ACCT 2102 Test 3

Direct fixed costs

- Relate specifically to one responsibility center. - Incurred for the sole benefit of the center. - Called traceable costs since they can be traced directly to one center. - Most direct fixed costs are controllable by the profit center manager.

Benefits of Budgeting

- Requires all levels of management to plan ahead. - Provides definite objectives for evaluating performance. - Creates an early warning system for potential problems. - Facilitates coordination of activities within the business. - Results in greater management awareness of the entity's overall operations. - Motivates personnel throughout organization to meet planned objectives.

Prepared from the operating budgets:

- Sales - Direct Materials - Direct Labor - Manufacturing Overhead - Selling and Administrative Expense

Cash Budget:

- Shows anticipated cash flows. - Often considered to be the most important output in preparing financial budgets. Must prepare in sequence. - Ending cash balance of one period is the beginning cash balance for the next. - Data obtained from other budgets and from management. - Often prepared for the year on a monthly basis. - Contributes to more effective cash management. - Shows managers the need for additional financing before actual need arises. - Indicates when excess cash will be available. Contains three sections: - Cash Receipts - Cash Disbursements - Financing

Direct Materials Budget

- Shows both the quantity and cost of direct materials to be purchased. - Formula for direct materials quantities: Direct Materials Units Required for Production + Desired Ending Materials Units - Beginning Direct Materials Units= Required Direct Materials Units to Be Purchased - Budgeted cost of direct materials to be purchased = required units of direct materials x anticipated cost per unit. - Inadequate inventories could result in temporary shutdowns of production

Direct Labor Budget

- Shows both the quantity of hours and cost of direct labor necessary to meet production requirements. - Critical in maintaining a labor force that can meet expected production. Total Direct Labor Cost= Units to Be Produced * Direct Labor Time per Unit * Direct Labor Cost per Hour

Production Budget:

- Shows units that must be produced to meet anticipated sales. - Derived from sales budget plus the desired change in ending finished goods inventory. - Essential to have a realistic estimate of ending inventory. Budgeted Sales Units + Desired Ending Finished Goods Units - Beginning Finished Goods Units = Required Production

Responsibility Center:

- any individual who has control and is accountable for activities. May extend to any level of management. Especially valuable in a decentralized company. - Control of operations delegated to many managers throughout the organization. - Segment - area of responsibility for which reports are prepared.

Flexible Budgets

- projects budget data for various levels of activity. - Budgetary process 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. - Over budget in three of six overhead costs. Comparison based on budget data for 10,000 units - the original activity level which is not relevant. - Meaningless to compare actual variable costs for 12,000 units with budgeted variable costs for 10,000 units. - Variable cost increase with production.

Developing the Flexible Budget

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.

Expected direct materials purchases in Read Company are $70,000 in the first quarter and $90,000 in the second quarter. Forty percent of the purchases are paid in cash as incurred, and the balance is paid in the following quarter. The budgeted cash payments for purchases in the second quarter are:

78000

Flexible Budget Reports

Monthly comparisons of actual and budgeted manufacturing overhead costs. A type of internal report. Consists of two sections: - Production data for a selected activity index, such as direct labor hours. - Cost data for variable and fixed costs. Widely used in production and service departments to evaluate a manager's performance.

Budgeting and Human Behavior

Participative Budgeting: Each level of management should be invited to participate. - May inspire higher levels of performance or discourage additional effort. - Depends on how budget developed and administered.

Responsibility Accounting for Investment Centers

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.

Merchandisers

Sales Budget: - starting point and key factor in developing the master budget. Use a purchases budget instead of a production budget. - Does not use the manufacturing budgets (direct materials, direct labor, manufacturing overhead). To determine budgeted merchandise purchases: Budgeted Cost of Goods Sold + Desired Ending Merchandise Inventory - Beginning Merchandise Inventory = Required Merchandise Purchases

The Master Budget

Set of interrelated budgets that constitutes a plan of action for a specified time period. Contains two classes of budgets: - Operating budgets: - Financial budgets:

Manufacturing Overhead Budget:

Shows the expected manufacturing overhead costs for the budget period. - Distinguishes between fixed and variable overhead costs.

Static Budget Reports

Static budget is a projection of budget data at one level of activity. - When used in budgetary control, each budget included in the master budget is considered to be static. - Ignores data for different levels of activity. - Compares actual results with budget data at the activity level used in the master budget.

Financial Budgets:

The capital expenditures budget, the cash budget, and the budgeted balance sheet - focus primarily on cash needs to fund operations and capital expenditures.

Budgetary Control

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. Works best when a company has a formalized reporting system which: - Identifies the name of the budget report. - States the frequency of the report. - Specifies the purpose of the report. - Indicates recipient(s) of the report.

Budgeting and Long- Range Planning

Three basic Differences: Time period: - Budgeting is short-term (1 year) - Long range planning (atleast 5 yrs) Emphasis Detail presented

Responsibility Accounting

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. Costs and revenues can be directly associated with the specific level of management responsibility. 2. Costs and revenues can be controlled by employees 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.

Uses and Limitations

Appropriate for evaluating a manager's effectiveness in controlling costs when: - Actual level of activity closely approximates master budget activity level. - Behavior of costs is fixed in response to changes in activity. Appropriate for fixed costs. Not appropriate for variable costs.

$400 unfavorable

At 9,000 direct labor hours, the flexible budget for indirect materials is $27,000. If $28,000 of indirect materials costs are incurred at 9,200 direct labor hours, the flexible budget report should show the following difference for indirect materials:

Sales Budget:

First budget prepared. Derived from the sales forecast. - Management's best estimate of sales revenue for the budget period. Every other budget depends on the sales budget. Prepared by multiplying expected unit sales volume for each product times anticipated unit selling price.

A static budget is useful in controlling costs when cost behavior is

Fixed

Controllable Margin

In a responsibility report for a profit center, controllable fixed costs are deducted from contribution margin to show:

Operating Budgets:

Individual budgets that result in the preparation of the budgeted income statement - establish goals for sales and production personnel.

Which of the following is not a benefit of budgeting?

It enables disciplinary action to be taken at every level of responsibility.

A sales budget is:

Management's best estimate of sales revenue for the year.

Length of the Budget Period

May be prepared for any period of time. - Most common - one year. - Supplement with monthly and quarterly budgets. - Different budgets may cover different time periods. Long enough to provide an attainable goal and minimize seasonal or cyclical fluctuations. Short enough for reliable estimates.

Indirect fixed costs

- Pertain to a company's overall operating activities. - Incurred for the benefit of more than one profit center. - Called common costs since they apply to more than one center. - Most are not controllable by the profit center manager.

Selling and Administrative Expense Budget

- Projection of anticipated operating expenses. - Distinguishes between fixed and variable costs.

Financing Section

Expected borrowings and repayments of borrowed funds plus interest.

The budget for a merchandiser differs from a budget for a manufacturer because:

- A merchandise purchases budget replaces the production budget - The manufacturing budgets are not applicable.

Responsibility Accounting for Profit Centers

- Based on detailed information about both controllable revenues and controllable costs. - Manager controls operating revenues earned, such as sales. - Manager controls all variable costs incurred by the center because they vary with sales.

Reporting Principles

- Contain only data controllable by manager of responsibility center. - Provide accurate and reliable budget data to measure performance. - Highlight significant differences between actual results and budget goals. - Be tailor-made for intended evaluation. - Be prepared at reasonable intervals.

Essentials of Effective Budgeting

- Depends on a sound organizational structure with authority and responsibility for all phases of operations clearly defined. - Based on research and analysis with realistic goals. - Accepted by all levels of management.

Cash Disbursements Section

- Expected cash payments for direct materials and labor, taxes, dividends, plant assets, etc.

Cash Receipts Section:

- Expected receipts from the principal sources of revenue. - Expected interest and dividends receipts, proceeds from planned sales of investments, plant assets, and capital stock.

Factors considered in Sales Forecasting:

- General economic conditions - Industry trends - Market research studies - Anticipated advertising and promotion - Previous market share - Price changes - Technological developments

Budgeting and Accounting

- Historical accounting data on revenues, costs, and expenses help in formulating future budgets. - Accountants normally responsible for presenting management's budgeting goals in financial terms. - The budget and its administration are the responsibility of management.

Budgeted Income Statement

- Important end-product of the operating budgets. - Indicates expected profitability of operations. - Provides a basis for evaluating company performance. - Prepared from the operating budgets:

Responsibility Reporting System

- Involves preparation of a report for each level of responsibility in the company's organization chart. - Begins with the lowest level of responsibility and moves upward to higher levels. - Permits management by exception at each level of responsibility. - Each higher level can obtain the detailed report for each lower level.

Not-For- Profit Organizations

- Just as important as for profit-oriented company. - Budget process differs from profit-oriented company. - Budget on the basis of cash flows (expenditures and receipts), not on a revenue and expense basis. - Starting point is usually expenditures, not receipts. - Management's task is to find receipts needed to support planned expenditures. - Budget must be followed, overspending often illegal.

Principles of Performance Evaluations

- Management function that compares actual results with budget goals. - Includes both behavioral and reporting principles.

Behavioral Principles

- Managers of responsibility centers should have direct input into the process of establishing budget goals of their area of responsibility. - The evaluation of performance should be based entirely on matters that are controllable by the manager being evaluated. - Top management should support the evaluation process. - The evaluation process must allow managers to respond to their evaluations. - The evaluation should identify both good and poor performance.

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.

Advantages of Participative Budgeting

- More accurate budget estimates because lower level managers have more detailed knowledge of their area. - Tendency to perceive process as fair due to involvement of lower level management. Overall goal - produce budget considered fair and achievable by managers while still meeting corporate goals. Risk of unreliable budgets greater when they are "top-down."

The Budgeting Process

Base budget goals on past performance - Collect data from organizational units. - Begin several months before end of current year. Develop budget within the framework of a sales forecast. - Shows potential industry sales. - Shows company's expected share.

Responsibility Accounting for Cost Centers

Based on a manager's ability to meet budgeted goals for controllable costs. Results in responsibility reports which compare actual controllable costs with flexible budget data. - Include only controllable costs in reports. - No distinction between variable and fixed costs.

Budgeting Basics

Budget: - a formal written statement of management's plans for a specified future time period, expressed in financial terms. - Primary way to communicate agreed-upon objectives to all parts of the company. - Promotes efficiency. - Control device - important basis for performance evaluation once adopted.

Responsibility Report

Budgeted and actual controllable revenues and costs. Uses cost-volume-profit income statement format: - Deduct controllable fixed costs from the contribution margin. - Controllable margin - excess of contribution margin over controllable fixed costs. - Do not report noncontrollable fixed costs. Scope of manager's responsibility affects content. Investment center is an independent entity for operating purposes. All fixed costs are controllable by center manager. Shows budgeted and actual ROI below controllable margin.

Disadvantages:

Can be time consuming and costly. Can foster budgetary "gaming" through budgetary slack

Each of the following budgets is used in preparing the budgeted income statement except the:

Capital expenditure budget

Return on Investment (ROI)

Controllable / Average Operating Assets = Return on Investment - Operating assets include current assets and plant assets used in operations by the center and controlled by the manager. - Base average operating assets on the beginning and ending cost or book values of the assets.

In the formula for return on investment (ROI), the factors for controllable margin and operating assets are, respectively:

Controllable margin dollars and average operating assets.

Service Companies

Critical factor in budgeting is coordinating professional staff needs with anticipated services. Problems if overstaffed: - Disproportionately high labor costs. - Lower profits due to additional salaries. - Increased staff turnover due to lack of challenging work. Problems if understaffed: - Lost revenues because existing and future client needs for services cannot be met. - Loss of professional staff due to excessive work loads.

Controllable Vs. Non- controllable Revenues and Costs

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 called 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.

Budgeted Balance Sheet

Developed from the budgeted balance sheet for the preceding year and the budgets for the current year.

Types of Responsibility Centers

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 department or a service department. Profit centers - Incurs costs and generates revenues. - Managers judged on profitability of center. - Examples include individual departments of a retail store or branch bank offices. 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.

Residual Income Compared to ROI

To evaluate performance using minimum rate of return, companies use the residual income approach. Residual income is the income that remains after subtracting from the controllable margin the minimum rate of return on a company's average operating assets. Controllable Margin - Minimum Rate of Return x Average Operating Assets

The essentials of effective budgeting do not include:

Top-down budgeting

Different entities of Responsibility Center:

Two differences from budgeting in reporting costs and revenues: - Distinguishes between controllable and noncontrollable costs. - Emphasizes or includes only items controllable by the individual manager in performance reports. Applies to both profit and not-for- profit entities. - Profit entities: maximize net income. - Not-for-profit: minimize cost of providing services.

Directly Controls

Under responsibility accounting, the evaluation of a manager's performance is based on matters that the manager:

Budgetary control involves all but one of the following:

Using static budgets

Judgmental Factors in ROI

Valuation of operating assets. - Acquisition cost, book value, appraised value, or fair value. - Each provides a reliable basis for evaluating performance. Margin (income) measure. - Controllable margin, income from operations, or net income. - Only controllable margin is a valid basis for evaluating performance of investment center manager.