget for the Secure-Care Department Expense Budgeted Expense Budgeted Category Amount Category Amount

19. 16-19 Variable expenses: Supplies$ 10,000 Telephone 3,600 Total variable expenses$ 13,600 Fixed expenses: Salaries and benefits$210,000 Rent36,000 PC and Internet4,000 Travel3,000 Investigative services6,000 Telephone 1,200 Total fixed expenses 260,200 Total expenses$273,800 Flexible Budget for the Secure-Care Department Expense Budgeted Amounts Expense Budgeted Amounts Category for 60 Clients Category for 60 Clients

20. 16-20 Processing mailNo. of clients$125.0060$ 7,500 Paying billsNo. of bills1.7512,00021,000 Reconciling accountsNo. of accounts114.0035039,900 Advertising/ interviewingNo. of new hires120.00607,200 InvestigatingNo. of new hires100.00606,000 Visiting homesNo. of clients650.006039,000 Writing reportsNo. of clients175.006010,500 Managing dept. 142,700 Total$273,800 Activity-Based Budget for the Secure-Care Department Activity Activity Cost per Unit Amount of Activity Activity Activity Cost per Unit Amount of Activity Description Driver of Driver Driver Cost Description Driver of Driver Driver Cost

21. 16-21 The Behavioral Dimension of Budgeting Positive behavior occurs when the goals of individual managers are aligned with the goals of the organization and the manager has the drive to achieve them. If the budget is improperly administered, the reaction of subordinate managers may be negative.

22. 16-22 Characteristics of a Good Budgetary System An ideal budgetary system is one that achieves complete goal congruence and simultaneously creates a drive in managers to achieve the organization’s goals in an ethical manner.

23. 16-23 Monetary and Nonmonetary Incentives Monetary and Nonmonetary Incentives Incentives are the means that are used to encourage managers to work toward achieving the organization’s goals.

24. 16-24 Participative Budgeting Participative Budgeting Participating budgeting has three potential problems: 1.Setting standards that are either too high or too low 2.Building slack into the budget (padding the budget) 3.Pseudoparticipation Only superficial participation is sought from lower-level managers

25. 16-25 Zero-Base Budgeting Zero-Base Budgeting The prior year’s budgeted level is not taken for granted Existing operations are subject to in-depth analysis Continuance of the activity must be justified on the basis of need Each submit company starts from ground zero Time-consuming and costly

26. 16-26 Zero-Base Budgeting Zero-Base Budgeting A reasonable compromise to cost is to use zero-base budgeting every three to five years in order to weed out waste and inefficiency.

27. 16-27 Chapter End of

28. 16-28