Chapter 10-1 CHAPTER 10 BUDGETARY CONTROL AND RESPONSIBILIT Y ACCOUNTING Managerial Accounting, Fifth Edition Chapter 10-2 Study Study Objectives Objectives Describe the concept of budgetary control Evaluate the usefulness of static budget reports Explain the development of flexible budgets and the usefulness of flexible budget reports Describe the concept of responsibility accounting Indicate the features of responsibility reports for cost centers Chapter 10-3 Study Study Objectives Objectives Identify the content of responsibility reports for profit centers Explain the basis and formula used in evaluating performance in investment centers Chapter 10-4 Preview Preview of of Chapter Chapter Considers how budgets are used by management to control operations Focuses on two aspects of management control: Budgetary control, and Responsibility accounting Chapter 10-5 Budgetary Budgetary Control Control and and Responsibility Responsibility Accounting Accounting The The Concept Concept of of Budgetary Budgetary Control Budget reports Control activities Reporting systems Static Static Budget Budget Reports Examples Use and limitations Why flexible budgets? Development Chapter 10-6 The The Concept Concept of of Responsibility Responsibility Accounting Case study Controllable vs noncontrollable Reporting system Flexible Flexible Budgets Budgets Reports Managemen t by exception Types Types of of Responsibility Responsibility Centers Cost centers Profit centers Investment centers Performance evaluation The The Concept Concept of of Budgetary Budgetary Control Control A major function of management is to control operations 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 Chapter 10-7 LO 1: Describe the concept of budgetary control The The Concept Concept of of Budgetary Budgetary Control Control Budgetary control involves the following activities: Illustration 10-1 Chapter 10-8 LO 1: Describe the concept of budgetary control The The Concept Concept of of Budgetary Budgetary Control Control Works best when a company has a formalized reporting system which: 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 recipient of the report Chapter 10-9 LO 1: Describe the concept of budgetary control The The Concept Concept of of Budgetary Budgetary Control Control Illustrated below is a partial budgetary control system for a manufacturing company Note the frequency of reports and their emphasis on control Chapter 10-10 Illustration 10-2 LO 1: Describe the concept of budgetary control Responsibility Responsibility Accounting Accounting for for Investment Investment Centers Centers Example – Mantle Manufacturing Company Illustration 10-24 Chapter 10-61 LO 7: Explain the basis and formula used in performance in investment centers eval Judgmental Judgmental Factors Factors in in Rate Rate of of Return Return ROI approach includes two judgmental factors: Valuation of operating assets: May be valued at acquisition cost, book value, appraised value, or market value Each alternative provides a reliable basis for evaluating performance as long as it is consistently applied between periods Margin (income) measure: May be controllable margin, income from operations, or net income Only controllable margin is a valid basis for evaluating performance of investment center manager Chapter 10-62 LO 7: Explain the basis and formula used in evaluating performance in investment centers Improving Improving Rate Rate of of Return Return Illustration 10-25 Chapter 10-63 LO 7: Explain the basis and formula used in evaluating performance in investment centers Improving Improving ROI ROI –– Increasing Increasing Controllable Controllable Margin Margin Increase ROI by increasing sales or by reducing variable and controllable fixed costs Increase sales by 10% Sales increase $200,000 and contribution margin increases $90,000 ($200,000 × 0.45) Thus, controllable margin increases to $690,000 ($600,000 + $90,000) New ROI is 13.8% Illustration 10-26 Chapter 10-64 LO 7: Explain the basis and formula used in evaluating performance in investment centers Improving Improving ROI ROI –– Reducing Reducing Average Average Operating Operating Assets Assets Reduce average operating assets by 10% or $500,000 Average operating assets become $4,500,000 [$5,000,000 - ($5,000,000 × 10%)] Controllable margin remains unchanged at $600,000 New ROI becomes 13.3% Illustration 10-28 Chapter 10-65 LO 7: Explain the basis and formula used in evaluating performance in investment centers Review Review Question Question In the formula for return on investment (ROI), the factors for controllable margin and operating assets are, respectively: a Controllable margin percentage and total operating assets b Controllable margin dollars and average operating assets c Controllable margin dollars and total assets d Controllable margin percentage and average operating assets Chapter 10-66 LO 7: Explain the basis and formula used in performance in investment centers eva Principles Principles of of Performance Performance Evaluation Evaluation Management function that compares actual results with budget goals At center of responsibility accounting Includes both behavioral and reporting principles Chapter 10-67 Principles Principles of of Performance Performance Evaluation Evaluation -Behavioral Behavioral Principles 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 Managers lose faith in process when top management ignores, overrules, or bypasses established procedures Chapter 10-68 Principles Principles of of Performance Performance Evaluation Evaluation -Behavioral Behavioral Principles Principles Behavioral principles – Human factor critical in evaluating performance: Managers should have direct input into the process of establishing budget goals for their area of responsibility Criticism of noncontrollable matters reduces effectiveness of evaluation May lead to negative reactions by manager and doubts about fairness of evaluation The evaluation should be based entirely on matters that are controllable by the manager Without this input, managers may view goals as unrealistic or arbitrary Affects motivation to meet targets Chapter 10-69 Principles Principles of of Performance Performance Evaluation Evaluation -Behavioral Behavioral Principles Principles The evaluation process must allow managers to respond to their evaluations Evaluation is not a one-way street Managers must be able to defend their performance Evaluation without feedback is impersonal and ineffective The evaluation should identify both good and poor performance Praise is a powerful motivator Manager compensation should include rewards for meeting goals Chapter 10-70 Principles Principles of of Performance Performance Evaluation Evaluation -Reporting Reporting Principles Principles Reporting principles for performance reports include reports which: Contain only data that are controllable by the manager of the responsibility center Provide accurate and reliable budget data to measure performance Highlight significant differences between actual results and budget goals Are tailor-made for the intended evaluation Are prepared at reasonable intervals Chapter 10-71 Chapter Chapter Review Review For the year ending December 31, 2011, Kaspar Company accumulates the following data for the Plastics Division which it operates as an investment center: contribution margin $700,000 budget, $715,000 actual; controllable fixed costs $300,000 budget, $309,000 actual Average operating assets for the year were $2,000,000 Prepare a responsibility report for the Plastics Division beginning with contribution margin Chapter 10-72 Chapter Chapter Review Review Solution Solution Kaspar Company Responsibility Report For Year Ending December 31, 2011 Budget Actual Contribution Margin Controllable Fixed Costs Controllable Margin Favorable – F Unfavorable - U Chapter 10-73 Difference $700,000 $715,000$15,000 F 300,000 309,000 9,000 U $400,000 $406,000 $ 6,000 F All About YOU: Budgeting for Housing Costs Chapter 10-74 Copyright Copyright Copyright © 2010 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Chapter 10-75 .. .CHAPTER 10 BUDGETARY CONTROL AND RESPONSIBILIT Y ACCOUNTING Managerial Accounting, Fifth Edition Chapter 10- 2 Study Study Objectives Objectives Describe... reports for profit centers Explain the basis and formula used in evaluating performance in investment centers Chapter 10- 4 Preview Preview of of Chapter Chapter Considers how budgets are used by management... Flexible Budgets Budgets Example – Barton Steel Static budget for the Forging Department at a 10, 000 unit level: Illustration 10- 6 Chapter 10- 19 LO 3: Explain the development of flexible budgets and