1. Chapter 22 Budgetary Control and Responsibility Accounting
Prepared by: Carole Bowman, Sheridan College

2. Budgetary Control Budgetary control involves: a) Developing budgets.
b) Analysing the differences between actual and budgeted results.
c) Taking corrective action.
d) Modifying future plans, if necessary.

3. Budgetary Control A budgetary control system should:
a) Identify the name of the budget report such as the sales budget or the manufacturing overhead budget.
b) State the frequency of the report such as weekly, or monthly.
c) Specify the purpose of the report.
d) Indicate the primary recipient(s) of the report.

4. Static Budget Reports
A static budget is a projection of budget data at one level of activity.
Data for different levels of activity are ignored.
As a result, actual results are always compared with the budget data at the activity level used in developing the master budget.

5. Budget and Actual Sales Data
To illustrate the role of a static budget in budgetary
control, we will use selected data for Wei Corporation prepared in Chapter 21.
Budget and actual sales data for the Kitchenmate product in the first and second quarters of 2012 are as follows:
$1, $10, $11,500

6. Sales Budget Report: First Quarter
Illustration 22-2
Sales Budget Report: First Quarter
The sales budget report for Wei Corporation’s 1st quarter is shown below.
$1,000 U
The report shows that sales are $1,000 under budget - an unfavorable result. This difference is less than 1% of budgeted sales ($1,000/$180,000 = ), we will assume that top management of Wei Corporation will view the difference as immaterial and take no specific action.

7. Sales Budget Report: Second Quarter
Illustration 22-3
Sales Budget Report: Second Quarter
$10,500 U
The second quarter shows that sales were $10,500 below budget, which is 5% of budgeted sales ($10,500/$210,000). Top management may conclude that the difference between budgeted and actual sales in the second quarter merits investigation and will begin by asking the sales manager the cause(s).

8. Uses and Limitations
A static budget is appropriate in evaluating a manager’s effectiveness in controlling costs when:
a)The actual level of activity closely approximates the master budget activity level, and/or
b)The behaviour of the costs in response to changes in activity is fixed.

9. Flexible Budgets
A flexible budget projects budget data for various levels of activity.
The flexible budget recognizes that the budgetary process is more useful if it is adaptable to changing operating conditions.

10. Static Overhead Budget Report
Illustration 22-4
Static Overhead Budget Report
If demand for steel
ingots has increased
and 12,000 units are
produced during the
year, rather than
10,000, the budget
report will show
very large variances.
This is because the
comparison is based
on budget data based
on the original activity level (10,000 steel ingots). Variable
budget allowances
Should increase with
production.
$ 45,000 U
52,000 U 35,000 U
-0-
$132,000 6

11. Variable Costs per Unit
/10,000 units $25
/10,000 units
/10,000 units
$70
Comparing actual variable costs with budgeted costs is meaningless (due to different levels of activity), variable per unit costs must be isolated, so the budget can be adjusted. An analysis of the budget data for these costs at 10,000 units produces the above per unit results. 7

12. Budgeted Variable Costs
(12,000 units)
$300,000
312,000
228,000
$840,000
The budgeted variable costs at 12,000
units, therefore, are shown above.
Because FIXED costs do not change in
total as activity changes, the budgeted
amounts for these costs remain the same.

13. Flexible Overhead Budget Report
Illustration 22-5
Flexible Overhead Budget Report
This budget
report based
on the flexible
budget for
12,000 units
of production
shows that
the Forging
Department
is below budget-
a favourable
difference.
$ 5,000 F
-0-
3,000 F
8,000 F
$ 8,000 F

14. Developing the Flexible Budget
To develop the flexible budget, management should take the following steps:
1) Identify the activity index and the relevant range of activity.
2) Identify the variable costs and determine the budgeted variable cost per unit of activity for each cost.
3) Identify the fixed costs and determine the budgeted amount for each cost.
4) Prepare the budget for selected increments of activity within the relevant range.

15. Flexible Budget – A Case Study
Master Budget Data
Cyr Manufacturing wants to use a flexible budget for monthly
comparisons of actual and budgeted manufacturing overhead costs. The master budget for the year ended December 31,
2012 is prepared using 120,000 direct labour hours and the following overhead costs.
STEP 1: Identify the activity index and the relevant range of activity: The activity index is direct labour hours and management concludes that the relevant range is 8,000-12,000 direct labour hours.

16. Flexible Budget – A Case Study
STEP 2: Identify the variable costs and determine the budgeted variable cost per unit of activity for each cost.
There are 3 variable costs and the per unit variable cost is found by dividing each total budgeted cost by the direct labour hours used in preparing the master budget (120,000 hours).

17. Flexible Budget – A Case Study
Step 3: Identify the fixed costs and determine the budgeted amount for each cost.
There are three fixed costs and since Cyr desires monthly budget data, the budgeted amount is found by dividing each annual budgeted cost by 12 (e.g. Depreciation = $180,000/12 =$15,000)

18. Flexible Budget – A Case Study
Illustration 22-6: Flexible Monthly Overhead Budget
Step 4: Prepare the budget for selected increments of activity within the relevant range.

19. + Flexible Budget – A Case Study
Illustration 22-7: Formula for Total Budgeted Costs
From the budget, the following formula may be used to determine total budgeted costs at any level of activity.
For Cyr Manufacturing, fixed costs are $30,000, and total variable costs per unit is $4.00.
Thus, at 8,622 direct labour hours, total budgeted costs are:
EXAMPLE
Total
Budgeted
Costs
Fixed
Costs +
Variable
Costs
$30,000
$4.00 x 8,622
$64,488

20. Flexible Budget Reports
Flexible budget reports are another type of internal report produced by managerial accounting.
The flexible budget report consists of two sections:
1) Production data such as direct labour hours and
2) Cost data for variable and fixed costs.
Flexible budgets are used to evaluate a manager’s performance in production control and cost control. 8

21. Flexible Overhead Budget Report
Illustration 22-9
Flexible Overhead Budget Report
$13, , , ,000
15, , , , $66,000
In this budget report, 8,800 DLH were expected but 9,000 hours were worked. Budget data are based on the flexible budget for 9,000 hours.

22. Management by Exception
Management by exception means that top management's review of a budget report is focused entirely or primarily on differences between actual results and planned objectives.
For management by exception to be effective, there must be guidelines for identifying an exception. The usual criteria are:
1) Materiality- expressed as a percentage difference from budget.
2) Controllability of the item - exception guidelines are more restrictive for controllable items than for items that are not controllable by the manager.

23. The Concept of Responsibility Accounting
Responsibility accounting involves 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.
A manager's performance is evaluated on the matters directly under manager's control.

24. Responsibility Accounting
Responsibility accounting can be used at every level of management in which the following conditions exist:
1) Costs and revenues can be directly associated with the specific level of management responsibility.
2)The costs and revenues are controllable 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.

25. Responsibility Accounting
Responsibility accounting is especially valuable in a decentralized company.
Decentralization means that the control of operations is delegated to many managers throughout the organization.
A segment is an identified area of responsibility in decentralized operations.

26. Responsibility Accounting versus Budgetary Control
Responsibility accounting is essential to any effective system of budgetary control. It differs from budgeting in two respects:
1)A distinction is made between controllable and noncontrollable items.
2)Performance reports either emphasize or include only items controllable by the individual manager.

27. Controllable versus Noncontrollable Revenues and Costs
A cost is considered controllable at a given level of managerial responsibility if the manager has the power to incur it within a given period of time.
Costs incurred indirectly and allocated to a responsibility level are considered to be noncontrollable at that level.

28. Responsibility Reporting System
A responsibility reporting system involves the preparation of a report for each level of responsibility in the company's organization chart.
A responsibility reporting system permits management by exception at each level of responsibility.

29. Types of Responsibility Centres
Responsibility centres may be classified into one of three types.
1) A cost centre incurs costs (and expenses) but does not directly generate revenues.
2) A profit centre incurs costs (and expenses) and also generates revenues.
3) An investment centre incurs costs (and expenses), generates revenues, and has control over investment funds available for use.

30. Responsibility Accounting for Cost Centres
Illustration 22-13
Responsibility Accounting for Cost Centres
The evaluation of a manager’s performance for cost centres is based on his or her ability to meet budgeted goals for controllable costs. Responsibility reports for cost centres compare actual controllable costs with flexible budget data. Assume that the Finishing Department manager is able to control the following costs (from Illustration 22-9) only.
Top
management
may want an
explanation
of these
variance.
$ 500 U
1,000 F
100 U
Supervision , ,
$400 F

31. Responsibility Report
A responsibility report for a profit centre shows budgeted and actual controllable revenues and costs.
The report is prepared using the cost-volume-profit income statement format. In the report:
1) Controllable fixed costs are deducted from contribution margin.
2) The excess of contribution margin over controllable fixed costs is identified as controllable margin.
Controllable margin is considered to be the best measure of the manager’s performance in controlling revenues and costs.
3) Noncontrollable fixed costs are not reported.

32. Responsibility Report for Profit Centres
Illustration 22-14
Responsibility Report for Profit Centres
Note that this report does not show noncontrollable fixed costs.
This manager was below budgeted expectations
by approximately 10% ($36,000/ $360,000).
Controllable fixed costs
Controllable margin $360, $324, $36,000 U

33. Responsibility Accounting for Investment Centres
An important characteristic of an investment centre is that the manager can control or significantly influence the investment funds available for use.
Thus, the primary basis for evaluating the performance of a manger of an investment centre is return on investment (ROI).
ROI is considered to be superior to any other performance measurement because it shows the effectiveness of the manager in utilizing the assets at his or her disposal.

34. / Illustration 22-15 ROI Formula $1,000,000 / $5,000,000 = 20%
The formula for computing ROI for an investment centre, together with assumed illustrative data is shown below.
Operating assets consist of current assets and plant assets used in operations by the centre. Nonoperating assets such as idle plant assets and land held for future use are excluded.
Average operating assets are usually based on the beginning and ending cost or book values of the assets.
$1,000, / $5,000, = %
Investment
centre
Controllable
Margin
(in dollars)
Average
Investment
centre
Operating
Assets /
Return on
Investment
(ROI)

35. Responsibility Report for Investment Centre
Illustration 22-16
Responsibility Report for Investment Centre
Since an
investment
centre is an
independent
entity for operating
purposes,
all fixed costs are
controllable by the
investment centre
manager. Assume
in this example
that the manager
can control $60,000
of fixed costs that
were not
controllable when
the division was a
profit centre.
Other fixed costs , ,
Controllable margin $300, $264, $36,000 U

36. Responsibility Report for Investment Centre
Assuming actual average operating assets are $2,000,000
actual and budgeted ROI is calculated as follows:
Return on Investment % % %
Top management would likely want an
explanation of the reasons for actual ROI
being 12% below budgeted ROI (1.8% / 15%).

37. Assumed Data for Marine Division
A manager can improve ROI by:
(a)Increasing controllable margin or
(b)Reducing average operating assets.
Assume the following data for the Marine Division of Mantle Manufacturing:

38. ROI Calculation – Increase in Sales
If sales increased by 10%, or $200,000 ($2,000,000 x .10) and there was no change in the contribution margin percentage of 45%, contribution margin will increase $90,000 ($200,000 x .45). Controllable margin will increase by the same amount because
controllable fixed costs will not change. Thus, controllable
margin becomes $690,000 ($600,000 +$90,000). The new ROI is 13.8%, calculated as follows:
New controllable margin / Average operating assets
$690,000 / $5,000,000 =
13.8%

39. ROI Calculation – Decrease in Costs
Controllable margin can also be increased by reducing variable and
controllable fixed costs.
If variable and fixed costs were decreased by 10%, total costs will
decrease $140,000[($1,100,000 + $300,000) x .10]. This reduction will
result in a corresponding increase in controllable margin. Thus, this
margin becomes $740,000 ($600,000 + $140,000), and the new ROI is
14.8%, calculated as follows:
New Controllable margin / Average operating assets
$740,000 / $5,000,000 =
14.8%

40. ROI Calculation – Decrease in Operating Assets
A manager can also improve ROI by reducing average operating
assets. Assume that average operating assets are reduced 10% or
$500,000 ($5,000,000 x .10). Average operating assets become
$4,500,000 ($5,000,000 - $500,000), Since controllable margin remains
unchanged at $600,000, the new ROI is 13.3%, calculated as follows:
Controllable margin / New average operating assets
$600,000 / $4,500,000 =
13.3%

41. Principles of Performance Evaluation
Performance evaluation is a management function that compares actual results with budget goals.
Performance evaluation includes both behavioural and reporting principles.

42. Behavioural Principles
Behavioural principles should include:
1) Managers of responsibility centres should have direct input into the process of establishing budget goals for their area of responsibility.
2) The evaluation of performance should be based entirely on matters that are controllable by the manager being evaluated.
3) Top management should support the evaluation process.
4) The evaluation process must allow managers to respond to their evaluations.
5) The evaluation should identify both good and poor performance.

43. Reporting Principles of Performance Evaluation
Performance reports should:
1) Contain only data that are controllable by the manager of the responsibility centre.
2) Provide accurate and reliable budget data to measure performance.
3) Highlight significant differences between actual results and budget goals.
4) Be tailor-made for the intended evaluation.
5) Be prepared at reasonable intervals.

44. COPYRIGHT
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