CH 24

At zero direct labor hours in a flexible budget graph, the total budgeted cost line intersects the vertical axis at $30,000. At 10,000 direct labor hours, a horizontal line drawn from the total budgeted cost line intersects the vertical axis at $90,000. Fixed and variable costs may be expressed as: (a)$30,000 fixed plus $6 per direct labor hour variable. (b)$30,000 fixed plus $9 per direct labor hour variable. (c)$60,000 fixed plus $3 per direct labor hour variable. (d)$60,000 fixed plus $6 per direct labor hour variable.

(a)$30,000 fixed plus $6 per direct labor hour variable. The intersection point of $90,000 is total budgeted costs, or budgeted fixed costs plus budgeted variable costs. Fixed costs are $30,000 (amount at zero direct labor hours), so budgeted variable costs are . Budgeted variable costs ($60,000) divided by total activity level (10,000 direct labor hours) gives the variable cost per unit of $6 per direct labor hour. The other choices are therefore incorrect.

A static budget is: (a)a projection of budget data at several levels of activity within the relevant range of activity. (b)a projection of budget data at a single level of activity. (c)compared to a flexible budget in a budget report. (d)never appropriate in evaluating a manager's effectiveness in controlling costs.

(b)a projection of budget data at a single level of activity. A static budget is a projection of budget data at a single level of activity. The other choices are incorrect because a static budget (a) is a projection of budget data at a single level of activity, not at several levels of activity within the relevant range of activity; (c) is not compared to a flexible budget in a budget report; and (d) is appropriate in evaluating a manager's effectiveness in controlling fixed costs.

A static budget is useful in controlling costs when cost behavior is: (a)mixed. (b)fixed. (c)variable. (d)linear.

(b)fixed. A static budget is useful for controlling fixed costs. The other choices are incorrect because a static budget is not useful for controlling (a) mixed costs, (c) variable costs, or (d) linear costs.

A production manager in a manufacturing company would most likely receive a: (a)sales report. (b)income statement. (c)scrap report. (d)shipping department overhead report.

(c)scrap report. A production manager in a manufacturing company would most likely receive a scrap report. The other choices are incorrect because (a) top management or a sales manager would most likely receive a sales report, (b) top management would most likely receive an income statement, and (d) a department manager would most likely receive a shipping department overhead report.

Budgetary control involves all but one of the following: (a)modifying future plans. (b)analyzing differences. (c)using static budgets but not fiexible budgets. (d)determining differences between actual and planned results.

(c)using static budgets but not fiexible budgets. Budgetary control involves using flexible budgets and sometimes static budgets. The other choices are all part of budgetary control

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: (a)$1,000 unfavorable. (b)$1,000 favorable. (c)$400 favorable. (d)$400 unfavorable.

(d)$400 unfavorable. Budgeted indirect materials per direct labor hour (DLH) is $3 ($27,000/9,000). At an activity level of 9,200 direct labor hours, budgeted indirect materials are 27600(9,200 x $3 per DLH) but actual indirect materials costs are $28,000, resulting in a $400 unfavorable difference. The other choices are therefore incorrect.

Budget reports are prepared: (a)daily. (b)weekly. (c)monthly. (d)All of the above.

(d)All of the above. Budget reports are prepared daily, weekly, or monthly. The other choices are correct, but choice (d) is the better answer.

Fixed costs

Direct fixed costs: Costs that relate specifically to a responsibility center and are incurred for the sole benefit of the center. Indirect fixed costs: Costs that are incurred for the benefit of more than one profit center.

management by exception

Management by exception means that top management's review of a budget report is focused either entirely or primarily on differences between actual results and planned objectives. This approach enables top management to focus on problem areas. For example, many companies now use online reporting systems for employees to file their travel and entertainment expense reports. In addition to cutting reporting time in half, the online system enables managers to quickly analyze variances from travel budgets. This cuts down on expense account "padding" such as spending too much on meals or falsifying documents for costs that were never actually incurred. Management by exception does not mean that top management will investigate every difference. For this approach to be effective, there must be guidelines for identifying an exception. The usual criteria are materiality and controllability.

Budgetary control

The use of budgets in controlling operations is known as budgetary control. Such control takes place by means of budget reports that compare actual results with planned objectives. The use of budget reports is based on the belief that planned objectives lose much of their potential value without some monitoring of progress along the way. *Just as your professors give midterm exams to evaluate your progress, top management requires periodic reports on the progress of department managers toward their planned objectives. Budget reports provide management with feedback on operations. The feedback for a crucial objective, such as having enough cash on hand to pay bills, may be made daily. For other objectives, such as meeting budgeted annual sales and operating expenses, monthly budget reports may suffice. Budget reports are prepared as frequently as needed. From these reports, management analyzes any differences between actual and planned results and determines their causes. Management then takes corrective action, or it decides to modify future plans. Budgetary control works best when a company has a formalized reporting system. The system does the following: -Identifies the name of the budget report, such as the sales budget or the manufacturing overhead budget. -States the frequency of the report, such as weekly or monthly. -Specifies the purpose of the report. Indicates the primary recipient(s) of the report.

static budget vs. flexible budget

the master budget formalizes management's planned objectives for the coming year. When used in budgetary control, each budget included in the master budget is considered to be static. A static budget is a projection of budget data at one level of activity. These budgets do not consider data for different levels of activity. As a result, companies always compare actual results with budget data at the activity level that was used in developing the master budget. A static budget is not useful for performance evaluation if a company has substantial variable costs. Alternative Terminology The difference between budget and actual is sometimes called a budget variance. USES AND LIMITATIONS From these examples, you can see that a master sales budget is useful in evaluating the performance of a sales manager. It is now necessary to ask: Is the master budget appropriate for evaluating a manager's performance in controlling costs? Recall that in a static budget, data are not modified or adjusted, regardless of changes in activity. It follows, then, that a static budget is appropriate in evaluating a manager's effectiveness in controlling costs when: The actual level of activity closely approximates the master budget activity level, and/or The behavior of the costs in response to changes in activity is fixed. A static budget report is, therefore, appropriate for fixed manufacturing costs and for fixed selling and administrative expenses. But, as you will see shortly, static budget reports may not be a proper basis for evaluating a manager's performance in controlling variable costs. In contrast to a static budget, which is based on one level of activity, a flexible budget projects budget data for various levels of activity. In essence, the flexible budget is a series of static budgets at different levels of activity. The flexible budget recognizes that the budgetary process is more useful if it is adaptable to changed operating conditions. Flexible budgets can be prepared for each of the types of budgets included in the master budget. For example, Marriott Hotels can budget revenues and net income on the basis of 60%, 80%, and 100% of room occupancy. Similarly, American Van Lines can budget its operating expenses on the basis of various levels of truck-miles driven. Duke Energy can budget revenue and net income on the basis of estimated billions of kwh (kilowatt hours) of residential, commercial, and industrial electricity generated. In the following pages, we will illustrate a flexible budget for manufacturing overhead. The four steps for developing the flexible budget are applied as follows. STEP 1.Identify the activity index and the relevant range of activity. The activity index is direct labor hours. The relevant range is 8,000-12,000 direct labor hours per month. STEP 2.Identify the variable costs, and determine the budgeted variable cost per unit of activity for each cost. There are three variable costs. The variable cost per unit is found by dividing each total budgeted cost by the direct labor hours used in preparing the annual master budget (120,000 hours) STEP 3.Identify the fixed costs, and determine the budgeted amount for each cost. There are three fixed costs. Since Fox desires monthly budget data, it divides each annual budgeted cost by 12 to find the monthly amounts. Therefore, the monthly budgeted fixed costs are depreciation $15,000, supervision $10,000, and property taxes $5,000. STEP 4.Prepare the budget for selected increments of activity within the relevant range. Management prepares the budget in increments of 1,000 direct labor hours. Flexible budget reports are another type of internal report. The flexible budget report consists of two sections: (1) production data for a selected activity index, such as direct labor hours, and (2) cost data for variable and fixed costs. The report provides a basis for evaluating a manager's performance in two areas: production control and cost control. Flexible budget reports are widely used in production and service departments.