2. 23 - 1©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber The Master Budget and Responsibility Accounting Chapter 23

3. 23 - 2©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Identify the benefits of budgeting. Objective 1

4. 23 - 3©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Benefits of Budgeting requires managers to plan promotes coordination and communication helps managers evaluate performance motivates employees to achieve company goals

5. 23 - 4©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Components of the Master Budget Purchases Budget ____ Cost of Goods Sold Budget ____ Operating Expenses Budget ____ Budgeted Income Statement ____ Sales Budget ____ Inventory Budget ____ Operating Budget

6. 23 - 5©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Components of the Master Budget Budgeted Balance Sheet _____ Budgeted Statement of Cash Flows _____ Budgeted Income Statement _____ Capital Expenditures Budget _____ Cash Budget _____ Financial Budget

7. 23 - 6©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Preparing the Master Budget n Suppose that J.J. manages Plantation Sporting Store No. 13. n Selected parts of the master budget will be prepared for Store No. 13 for April, May, June, and July.

8. 23 - 7©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Preparing the Master Budget n Sales are 60% cash and 40% on credit. n Credit sales are collected in the month following the sale. n Accounts receivable on March 31 amounted to $19,200. n How much were total sales in March? n $19,200 ÷.40 = $48,000

9. 23 - 8©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Projected Sales April ……………$50,000 May ……………$80,000 June ……………$60,000 July ……………$50,000 Preparing the Master Budget

10. 23 - 9©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Preparing the Master Budget n Plantation maintains inventory equal to $10,000 plus 40% of the budgeted cost of goods sold for the following month. n Cost of goods sold averages 70% of sales. n Target ending inventory on July 31 is $32,000.

11. 23 - 10©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Preparing the Master Budget n What is the ending inventory on March 31? n $10,000 + (0.40 × 0.70 × April sales of $50,000) n What is the beginning inventory? n $10,000 + (0.40 × 0.70 × $48,000) = $23,440

12. 23 - 11©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Preparing the Master Budget n Plantation pays for inventory as follows: 50% during the month of purchase and 50% during the next month. n March purchases were $34,160. n How much was paid in March for March’s purchases? n $34,160 × 50% = $17,080

13. 23 - 12©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Prepare an operating budget. Objective 2

14. 23 - 13©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Sales Budget (Schedule A) n Sales revenue is the key measure of business activity. n The budgeted total sales revenue for each product is the sales price multiplied by the expected number of units sold.

15. 23 - 14©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber April May June July Cash sales 60%$30,000$48,000$36,000$30,000 Credit sales 40% 20,000 32,000 24,000 20,000 Total$50,000$80,000$60,000$50,000 Total sales April through July = $240,000 Sales Budget (Schedule A)

16. 23 - 15©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Purchases, Cost of Goods Sold, and Inventory Budget n Cost of goods sold = 70% × sales n How much are the cost of goods sold for May? n 70% × $80,000 = $56,000 n What is the desired ending inventory for April? n $10,000 + (40% × $56,000) = $32,400

17. 23 - 16©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Beginning inventory + Purchases – Ending inventory = Cost of goods sold Cost of goods sold + Ending inventory – Beginning inventory = Purchases Purchases, Cost of Goods Sold, and Inventory Budget

18. 23 - 17©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber April May June July Cost of goods sold (70% × sales)$35,000$56,000$42,000$35,000 Desired ending inventory 32,400 26,800 24,000 32,000 Total required$67,400$82,800$66,000$67,000 Beginning inventory 24,000 32,400 26,800 24,000 Purchases$43,400$50,400$39,200$43,000 Schedule B

19. 23 - 18©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Schedule B April………………$ 35,000 May………………. 56,000 June………………. 42,000 July………………. 35,000 Total$168,000 How much is the cost of goods sold for the four-month period?

20. 23 - 19©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Operating Expenses Budget n Assume that Plantation Sporting Goods incurs $4,000 of fixed expenses every month and that commissions and other variable expenses equal 20% of sales. n What is the operating expenses budget (Schedule C)?

21. 23 - 20©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber April May June July Variable expenses (From Schedule A) 20% of sales$10,000$16,000$12,000$10,000 Fixed expenses 4,000 4,000 4,000 4,000 Total$14,000$20,000$16,000$14,000 Total operating expenses: $64,000 Operating Expenses Budget (Schedule C)

22. 23 - 21©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Budgeted Income Statement Plantation Sporting Goods Store No. 13 Budgeted Income Statement Four Months Ending July 31, 20xx Amount Source Sales$240,000Schedule A Cost of goods sold 168,000Schedule B Gross margin$ 72,000 Operating expense 64,000Schedule C Net income$ 8,000

23. 23 - 22©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Prepare the components of a financial budget. Objective 3

24. 23 - 23©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Cash budget Budgeted balance sheet Preparing the Financial Budget n The financial budget includes:

25. 23 - 24©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Preparing the Cash Budget n The cash budget has the following major parts: – cash collections from customers (Schedule D) – cash disbursements for purchases (Schedule E) – cash disbursements for operating expenses (Schedule F) – capital expenditures (not illustrated in this chapter)

26. 23 - 25©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Cash Collections from Customers (Schedule D) April May June July Cash sales$30,000$48,000$36,000$30,000 Collections of last month’s credit sales 19,200* 20,000 32,000 24,000 Total$49,200$68,000$68,000$54,000 Total collections: $239,200 *19,200 = March 31 accounts receivable From Schedule A

27. 23 - 26©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Cash Disbursements for Purchases (Schedule E) April May June July Payment of last month’s purchases$17,080$21,700$25,400$19,600 Payment of this month’s purchases 21,700 25,200 19,600 21,500 Total$38,780$46,900$45,000$41,100 Total disbursements: $171,780 From Schedule B

28. 23 - 27©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber April May June July Payment of last month’s expenses$ 6,800$ 7,000$10,000$ 8,000 Payment of this month’s expenses 7,000 10,000 8,000 7,000 Total$13,800$17,000$18,000$15,000 Total disbursements: $63,800 Cash Disbursements for Operating Expenses (Schedule F) From Schedule C

29. 23 - 28©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Plantation Sporting Goods Store No. 13 Cash Budget Four Months Ending July 31, 20xx Budgeted cash receipts$239,200 Budgeted cash disbursements Purchases$171,780 Operating expenses 63,800 235,580 Budgeted cash increase$ 3,620 Cash Budget

30. 23 - 29©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Preparing the Budgeted Balance Sheet n Assets, liabilities, and owners’ equity are projected based upon the previous schedules. n Assume that the cash balance on March 31 was $15,000. n What is the budgeted cash balance on July 31? n $15,000 + $3,620 expected increase = $18,620

31. 23 - 30©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Use sensitivity analysis in budgeting. Objective 4

32. 23 - 31©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Budgeting and Sensitivity Analysis n Sensitivity analysis helps managers plan for different courses of action. n This type of “what if” analysis shows the result of changing an underlying assumption in the budgeting process. n Sensitivity analysis may affect very specific plans.

33. 23 - 32©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Distinguish among different types of responsibility centers. Objective 5

34. 23 - 33©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Responsibility Accounting... – is a system for evaluating the performance of managers and the activities they supervise. n A responsibility center is a part, segment, or subunit of an organization whose manager is accountable for specific activities.

35. 23 - 34©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Investment center Cost center Revenue center Profit center Responsibility Center

36. 23 - 35©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Prepare a performance report for management by exception. Objective 6

37. 23 - 36©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Management by Exception Northern California District Manager San Francisco Branch Manager San Jose Branch Manager Oakland Branch Manager Sacramento Branch Manager Geary Store Manager Beale Store Manager Wharf Store Manager Other Managers

38. 23 - 37©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Management by Exception n Performance reports show differences between budgeted and actual amounts. n Management by exception is the practice of focusing on important variances so that managers can direct their attention to areas that need improvement.

39. 23 - 38©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Management by Exception Plantation Sporting Goods Store No. 13 Monthly Responsibility Report (Budget) Month YTD Revenues$50,000$388,000 Cost of goods sold 35,000 271,600 Wages 6,700 51,992 Repairs 2,000 15,520 General 1,300 10,088 Fixed costs 4,000 28,000 Operating income$ 1,000$ 10,800

40. 23 - 39©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Management by Exception Plantation Sporting Goods Store No. 13 Monthly Responsibility Report (Actual) Month YTD Revenues$55,000$408,000 Cost of goods sold 37,400 277,440 Wages 7,370 54,672 Repairs 550 8,160 General 900 8,160 Fixed costs 4,000 28,000 Operating income$ 4,780$ 31,568

41. 23 - 40©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Management by Exception Plantation Sporting Goods Store No. 13 July 20xx, Responsibility Report Budget Actual Variance (F/U) Revenues$50,000$55,000$5,000 (F) Cost of goods sold 35,000 37,400 2,400 (U) Wages 6,700 7,370 670 (U) Repairs 2,000 550 1,450 (F) General 1,300 900 400 (F) Fixed costs 4,000 4,000 --- Operating income$ 1,000$ 4,780$3,780 (F)

42. 23 - 41©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Management by Exception n J.J., manager of Plantation Sporting Goods Store No. 13, will investigate why cost of goods sold and wages were more than budgeted. n Cost of goods sold was originally budgeted to be 70% of sales. n Wages was budgeted to be 67% of total operating variable expenses or 13.4% of sales.

43. 23 - 42©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Management by Exception n Management will determine that cost of goods sold were 68% of sales instead of the 70% originally budgeted. n $37,400 ÷ $55,000 = 68% n Pleasant news!

44. 23 - 43©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Management by Exception n Management may investigate why wages were 84% of total variable operating expenses instead of the 67% originally budgeted, although in total they remained 13.4% of sales. n $7,370 ÷ $8,820 = 84% n It will be determined that other variable operating expenses were less than anticipated.

45. 23 - 44©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Management by Exception Broward County Branch Manager Plantation Sporting Stores July 20xx, Responsibility Report Budget Actual Variance (F/U) Branch manager office expense$20,000$25,000$ 5,000 (U) Income: Store 13 1,000 4,780 3,780 (F) Others 80,000 95,220 15,220 (F) Operating income$61,000$75,000$14,000 (F)

46. 23 - 45©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Management by Exception South Florida District Manager Plantation Sporting Stores July 20xx, Responsibility Report Budget Actual Variance (F/U) District manager office expense$ 95,000$ 99,000$ 4,000 (U) Income: Broward county 61,000 75,000 14,000 (F) Other counties 280,000 325,000 45,000 (F) Operating income$246,000$301,000$55,000 (F)

47. 23 - 46©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Allocate indirect costs to departments. Objective 7

48. 23 - 47©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Allocation of Indirect Costs n Indirect costs are allocated to departments or responsibility centers using the following steps: 1 Choose an allocation base for the indirect cost. 2 Compute an indirect cost allocation rate. 3 Allocate the indirect cost.

49. 23 - 48©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Choose an Allocation Base Cost or Expense Basis Indirect laborTime spent Building depreciationSquare feet Heat, lights, etc.Square feet Janitorial servicesSquare feet Payroll and personnel# of employees Purchasing# of purchase orders placed

50. 23 - 49©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Choose an Allocation Base n Lets consider the Healthy Clinic, a provider of Ear, Nose, and Throat (ENT) plus Audiology services. n Rent for the year is $120,000. n Total square footage occupied by the clinic is 12,000. n What is the rent per square foot? n $120,000 ÷ 12,000 = $10

51. 23 - 50©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Compute a Cost Allocation Rate n Other expenses amounted to $100,000 and are allocated on the basis of professional services expenses. n Total professional services expenses amounted to $250,000. n ENT accounted for $175,000 of these expenses and Audiology for $75,000.

52. 23 - 51©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Compute a Cost Allocation Rate n What is the allocation rate? n $100,000 ÷ $250,000 = 40% n 40% of what? n 40% of professional services expenses.

53. 23 - 52©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Allocate the Indirect Cost n ENT occupies 9,000 square feet. n How much rent is allocated to ENT? n 9,000 × $10 = $90,000 n How much rent is allocated to Audiology? n 12,000 – 9,000 = 3,000 square feet n 3,000 × $10 = $30,000

54. 23 - 53©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Allocate the Indirect Cost n How much of the “other expenses” are allocated to ENT? n $175,000 × 40% = $70,000 n How much to Audiology? n $75,000 × 40% = $30,000

55. 23 - 54©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Evaluate Performance Healthy Clinic Departmental Partial Income Statement For the Year Ended December 31, 20xx (in thousands) TotalENT Audiology Service revenue$500$350$150 Professional services 250 175 75 Margin$250$175$ 75 Rent expense 120 90 30 Other 100 70 30 Operating income$ 30$ 15$ 15

56. 23 - 55©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Evaluate Performance n ENT generates a professional margin of $175,000 compared to $75,000 by Audiology. n However, the margin per square foot is $175,000 ÷ 9,000 = $19.44 for ENT and $75,000 ÷ 3,000 = $25.00 for Audiology.

57. 23 - 56©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber End of Chapter 23