1. Budgetary Control and Responsibility Accounting
Chapter 10
Richard E. McDermott, Ph.D.

2. 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.

3. 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

4. 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

5. Example Problem
The controller of XYZ Company has provided you with the following cost information on the company’s 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, (25,000)
Y = $450,000

6. 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.

7. 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.

8. 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.
Let’s see an example!

9. Responsibility Report Format
Everything here is under control of one manager!
Budget
Actual
Variance
Sales
$xxx
Less variable costs
Contribution margin
Less controllable fixed costs
Controllable margin

10. 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

11. Exercise 10-1
Identify each of the statements on the following slide as true or false.
If false, indicate how to correct the statement.

12. 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

13. 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.

14. 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.

15. Exercise 10-1
9. Top management’s reaction to unfavorable differences is not influenced by the materiality of the difference
False. Top management’s reaction to unfavorable differences is often influenced by the materiality of the difference.
10.A static budget is not appropriate in evaluating a manager’s effectiveness in controlling costs unlessthe actual activity level approximates the static budget level or the behavior of the cost is fixed.
True.

16. 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

17. 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.

18. 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.
Activity level Direct labor hours
  7,000
  8,000
  9,000
 10,000

19. Exercise 10-3
Now multiply in the variable costs per activity level by the budgeted number of activities to get total variable costs.
Activity level Direct labor hours Variable costs Indirect labor ($1) Indirect materials ($.50) Utilities ($.40) Total variable costs ($1.90)
  7,000 $ 7,000   3, , ,300   
  8,000 $ 8,000   4, , ,200     
  9,000 $ 9,000   4, , ,100     
 10,000 $10,000   5, , ,000  

20. Exercise 10-3
Now insert fixed costs. Then total variable and fixed costs to give a total budget at each level of activity.
Activity level Direct labor hours Variable costs Indirect labor ($1) Indirect materials ($.50) Utilities ($.40) Total variable costs ($1.90) Fixed costs Supervision Depreciation Property taxes Total fixed costs Total costs
  7,000 $ 7,000   3, , ,300    4,000   1, ,300 $19,600
  8,000 $ 8,000   4, , ,200    4,000   1, ,300 $21,500
  9,000 $ 9,000   4, , ,100    4,000   1, ,300 $23,400
 10,000 $10,000   5, , ,000    4,000   1, ,300 $25,300

21. Exercise 10-4
Using the information from exercise 10-3, assume that in 2008, the company incurs the following manufacturing overhead costs.
Variable costs
Fixed costs
Indirect labor
$8,700
Supervision
$4,000
Indirect materials
4,300
Depreciation
1,500
Utilities
3,200
Property taxes
800

22. Manufacturing Overhead Flexible Budget Report
RANEY COMPANY
Manufacturing Overhead Flexible Budget Report
For the Month Ended July 31, 2008
Direct labor hours (DLH)
Variable costs
Indirect labor
Indirect materials
Utilities
Total variable costs
Fixed costs
Supervision
Depreciation
Property taxes
Total fixed costs
Total costs
Budget at
9,000 DLH
$ 9,000
  4,500
3,600
17,100   
4,000
  1,500
800
6,300
$23,400
Actual Costs
$ 8,700
  4,300
3,200
16,200
$22,500
Difference
$300 F
 200 F
400 F
900 F
$900 F
Prepare a flexible budget at 9,000 hours.

23. Manufacturing Overhead Flexible Budget Report
RANEY COMPANY
Manufacturing Overhead Flexible Budget Report
For the Month Ended July 31, 2008
Direct labor hours (DLH)
Variable costs
Indirect labor
Indirect materials
Utilities
Total variable costs
Fixed costs
Supervision
Depreciation
Property taxes
Total fixed costs
Total costs
Budget at
8,500 DLH
$ 8,500
4,250
3,400
16,150   
4,000
  1,500
800
6,300
$22,450
Actual Costs
$ 8,700
  4,300
3,200
16,200  
 4,000
$22,500
Difference
$200 U
 50 U
200 F
50 U
$ 50 U
Prepare a flexible budget at 8,500 hours.

24. 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.

25. 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.

26. Garber Company Budget Report for October 31, 2008
Original Report
Garber Company Budget Report for October 31, 2008
Budget
Actual
Difference
Sales in units
8000
10,000
-2,000
Variable expenses
Sales commissions
2000
2600
-600
Advertising expenses
800
850
-50
Travel expense
3600
4000
-400
Free samples give amount
1600
1300
300
Total variable
8750
-750
Fixed expenses
Rent
1500
Sales salaries
1200
Office salaries
Depreciation
500
Total fixed
Total expenses
12000
12750

27. Garber Company Budget Report for October 31, 2008
Corrected Variable Cost Report
Then we multiply per unit cost by actual activity
Garber Company Budget Report for October 31, 2008
Variable
Budget
Cost per unit
Actual
Difference
Sales in units
10,000
-2,000
Variable expenses
Sales commissions
2,500
0.25
2,600
-100
Advertising expenses
1,000
0.10
850
150
Travel expense
4,500
0.45
4,000
500
Free samples give amount
2,000
0.20
1,300
700
Total variable
1.00
8,750
1,250
Fixed expenses
Rent
1500
Sales salaries
1200
Office salaries
800
Depreciation
Total fixed
4000
Total expenses
14000
12,750
We calculate per unit cost first by dividing budget by units of activity.

28. Exercise 10-8
Terry should not have been reprimanded. As shown in the flexible budget report, variable costs were $1,250 below budget.

29. 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.

30. Exercise 10-9 Budgeted Actual Service revenue 25,000 26,000
Allocated portion of:
Building depreciation
11,000
Advertising
5000
4200
Billing
3500
3000
Property taxes
1200
1000
Material and supplies
1500
Supervisory salaries
9000
9400
Insurance
4000
Wages
3300
Gas and oil
2700
3400
Equipment depreciation
1600
1300

31. Exercise 10-9
Prepare a responsibility report for the first quarter of for the home plumbing service segment.
Remember the formula:
Revenue – variable expenses – controllable fixed expenses = controllable margin

32. Responsibility Report For the Quarter Ended March 31, 2008
Calculate the contribution margin first:
Budget
Actual
Difference Favorable F Unfavorable U
Service revenue
$25,000
$26,000
$1,000 F
Variable costs:
Material and supplies
1,500
1,200
300 F
Wages
3,000
3,300
300 U
Gas and oil
2,700
3,400
700 U
Total variable costs
7,200
7,900
Contribution margin
17,800
18,100

33. Responsibility Report For the Quarter Ended March 31, 2008
Then subtract controllable fixed expenses:
Budget
Actual
Difference Favorable F Unfavorable U
Service revenue
$25,000
$26,000
$1,000 F
Variable costs:
Material and supplies
1,500
1,200
300 F
Wages
3,000
3,300
300 U
Gas and oil
2,700
3,400
700 U
Total variable costs
7,200
7,900
Contribution margin
17,800
18,100
Controllable fixed costs:
Supervisory salaries
9,000
9,400
400 U
Insurance
4,000
3,500
500 F
Equipment depreciation
1,600
1,300
Total controllable fixed costs
14,600
14,200
400 F
Controllable margin
$ 3,200
$ 3,900
$ F

34. Exercise 10-9
Write a memo to the president discussing the principles that should be used when preparing a performance report.

35. Exercise 10-9 Points to be covered:
When evaluating the performance of a company’s segments, the performance reports should:
Contain only data that are controllable by the segment’s 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.

36. The End