CHAPTER 10 BUDGETARY CONTROL AND RESPONSIBILITY ACCOUNTING SUMMARY OF QUESTIONS BY STUDY OBJECTIVES AND BLOOM’S TAXONOMY Item SO BT Item SO BT 1 2 2 K C K K C C K C 10 11 12 13 14 15 16 3 3 3 3 C K K C C C K K Item SO BT Item SO BT 7 8 K K K K C C K K 6 7 7 7 7 7 7 7 7 7 7 C C AP AN AP AN AP AP AP AP AP AP AP AN AP AP C C K C K AP K K Item SO BT 33 34 sg 35 sg 36 a,sg 37 K C K K K 134 135 136 137 a 138 a 139 a 140 a 141 a 142 a 143 a 144 a 145 sg 146 sg 147 st 148 sg 149 st 150 sg 151 st 152 sg 153 st 154 sg 155 st 156 sg 157 7 7 8 8 8 8 2 3 3 4 7 AP C AP C AP K C C C AP AP AN C K K AP K K K K K K K AP True-False Statements 17 18 19 20 21 22 23 24 3 4 4 K K C C C C C C 25 26 27 28 a 29 a 30 sg 31 sg 32 sg sg Multiple Choice Questions 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 sg st a 1 1 1 2 2 2 2 2,3 3 3 3 3 K C K C K K K C C C C C C C C C C AP AP AP C C K C 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 3 3 3 3 3 3 3 3 3 4 4 C K C K C C K K AP C C C AP AP AP AP AP AP AP K AP C C C 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 4 4 4 4 4 5 5 6 6 6 6 K C C C C K C C C C K C C C C C K C K C C AP C AP 110 111 112 113 114 115 116 117 118 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133 This question also appears in the Study Guide This question also appears in a self-test at the student companion website This question covers a topic in an Appendix to the chapter 10 - Test Bank for ISV Managerial Accounting, Fourth Edition SUMMARY OF QUESTIONS BY STUDY OBJECTIVES AND BLOOM’S TAXONOMY Brief Exercises 158 159 160 3 AP AP AP 161 162 163 AP AP AP 164 165 166 7 AP AP AP a 167 168 a 169 8 AN AP AP 182 183 184 185 5 AN AP AN AP 7 K K K Exercises 170 171 172 173 2,3 3 AP AP AP AP 174 175 176 177 3 3 AP AP AP AP 190 191 192 1 K K K 193 194 195 3 K K K 178 179 180 181 3 3,6 4,5 AP AP AP AP 186 187 188 189 7 7 AN AN AN AN Completion Statements 196 197 198 4 K K K 199 200 201 SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item Type Item Type Item TF TF TF 31 38 39 TF MC MC 40 41 42 TF TF TF 32 TF TF TF 45 46 47 10 11 12 13 14 15 16 17 TF TF TF TF TF TF TF TF TF 18 33 53 54 55 56 57 58 59 TF TF MC MC MC MC MC MC MC 60 61 62 63 64 65 66 67 68 19 20 21 22 23 TF TF TF TF TF 34 81 82 83 84 TF MC MC MC MC 85 86 87 88 89 24 TF 35 TF 98 Type Item Type Item Study Objective MC 43 MC 190 MC 44 MC 191 MC 146 MC 192 Study Objective MC 48 MC 51 MC 49 MC 52 MC 50 MC 53 Study Objective MC 69 MC 78 MC 70 MC 79 MC 71 MC 80 MC 72 MC 149 MC 73 MC 150 MC 74 MC 151 MC 75 MC 152 MC 76 MC 158 MC 77 MC 159 Study Objective MC 90 MC 95 MC 91 MC 96 MC 92 MC 153 MC 93 MC 154 MC 94 MC 162 Study Objective MC 100 MC 181 Type Item Type Item Type MC MC MC 147 148 170 MC MC Ex 171 Ex MC MC MC MC MC MC MC BE BE 160 161 171 172 173 174 175 176 177 BE BE Ex Ex Ex Ex Ex Ex Ex 178 179 180 193 194 Ex Ex Ex C C MC MC MC MC BE 181 195 196 197 198 Ex C C C C Ex 183 Ex C C C Budgetary Control and Responsibility Accounting 25 TF 97 MC 99 MC 101 MC 182 10 - Ex SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE 26 102 103 TF MC MC 104 105 106 MC MC MC 107 108 109 27 28 36 113 114 115 TF TF TF MC MC MC 116 117 118 119 120 121 MC MC MC MC MC MC 122 123 124 125 126 127 29 30 TF TF 37 138 TF MC 139 140 Note: TF = True-False MC = Multiple Choice Study Objective MC 110 MC 155 MC 111 MC 163 MC 112 MC 180 Study Objective MC 128 MC 134 MC 129 MC 135 MC 130 MC 136 MC 131 MC 137 MC 132 MC 156 MC 133 MC 157 Study Objective 8a MC 141 MC 143 MC 142 MC 144 MC BE Ex 184 Ex MC MC MC MC MC MC 164 165 166 167 185 186 BE BE BE BE Ex Ex 187 188 189 199 200 201 Ex Ex Ex C C C MC MC 145 168 MC BE 169 BE BE = Brief Exercise Ex = Exercise C = Completion The chapter also contains one set of twelve Matching questions and four Short-Answer Essay questions CHAPTER STUDY OBJECTIVES Describe the concept of budgetary control Budgetary control consists of (a) preparing periodic budget reports that compare actual results with planned objectives, (b) analyzing the differences to determine their causes, (c) taking appropriate corrective action, and (d) modifying future plans, if necessary Evaluate the usefulness of static budget reports Static budget reports are useful in evaluating the progress toward planned sales and profit goals They are also appropriate in assessing a manager's effectiveness in controlling costs when (a) actual activity closely approximates the master budget activity level, and/or (b) the behavior of the costs in response to changes in activity is fixed Explain the development of flexible budgets and the usefulness of flexible budget reports To develop the flexible budget it is necessary to: (a) Identify the activity index and the relevant range of activity; (b) Identify the variable costs, and determine the budgeted variable cost per unit of activity for each cost; (c) Identify the fixed costs, and determine the budgeted amount for each cost; (d) Prepare the budget for selected increments of activity within the relevant range Flexible budget reports permit an evaluation of a manager's performance in controlling production and costs Describe the concept of responsibility accounting Responsibility accounting involves accumulating and reporting revenues and costs on the basis of the individual manager who has the authority to make the day-to-day decisions about the items The evaluation of a manager's performance is based on the matters directly under the manager's control In responsibility accounting, it is necessary to distinguish between controllable and 10 - Test Bank for ISV Managerial Accounting, Fourth Edition noncontrollable fixed costs and to identify three types of responsibility centers: cost, profit, and investment Indicate the features of responsibility reports for cost centers Responsibility reports for cost centers compare actual costs with flexible budget data The reports show only controllable costs, and no distinction is made between variable and fixed costs Identify the content of responsibility reports for profit centers Responsibility reports show contribution margin, controllable fixed costs, and controllable margin for each profit center Explain the basis and formula used in evaluating performance in investment centers The primary basis for evaluating performance in investment centers is return on investment (ROI) The formula for computing ROI for investment centers is: Controllable margin ÷ Average operating assets a Explain the difference between ROI and residual income ROI is controllable margin divided by average total assets Residual income is the income that remains after subtracting the minimum rate of return on a company’s average operating assets ROI sometimes provides misleading results because profitable investments are often rejected when the investment reduces ROI but increases overall profitability TRUE-FALSE STATEMENTS Budget reports comparing actual results with planned objectives should be prepared only once a year If actual results are different from planned results, the difference must always be investigated by management to achieve effective budgetary control Certain budget reports are prepared monthly, whereas others are prepared more frequently depending on the activities being monitored The master budget is not used in the budgetary control process A master budget is most useful in evaluating a manager's performance in controlling costs A static budget is one that is geared to one level of activity A static budget is changed only when actual activity is different from the level of activity expected A static budget is most useful for evaluating a manager's performance in controlling variable costs A flexible budget can be prepared for each of the types of budgets included in the master budget 10 A flexible budget is a series of static budgets at different levels of activities Budgetary Control and Responsibility Accounting 11 12 10 - Flexible budgeting relies on the assumption that unit variable costs will remain constant within the relevant range of activity Total budgeted fixed costs appearing on a flexible budget will be the same amount as total fixed costs on the master budget 13 A flexible budget is prepared before the master budget 14 The activity index used in preparing a flexible budget should not influence the variable costs that are being budgeted 15 A formula used in developing a flexible budget is: Total budgeted cost = fixed cost + (total variable cost per unit × activity level) 16 Flexible budgets are widely used in production and service departments 17 A flexible budget report will show both actual and budget cost based on the actual activity level achieved 18 Management by exception means that management will investigate areas where actual results differ from planned results if the items are material and controllable 19 Policies regarding when a difference between actual and planned results should be investigated are generally more restrictive for noncontrollable items than for controllable items 20 A distinction should be made between controllable and noncontrollable costs when reporting information under responsibility accounting 21 Cost centers, profit centers, and investment centers can all be classified as responsibility centers 22 More costs become controllable as one moves down to each lower level of managerial responsibility 23 In a responsibility accounting reporting system, as one moves up each level of responsibility in an organization, the responsibility reports become more summarized and show less detailed information 24 A cost center incurs costs and generates revenues and cost center managers are evaluated on the profitability of their centers 25 The terms "direct fixed costs" and "indirect fixed costs" are synonymous with "traceable costs" and "common costs," respectively 26 Controllable margin is subtracted from controllable fixed costs to get net income for a profit center 27 The denominator in the formula for calculating the return on investment includes operating and nonoperating assets 28 The formula for computing return on investment is controllable margin divided by average operating assets 10 - a Test Bank for ISV Managerial Accounting, Fourth Edition 29 When evaluating residual income, the calculation tells management what percentage return was generated by the particular division being evaluated a Residual income generates a dollar amount which represents the increase in value to the company beyond the cost necessary to pay for the financing of assets 30 Additional True-False Questions a 31 Budget reports provide the feedback needed by management to see whether actual operations are on course 32 A static budget is an effective means to evaluate a manager's ability to control costs, regardless of the actual activity level 33 The flexible budget report evaluates a manager's performance in two areas: (1) production and (2) costs 34 The terms controllable costs and noncontrollable costs are synonymous with variable costs and fixed costs, respectively 35 Most direct fixed costs are not controllable by the profit center manager 36 The manager of an investment center can improve ROI by reducing average operating assets 37 Residual income and ROI are used as performance evaluation methods for profit center performance Answers to True-False Statements Item Ans F F T F F T Item 10 11 12 Ans F F T T T T Item 13 14 15 16 17 18 Ans F F T T T T Item 19 20 21 22 23 24 Ans F T T F T F Item 25 26 27 28 a 29 a 30 Ans T F F T F T Item 31 32 33 34 35 36 Ans T F T F F T Item a 37 Ans F MULTIPLE CHOICE QUESTIONS 38 What is budgetary control? a Another name for a flexible budget b The degree to which the CFO controls the budget c The use of budgets in controlling operations d The process of providing information on budget differences to lower level managers 39 A major element in budgetary control is a the preparation of long-term plans b the comparison of actual results with planned objectives c the valuation of inventories Budgetary Control and Responsibility Accounting 40 10 - d approval of the budget by the stockholders Budget reports should be prepared a daily b monthly c weekly d as frequently as needed 41 On the basis of the budget reports, a management analyzes differences between actual and planned results b management may take corrective action c management may modify the future plans d all of these 42 The purpose of the departmental overhead cost report is to a control indirect labor costs b control selling expense c determine the efficient use of materials d control overhead costs 43 The purpose of the sales budget report is to a control selling expenses b determine whether income objectives are being met c determine whether sales goals are being met d control sales commissions 44 The comparison of differences between actual and planned results a is done by the external auditors b appears on the company's external financial statements c is usually done orally in departmental meetings d appears on periodic budget reports 45 A static budget a should not be prepared in a company b is useful in evaluating a manager's performance by comparing actual variable costs and planned variable costs c shows planned results at the original budgeted activity level d is changed only if the actual level of activity is different than originally budgeted 46 A static budget report a shows costs at only or different levels of activity b is appropriate in evaluating a manager's effectiveness in controlling variable costs c should be used when the actual level of activity is materially different from the master budget activity level d may be appropriate in evaluating a manager's effectiveness in controlling costs when the behavior of the costs in response to changes in activity is fixed 47 A static budget is appropriate in evaluating a manager's performance if a actual activity closely approximates the master budget activity b actual activity is less than the master budget activity c the company prepares reports on an annual basis d the company is a not-for-profit organization 10 - Test Bank for ISV Managerial Accounting, Fourth Edition 48 When budgeted and actual results are not the same amount, there is a budget a error b difference c anomaly d by-product 49 Top management's reaction to a difference between budgeted and actual sales often depends on a whether the difference is favorable or unfavorable b whether management anticipated the difference c the materiality of the difference d the personality of the top managers 50 If costs are not responsive to changes in activity level, then these costs can be best described as a mixed b flexible c variable d fixed 51 Assume that actual sales results exceed the planned results for the second quarter This favorable difference is greater than the unfavorable difference reported for the first quarter sales Which of the following statements about the sales budget report on June 30 is true? a The year-to-date results will show a favorable difference b The year-to-date results will show an unfavorable difference c The difference for the first quarter can be ignored d The sales report is not useful if it shows a favorable and unfavorable difference for the two quarters 52 A static budget is appropriate for a variable overhead costs b direct materials costs c fixed overhead costs d none of these 53 What is the primary difference between a static budget and a flexible budget? a The static budget contains only fixed costs, while the flexible budget contains only variable costs b The static budget is prepared for a single level of activity, while a flexible budget is adjusted for different activity levels c The static budget is constructed using input from only upper level management, while a flexible budget obtains input from all levels of management d The static budget is prepared only for units produced, while a flexible budget reflects the number of units sold 54 A flexible budget a is prepared when management cannot agree on objectives for the company b projects budget data for various levels of activity c is only useful in controlling fixed costs d cannot be used for evaluation purposes because budgeted data are adjusted to reflect actual results Budgetary Control and Responsibility Accounting 55 10 - The master budget of Benedict Company shows that the planned activity level for next year is expected to be 50,000 machine hours At this level of activity, the following manufacturing overhead costs are expected: Indirect labor Machine supplies Indirect materials Depreciation on factory building Total manufacturing overhead $240,000 60,000 70,000 50,000 $420,000 A flexible budget for a level of activity of 60,000 machine hours would show total manufacturing overhead costs of a $494,000 b $420,000 c $504,000 d $454,000 56 Rickets Crickets prepared a 2008 budget for 60,000 units of product Actual production in 2008 was 65,000 units To be most useful, what amounts should a performance report for this company compare? a The actual results for 65,000 units with the original budget for 60,000 units b The actual results for 65,000 units with a new budget for 65,000 units c The actual results for 65,000 units with last year's actual results for 67,000 units d It doesn't matter All of these choices are equally useful 57 A department has budgeted monthly manufacturing overhead cost of $270,000 plus $3 per direct labor hour If a flexible budget report reflects $522,000 for total budgeted manufacturing cost for the month, the actual level of activity achieved during the month was a 264,000 direct labor hours b 84,000 direct labor hours c 174,000 direct labor hours d Cannot be determined from the information provided 58 Which one of the following would be the same total amount on a flexible budget and a static budget if the activity level is different for the two types of budgets? a Direct materials cost b Direct labor cost c Variable manufacturing overhead d Fixed manufacturing overhead 59 In developing a flexible budget within a relevant range of activity, a only fixed costs are included b it is necessary to relate variable cost data to the activity index chosen c it is necessary to prepare a budget at 1,000 unit increments d variable and fixed costs are combined and are reported as a total cost 60 What budgeted amounts appear on the flexible budget? a Original budgeted amounts at the static budget activity level b Actual costs for the budgeted activity level c Budgeted amounts for the actual activity level achieved d Actual costs for the estimated activity level 10 - 10 Test Bank for ISV Managerial Accounting, Fourth Edition 61 The flexible budget a is prepared before the master budget b is relevant both within and outside the relevant range c eliminates the need for a master budget d is a series of static budgets at different levels of activity 62 A flexible budget can be prepared for which of the following budgets comprising the master budget? a Sales b Overhead c Direct materials d All of these 63 Another name for the static budget is a master budget b overhead budget c permanent budget d flexible budget 64 If a company plans to sell 24,000 units of product but sells 30,000, the most appropriate comparison of the cost data associated with the sales will be by a budget based on a the original planned level of activity b 27,000 units of activity c 30,000 units of activity d 24,000 units of activity 65 Within the relevant range of activity, the behavior of total costs is assumed to be a linear and upward sloping b linear and downward sloping c curvilinear and upward sloping d linear to a point and then level off 66 Sales results that are evaluated by a static budget might show favorable differences that are not justified unfavorable differences that are not justified a b c d 67 both and neither nor The selection of levels of activity to depict a flexible budget will be within the relevant range is largely a matter of expediency is governed by generally accepted accounting principles a b c d and Budgetary Control and Responsibility Accounting 10 - 35 Ex 176 Fagan Company uses a flexible budget for manufacturing overhead based on machine hours Variable manufacturing overhead costs per machine hour are as follows: Indirect labor $5.00 Indirect materials 2.50 Maintenance 50 Utilities 30 Fixed overhead costs per month are: Supervision Insurance Property taxes Depreciation $600 200 300 900 The company believes it will normally operate in a range of 2,000 to 4,000 machine hours per month During the month of August, 2008, the company incurs the following manufacturing overhead costs: Indirect labor $14,000 Indirect materials 8,100 Maintenance 1,400 Utilities 950 Supervision 720 Insurance 200 Property taxes 300 Depreciation 930 Instructions Prepare a flexible budget report, assuming that the company used 3,000 machine hours during August Solution 176 (20–25 min.) FAGAN COMPANY Manufacturing Overhead Budget Report (Flexible) For the Month Ended August 31, 2008 Budget at 3,000 hrs Actual at 3,000 hrs Difference Favorable F Unfavorable U Variable costs Indirect labor Indirect materials Maintenance Utilities Total variable $15,000 7,500 1,500 900 24,900 $14,000 8,100 1,400 950 24,450 $1,000 600 100 50 450 F U F U F Fixed Costs Supervision Insurance Property taxes Depreciation Total fixed Total costs 600 200 300 900 2,000 $26,900 720 200 300 930 2,150 $26,600 120 — — 30 150 $ 300 U U U F 10 - 36 Test Bank for ISV Managerial Accounting, Fourth Edition Ex 177 Molle Company uses flexible budgets to control its selling expenses Monthly sales are expected to be from $200,000 to $240,000 Variable costs and their percentage relationships to sales are: Sales commissions Advertising Traveling Delivery 6% 4% 5% 1% Fixed selling expenses consist of sales salaries $40,000 and depreciation on delivery equipment $10,000 Instructions Prepare a flexible budget for increments of $20,000 of sales within the relevant range Solution 177 (17–22 min.) MOLLE COMPANY Monthly Flexible Selling Expense Budget Activity level Sales Variable expenses Sales commissions Advertising Traveling Delivery Total variable Fixed expenses Sales salaries Depreciation Total fixed Total costs $200,000 $220,000 $240,000 $12,000 8,000 10,000 2,000 32,000 $13,200 8,800 11,000 2,200 35,200 $14,400 9,600 12,000 2,400 38,400 40,000 10,000 50,000 $82,000 40,000 10,000 50,000 $85,200 40,000 10,000 50,000 $88,400 Ex 178 Molle Company uses flexible budgets to control its selling expenses Monthly sales are expected to be from $200,000 to $240,000 Variable costs and their percentage relationships to sales are: Sales commissions Advertising Traveling Delivery 6% 4% 5% 1% Fixed selling expenses consist of sales salaries $40,000 and depreciation on delivery equipment $10,000 Budgetary Control and Responsibility Accounting Ex 178 10 - 37 (cont.) The actual selling expenses incurred in February, 2008, by Molle Company are as follows: Sales commissions Advertising Traveling Delivery $13,700 8,000 11,300 1,600 Fixed selling expenses consist of sales salaries $41,000 and depreciation on delivery equipment $10,000 Instructions Prepare a flexible budget performance report, assuming that February sales were $220,000 Solution 178 (17–22 min.) MOLLE COMPANY Selling Expense Budget Report (Flexible) For the Month Ended February 29, 2008 Variable expenses Sales commissions Advertising Traveling Delivery Total variable Fixed expenses Sales salaries Depreciation Total fixed Total expenses Difference Favorable F Unfavorable U Budget $220,000 Actual $220,000 $13,200 8,800 11,000 2,200 35,200 $13,700 8,000 11,300 1,600 34,600 $ 500 800 300 600 600 40,000 10,000 50,000 $85,200 41,000 10,000 51,000 $85,600 1,000 U — 1,000 U $ 400 U U F U F F Ex 179 A flexible budget graph for the Assembly Department shows the following: At zero direct labor hours, the total budgeted cost line intersects the vertical axis at $60,000 At normal capacity of 50,000 direct labor hours, the line drawn from the total budgeted cost line intersects the vertical axis at $180,000 Instructions Develop the budgeted cost formula for the Assembly Department and identify the fixed and variable costs 10 - 38 Test Bank for ISV Managerial Accounting, Fourth Edition Solution 179 (5 min.) Budgeted Costs: Assembly $60,000 + $2.40 Fixed costs are $60,000 Variable costs are $2.40 per labor hour ($180,000 – $60,000) ÷ 50,000 Ex 180 Pele Clothing Company's static budget at 2,000 units of production includes $8,000 for direct labor, $2,000 for utilities (variable), and total fixed costs of $16,000 Actual production and sales for the year was 6,000 units, with an actual cost of $47,200 Instructions Determine if Pele Clothing is over or under budget Solution 180 Variable costs: Direct labor Utilities Fixed costs Total costs (8–10 min.) 2,000 Units Unit Variable Cost 6,000 Units $ 8,000 2,000 10,000 16,000 $26,000 $4.00 1.00 $24,000 6,000 30,000 16,000 $46,000 The company is over budget by $1,200 The flexible budget amount allowed was $46,000, and the company incurred $47,200 of actual costs Ex 181 Colter Company produces men's ties The following budgeted and actual amounts are for 2008: Cost Direct materials Direct labor Equipment depreciation Indirect labor Indirect materials Rent and insurance Budget at 5,000 Units $60,000 75,000 5,000 7,500 9,000 12,000 Actual Amounts at 5,800 Units $71,000 86,500 5,000 8,600 9,600 13,000 Instructions Prepare a performance budget report for Colter Company for the year Budgetary Control and Responsibility Accounting Solution 181 10 - 39 (8–10 min.) COLTER COMPANY Manufacturing Performance Budget Report For the Year Ended December 31, 2008 Direct materials Direct labor Equipment depreciation Indirect labor Indirect materials Rent and insurance Total costs Budget $ 69,600 87,000 5,000 8,700 10,440 12,000 $192,740 Actual $ 71,000 86,500 5,000 8,600 9,600 13,000 $193,700 Differences $1,400 U 500 F 100 F 840 F 1,000 U $ 960 U Ex 182 Data concerning manufacturing overhead for Friendly Company are presented below The Mixing Department is a cost center An analysis of the overhead costs reveals that all variable costs are controllable by the manager of the Mixing Department and that 50% of supervisory costs are controllable at the department level The flexible budget formula and the cost and activity for the months of July and August are as follows: Flexible Budget Per Direct Labor Hour Actual Costs and Activity July August Direct labor hours 6,000 7,000 Overhead costs Variable Indirect materials $3.50 $ 20,500 $ 25,100 Indirect labor 6.00 39,500 40,700 Factory supplies 1.00 7,600 8,200 Fixed Depreciation $20,000 15,000 15,000 Supervision 25,000 23,000 26,000 Property taxes 10,000 12,000 12,000 Total costs $117,600 $127,000 Instructions (a) Prepare the responsibility reports for the Mixing Department for each month (b) Comment on the manager's performance in controlling costs during the two month period 10 - 40 Test Bank for ISV Managerial Accounting, Fourth Edition Solution 182 (20–25 min.) (a) FRIENDLY COMPANY Mixing Department Manufacturing Overhead Cost Responsibility Report For the Months of July and August Controllable Cost Indirect materials Indirect labor Factory supplies Supervision Total costs (b) Budget 21,000 36,000 6,000 12,500 75,500 July Actual 20,500 39,500 7,600 11,500 79,100 Difference 500 F 3,500 U 1,600 U 1,000 F 3,600 U Budget 24,500 42,000 7,000 12,500 86,000 August Actual Difference 25,100 600 U 40,700 1,300 F 8,200 1,200 U 13,000 500 U 87,000 1,000 U The manager did a better job of controlling costs in August ($1,000 U) than in July ($3,600 U) Ex 183 Gentry Company's manufacturing overhead budget for the first quarter of 2008 contained the following data: Variable Costs Indirect materials Indirect labor Utilities Maintenance $20,000 12,000 10,000 6,000 Fixed Costs Supervisor's salary Depreciation Property taxes $40,000 8,000 4,500 Actual variable costs for the first quarter were: Indirect materials Indirect labor Utilities Maintenance $18,600 13,200 10,500 5,300 Actual fixed costs were as expected except for property taxes which were $4,500 All costs are considered controllable by the department manager except for the supervisor's salary Instructions Prepare a manufacturing overhead responsibility performance report for the first quarter Budgetary Control and Responsibility Accounting Solution 183 10 - 41 (15–20 min.) GENTRY COMPANY Manufacturing Overhead Cost Responsibility Report For the Quarter Ended March 31, 2008 Controllable Costs Indirect materials Indirect labor Utilities Maintenance Depreciation Property taxes Total costs Budget $20,000 12,000 10,000 6,000 8,000 4,000 $60,000 Actual $18,600 13,200 10,500 5,300 8,000 4,500 $60,100 Difference $1,400 F 1,200 U 500 U 700 F — 500 U $ 100 U Ex 184 The Ace Division, a profit center of Berek Engineering Company, reported the following data for the first quarter of 2008: Sales Variable costs Controllable direct fixed costs Noncontrollable direct fixed costs Indirect fixed costs $6,000,000 4,200,000 800,000 530,000 200,000 Instructions (a) Prepare a performance report for the manager of the Ace Division (b) What is the best measure of the manager's performance? Why? (c) How would the responsibility report differ if the division was an investment center? Solution 184 (a) (15–20 min.) BEREK ENGINEERING COMPANY Ace Division Management Performance Report For the Quarter Ended March 31, 2008 Sales Variable costs Contribution margin Controllable fixed costs Controllable margin $6,000,000 4,200,000 1,800,000 800,000 $1,000,000 (b) Controllable margin is the best measure of the manager's performance because this amount equals the excess of controllable revenues over controllable costs (c) For an investment center, the responsibility report would also show the return on investment for the period 10 - 42 Test Bank for ISV Managerial Accounting, Fourth Edition Ex 185 RTO Rental Company reported the following: Beginning of year operating assets End of year operating assets Contribution margin Sales Controllable fixed costs $2,200,000 2,000,000 1,000,000 5,000,000 643,000 Its required return is 10% Instructions Compute the company’s ROI Solution 185 (3 min.) ($1,000,000 – $643,000) ÷ [($2,200,000 + $2,000,000) ÷ 2] = 17% Ex 186 Reese Company has two investment centers and has developed the following information: Departmental controllable margin Average operating assets Sales ROI Department ADepartment B $120,000 ? ? $400,000 800,000 250,000 10% 12% Instructions Answer the following questions about Department A and Department B What was the amount of Department A's average operating assets? $ What was the amount of Department B's controllable margin? $ If Department B is able to reduce its operating assets by $100,000, Department B's new ROI would be If Department A is able to increase its controllable margin by $60,000 as a result of reducing variable costs, Department A's new ROI would be _ Solution 186 (8–12 min.) $1,200,000 ($120,000 ÷ 10) $48,000 ($400,000 × 12) 16% [$48,000 ÷ ($400,000 – $100,000)] 15% [($120,000 + $60,000) ÷ $1,200,000] Budgetary Control and Responsibility Accounting 10 - 43 Ex 187 The Appliance Division of Malone Manufacturing Company reported the following results for 2008: Sales $4,000,000 Variable costs 3,200,000 Controllable fixed costs 300,000 Average operating assets 2,000,000 Management is considering the following independent alternative courses of action in 2009 in order to maximize the return on investment for the division Reduce controllable fixed costs by 20% with no change in sales or variable costs Reduce average operating assets by 20% with no change in controllable margin Increase sales $400,000 with no change in the contribution margin percentage Instructions (a) Compute the return on investment for 2008 (b) Compute the expected return on investment for each of the alternative courses of action Solution 187 (a) (15–20 min.) Controllable margin Return on investment = ———————————— Average operating assets $500,000 2008 ROI = —————— = 25% $2,000,000 (b) $560,000 (a) ——————— = 28% $2,000,000 $500,000 ———————— = 31.3% $1,600,000 (b) $580,000 (c) ——————— = 29% $2,000,000 (a) $500,000 + ($300,000 × 20%) = $560,000 (b) $2,000,000 – ($2,000,000 × 20) = $1,600,000 (c) Contribution margin 20% $4,000,000 – $3,200,000 (———————————— ); $4,000,000 $500,000 + ($400,000 × 20%) = $580,000 10 - 44 Test Bank for ISV Managerial Accounting, Fourth Edition Ex 188 Data for the following subsidiaries of Timmons Company, which are operated as investment centers, are as follows: Black Company Greer Company Sales $3,000,000 $2,000,000 Controllable margin (1) (3) Average operating assets (2) 4,000,000 Contribution margin 1,200,000 800,000 Controllable fixed costs 500,000 200,000 Return on Investment 10% (4) Instructions Compute the missing amounts using the ROI formula Solution 188 (1) (2) (3) (4) (9–14 min.) Controllable margin ($1,200,000 – $500,000) = $700,000 Average operating assets ($700,000 ÷ 10) = $7,000,000 Controllable margin ($800,000 – $200,000) = $600,000 ROI ($600,000 ÷ $4,000,000) = 15% Ex 189 The data for an investment center is given below 1/1/08 $ 300,000 3,000,000 250,000 1,200,000 Current assets Plant assets Idle plant assets Land held for future use 12/31/08 $ 500,000 4,000,000 330,000 1,200,000 The controllable margin is $780,000 Instructions What is the return on investment for the center for 2008? Solution 189 (4–5 min.) ROI = Controllable margin ÷ Average operating assets Plant assets Average current assets ($3,000,000 + $4,000,000) ÷ = $3,500,000 ($300,000 + $500,000) ÷ = 400,000 $3,900,000 Note: Idle plant assets and land held for future use are not included in average operating assets ROI = $780,000 ÷ $3,900,000 = 20% Budgetary Control and Responsibility Accounting 10 - 45 COMPLETION STATEMENTS 190 The use of budgets in controlling operations is known as 191 A major aspect of budgeting control is the use of budget reports that compare _ with _ 192 In analyzing differences from planned objectives, management may _, or it could decide to modify _ take 193 The master budget is a budget which is based on operating at one budgeted activity level 194 A budget projects budget data for various levels of activity 195 Total costs will be the same on the master budget and on a flexible budget which reflects the actual level of activity 196 Under _ accounting, the evaluation of a manager's performance is based on the costs and revenues directly under that manager's control 197 A cost is at a given level of managerial responsibility if a manager has the authority to incur the cost in a given time period 198 In general, costs directly by the level of responsibility are _, whereas costs that are to the responsibility level are 199 Responsibility centers may be classified into three types: (1) , (2) _ and, (3) 200 The primary basis for evaluating the performance of a manager of an investment center is _ 201 Return on investment is calculated by dividing _ by Answers to Completion Statements 190 191 192 193 194 195 196 budgetary control actual results, planned objectives corrective action, future plans static flexible fixed responsibility 197 controllable 198 incurred, controllable, allocated, noncontrollable 199 cost centers, profit centers, investment centers 200 return on investment (ROI) 201 controllable margin, average operating assets 10 - 46 Test Bank for ISV Managerial Accounting, Fourth Edition MATCHING 202 Match the items below by entering the appropriate code letter in the space provided A B C D E F Budgetary control Static budget Flexible budget Responsibility accounting Controllable costs Management by exception G H I J K L Responsibility reporting system Return on Investment Profit center Investment center Indirect fixed costs Direct fixed costs The review of budget reports by top management directed entirely or primarily to differences between actual results and planned objectives A part of management accounting that involves accumulating and reporting revenues and costs on the basis of the individual manager who has the authority to make the day-to-day decisions about the items The preparation of reports for each level of responsibility shown in the company's organization chart A projection of budget data at one level of activity Costs that a manager has the authority to incur within a given period of time The use of budgets to control operations A projection of budget data for various levels of activity A responsibility center that incurs costs, generates revenues, and has control over the investment funds available for use Costs that relate specifically to a responsibility center and are incurred for the sole benefit of the center 10 A responsibility center that incurs costs and also generates revenues 11 Costs which are incurred for the benefit of more than one profit center 12 A measure of the profitability of an investment center computed by dividing controllable margin (in dollars) by average operating assets Answers to Matching F D G B E A 10 11 12 C J L I K H Budgetary Control and Responsibility Accounting 10 - 47 SHORT-ANSWER ESSAY QUESTIONS S-A E 203 The master budget and flexible budgets are important aids to management in performing the management functions of planning and control Briefly describe how planning and control are facilitated by preparing a master budget and flexible budgets How are these two types of budgets interrelated with planning and control? Solution 203 The system of responsibility reporting begins with the lowest level of responsibility and moves up through each level At the lowest level each manager receives detailed information concerning the controllable costs for which they are responsible At higher levels of responsibility the detail of the lower levels may be omitted but the report encompasses all the areas for which the higher level has responsibility For example, a plant manager will receive reports concerning the controllable costs of each of the plant departments Management by exception is possible in such a system because, if management at the higher levels of responsibility identifies a significant variance, they can receive detailed reports for each lower level of responsibility This allows management to investigate causes and remedies for variances as they feel necessary S-A E 204 Managers are motivated to accomplish objectives if they feel that their efforts will be fairly evaluated Explain why an organization may use different bases for evaluating the performance of managers of different types of responsibility centers Solution 204 Because a manager should only be evaluated based on the performance results of matters that are controllable by the manager, it is necessary to use different bases for evaluation An investment center manager can control the investment funds available as well as costs and revenues Return on investment is therefore an appropriate basis for evaluation A profit center, however, controls only revenues and expenses but not investment, so controllable margin is a more appropriate basis relating only to the areas controllable by the profit center Similarly, because only costs are controllable for a cost center, such a center is evaluated only on the basis of its controllable costs S-A E 205 (Ethics) Howard Corporation evaluates its managers based on return on investment (ROI) Ann Wilsen and Jill Reese, managers of the electronics and housewares departments respectively, have recently suffered from declining profits in their departments Over lunch, they discuss the problem, and how they could improve performance Most of the discussion centers around ways to increase sales Near the end of the lunch period, however, Jill remarks that there are two components to consider, and that they have considered only one She wonders whether there is some way to reduce investment, and by decreasing the denominator of the ROI fraction, to improve the final result 10 - 48 Test Bank for ISV Managerial Accounting, Fourth Edition S-A E 205 (cont.) Back at work, Ann continues to mull over Jill's remarks She decides to pursue the matter further, and before the end of the quarter she has sold quite a bit of older equipment and replaced it with equipment obtained with a short-term lease Her performance, measured by ROI, is markedly improved, although sales continue to be disappointing Required: Who are the stakeholders in this situation? Is Ann's action ethical? Briefly explain Solution 205 The stakeholders include Ann Wilsen Jill Reese managers of Howard Corporation shareholders of Howard Corporation Ann's action is probably not ethical It appears that she has replaced equipment that had been purchased only because such a move would improve her ROI Of course, it is possible that the leased equipment will allow her department to function better, resulting in a benefit for the company Any action to promote one's own benefit at the expense of the company's welfare is unethical S-A E 206 (Communication) Clara County Electronics manufactures circuit boards for computer-controlled appliances for the home The sales have been very volatile, sometimes stressing the plant's capacity, and sometimes depressingly slow During a recent slow period, Mike Farmer, a production supervisor, complained to Sue Stein, accounting manager, about the flexible budget "I try as hard as I can to meet the budget," he says, "and then I find out that just meeting the budget's not good enough Last month, when we sold 8,000 units, I was $10,000 under my budget, and then you all blow me out of the water with your report that I actually was $5,000 over, because sales were slow I thought this responsibility accounting business was supposed to mean we are held accountable just for things we can control How we control sales? At the beginning of the year, you gave us all targets Mine says that for an average month of 10,000 unit sales, I should spend about $82,000 I spend less, and get an unfavorable budget report What gives?" Required: Write a short memo to respond to Mr Farmer Budgetary Control and Responsibility Accounting Solution 206 TO: Mike Farmer FROM: Sue Stein RE: Budget results I appreciate your coming to me with your questions about the budget I understand that the new procedures can be frustrating, especially when you receive an unfavorable report that you were not expecting Actually, the flexible budget does mean that you are held accountable only for the costs that you can control Last month, we calculated the cost of producing 8,000 units that were actually sold (and not the 10,000 that were estimated to be sold) Your costs were greater than that, although still less than the amount you would have been allowed had the full 10,000 been sold Please check the individual items on your budget report We noted which ones exceeded the budget You can then focus attention on those items for cost control Please contact the Accounting Department if you have further questions (signed) 10 - 49 ...10 - Test Bank for ISV Managerial Accounting, Fourth Edition SUMMARY OF QUESTIONS BY STUDY OBJECTIVES AND BLOOM’S TAXONOMY Brief Exercises... under the manager's control In responsibility accounting, it is necessary to distinguish between controllable and 10 - Test Bank for ISV Managerial Accounting, Fourth Edition noncontrollable fixed... for computing return on investment is controllable margin divided by average operating assets 10 - a Test Bank for ISV Managerial Accounting, Fourth Edition 29 When evaluating residual income,