24-1 The use of budgets in controlling operations is known as budgetary control.   Takes place by means of budget reports which compare actual results with planned objectives.   Provides management with feedback on operations.   Budget reports can be prepared as frequently as needed.   Analyze differences between actual and planned results and determines causes. Budgetary Control

24-2 Budgetary control involves the following activities. Illustration 24-1 Budgetary Control

24-3 Static Budget : budget data at one level of activity.   Ignores data for different levels of activity.   Compares actual results with budget data at the activity level used in the master budget. Static Budget Reports

24-4 Ex: Budget & actual sales data in the 1st & 2nd quarters of are: Static Budget Reports “Difference” often referred to as a Variance … or “Exception”

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24-9  Appropriate for evaluating a manager’s effectiveness in controlling costs when: ► Actual level of activity close to ximates master budget activity level.  Appropriate for fixed costs.  Not appropriate for variable costs. Uses and Limitations Static Budget Reports

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24-11 Flexible Budget: projects budget data for various levels of activity.  Budget is more useful if it is adaptable to changes in operating conditions.  Essentially a series of static budgets at different activity levels.  Can be prepared for each type of budget in the master budget. Flexible Budgets

24-12 Illustration: Barton Robotics, static budget based on a production volume of 10,000 units of robotic controls. Why Flexible Budgets? Flexible Budgets

24-13 Illustration: Static Budget based on 10,000 units Flexible Budgets

24-14  Over budget in three of six overhead costs.  Comparison based on budget data for 10,000 units - which is not relevant. ► Meaningless to compare actual variable costs for 12,000 units with budgeted variable costs for 10,000. ► Variable cost increase with production. Budgeted variable amounts should increase proportionately with production Flexible Budgets

24-15 Illustration: Analyzing the budget data for these costs at 10,000 units, you arrive at the following per unit results. Illustration 24-8 Variable costs per unit Illustration 24-9 Budgeted variable costs at 12,000 units. Flexible Budgets

24-16 Illustration: flexible budget for 12,000 units of production. Flexible Budgets

24-17 Ex: Corp uses a flexible budget to compare actual vs budgeted manufacturing overhead costs. The master budget year ending 12/31/14, shows expected annual operating capacity of 120,000 direct labor hours and these overhead costs. Flexible Budget – A Case Study These variable costs are based on 120,000 hours (120,000 / 12 = 10,000 hours per month)

24-18  Identify the activity index and the relevant range. ► Activity index: direct labor hours. ► Relevant range for the flexible budget: 96,000 – 144,000 labor hours per year (96,000 hrs yr / 12 months = 8,000 hours per month) (144,000 hrs yr / 12 months = 12,000 hours per month) Flexible Budget – A Case Study – 4 steps

24-19  Identify variable costs and determine the budgeted variable cost per unit of activity for each cost. Flexible Budget – A Case Study – 4 steps Original budget based on 120,000 hours

24-20  Identify the fixed costs and determine the budgeted amount for each cost. ► Three fixed costs per month: Depreciation …180,000 / 12 = 15,000 per mo. Supervision … 120,000 / 12 = 10,000 per mo. Property taxes 60,000 / 12 = 5,000 per mo. Flexible Budget – A Case Study – 4 steps Original budget based on 120,000 hours (12 months)

24-21  Prepare the budget for selected increments of activity within the relevant range. ► Prepared for range of 8,000 – 12,000 direct labor hours per month in increments of 1,000 direct labor hours. Flexible Budget – A Case Study – 4 steps

24-22 Monthly overhead flexible budget

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24-24 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. Conditions: 1. 1.Costs and revenues can be directly associated with the specific level of management responsibility Costs and revenues can be controlled by employees at the level of responsibility with which they are associated Budget data can be developed for evaluating the manager’s effectiveness in controlling the costs and revenues. Responsibility Accounting

24-25 Levels of responsibility for controlling costs. Illustration Responsibility Accounting

24-26   Different from budgeting: 1. 1.Distinguishes between controllable versus noncontrollable costs Emphasizes only items controllable by the individual manager in performance reports. Responsibility Accounting

24-27 Critical issue is whether the cost or revenue is controllable at the level of responsibility with which it is associated. A cost over which a manager has control is a controllable cost All costs are controllable by top management Fewer costs are controllable as one moves down to each lower level of managerial responsibility. Costs incurred indirectly and allocated to a responsibility level are noncontrollable costs. Controllable vs Noncontrollable Revenues and Costs Responsibility Accounting

24-28 Management by exception means that top management’s review of a budget report is focused primarily on differences between actual results and planned objectives.   Materiality - Without quantitative guidelines, management would have to investigate every budget difference regardless of the amount.   Controllability of the item - Exception guidelines are more restrictive for controllable items than for items the manager cannot control. Management by Exception Principles of Performance Evaluation

24-29 Responsibility Accounting Illustration Partial organization chart

24-30 Report A President sees summary data of vice presidents. Report B Vice president sees summary of controllable costs in his/her functional area. Report C Plant manager sees summary of controllable costs for each department in the plant. Responsibility Accounting Report D Department manager sees controllable costs of his/her department. Illustration Responsibility reporting system  Permits comparative evaluations.  Plant manager can rank each department manager’s effectiveness in controlling manufacturing costs.  Comparative rankings provide incentive for a manager to control costs.

24-31 Three basic types:   Cost centers ► ► Incurs costs but does not directly generate revenues. ► ► Managers have authority to incur costs. ► ► Managers evaluated on ability to control costs. ► ► Usually a production or a service department.   Profit centers   Investment centers Types of Responsibility Centers

24-32 Illustration: The following report is adapted from the flexible budget report for Fox Manufacturing Company in Illustration Illustration Types of Responsibility Centers

24-33 Three basic types:   Cost centers   Profit centers ► ► Incurs costs and generates revenues. ► ► Managers judged on profitability of center. ► ► Ex: individual departments of a retail store or branch bank offices.   Investment centers Types of Responsibility Centers

24-34 The Marine Division also had $60,000 of indirect fixed costs that were not controllable by the profit center manager. Illustration Types of Responsibility Centers

24-35 Three basic types:   Cost centers   Profit centers   Investment centers ► ► Incurs costs, generates revenues, and has investment funds available for use. ► ► Manager evaluated on profitability of the center and rate of return earned on funds. ► ► Often a subsidiary company or a product line. ► ► Manager able to control or significantly influence investment decisions such as plant expansion. Types of Responsibility Centers

24-36 Illustration: The Marine Division is an investment center. It has operating assets of $2,000,000. The manager can control $60,000 of fixed costs. Types of Responsibility Centers

24-37 Return on investment (ROI) is the primary basis for evaluating the performance of a manager of an investment center.   Shows the effectiveness of the manager in using the assets at his/her disposal.   Useful performance measure.   Factors in ROI formula are controllable by manager. Responsibility Accounting for Investment Centers Types of Responsibility Centers