Chapter 22 Accounting

Static budget is not appropriate for

variable costs

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:

$400 unfavorable.

Controllability of the item

- Exception guidelines are more restrictive for controllable items than for items the manager cannot control.

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

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.

investment center

-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.

Reporting Principles

1. Contain only data controllable by manager of responsibility center. 2. Provide accurate and reliable budget data to measure performance. 3. Highlight significant differences between actual results and budget goals. 4. Be tailor-made for intended evaluation. 5. Be prepared at reasonable intervals

Two differences from budgeting in reporting costs and revenues:

1. Distinguishes between controllable and noncontrollable costs. 2. 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.

Behavioral Principles

1. Managers of responsibility centers should have direct input into the process of establishing budget goals of their area of responsibility. 2. The evaluation of performance should be based entirely on matters that are controllable by the manager being evaluated. 3.Top management should support the evaluation process. 4.The evaluation process must allow managers to respond to their evaluations. 5. The evaluation should identify both good and poor performance.

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.

Static Budget reports are 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

The flexible budget contains

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.

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: 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

Three basic types of responsibility centers

Cost centers Profit centers Investment centers

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

Fixed

Total budgeted cost =

Fixed cost + Variable cost

Budgetary control 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.

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.

Responsibility accounting

May extend to any level of management. Especially valuable in a decentralized company. - Control of operations delegated to many managers throughout the organization.

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.

Responsibility accounting Permits

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

Responsibility accounting Permits

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

The budgetary control operates by

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

The use of budgets in controlling operations

Budgetary control involves all but one of the following:

Using static budgets.

A static budget

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.

Materiality

Without quantitative guidelines, management would have to investigate every budget difference regardless of the amount.

Responsibility center

any individual who has control and is accountable for activities.

Segment

area of responsibility for which reports are prepared.

Decentralization

control of operations in delegated to many managers throughout the organization

Static budget

is a projection of budget data at one level of activity.

Flexible budget

projects budget data for various levels of activity.