CHAPTER 24
Budgetary Control and Responsibility Accounting
LEARNING OBJECTIVES
1. DESCRIBE BUDGETARY CONTROL AND STATIC
BUDGET REPORTS.
2. PREPARE FLEXIBLE BUDGET REPORTS.
CHAPTER REVIEW
Budgetary Control and Static Budget Reports
1. (L.O. 1) The use of budgets in controlling operations is known as budgetary control. Such
2. Budgetary control involves:
a. Developing budgets.
3. Budgetary control works best when a company has a formalized reporting system. The system
should
4. A static budget does not modify or adjust data regardless of changes in activity during the year.
As a result, actual results are always compared with the budget data at the activity level used in
developing the master budget.
behavior of the costs in response to changes in activity is fixed.
Flexible Budgets
6. (L.O. 2) A flexible budget projects budget data for various levels of activity. The flexible budget
recognizes that the budgetary process is more useful if it is adaptable to changed operating
conditions. This type of budget permits a comparison of actual and planned results at the level of
activity actually achieved.
8. For manufacturing overhead costs, the activity index is usually the same as the index used in
developing the predetermined overhead rate; that is, direct labor hours or machine hours. For
selling and administrative expenses, the activity index usually is sales or net sales.
9. The following formula may be used to determine total budgeted costs at any level of activity:
Total budgeted costs = Fixed costs + (Total variable cost per unit X Activity level)
Responsibility Accounting and Responsibility Centers
12. (L.O. 3) Responsibility accounting involves 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. A manager’s performance is evaluated on matters directly under that
manager’s control.
15. Responsibility accounting is an essential part of any effective system of budgetary control. It
differs from budgeting in two respects:
a. A distinction is made between controllable and noncontrollable items.
b. Performance reports either emphasize or include only items controllable by the individual
manager.
expenses) but also generates revenues. An investment center incurs costs (and expenses),
generates revenues, and has control over investment funds available for use.
Cost Centers
Profit Centers
21. A responsibility report for a profit center shows budgeted and actual controllable revenues and
costs. The report is prepared using the cost-volume-profit income statement format.
Evaluating Investment Centers
25. (L.O. 4) The primary basis for evaluating the performance of a manger of an investment center is
return on investment (ROI). The formula for computing return on investment is: Controllable
Margin ÷ Average Operating Assets = Return on Investment.
26. A manager can improve ROI by (a) increasing controllable margin or (b) reducing average
operating assets.
27. The return on investment approach includes two judgmental factors:
a. Valuation of operating assets—cost, book value, appraised value, or market value.
b Margin (income) measure—controllable margin, income from operations, or net income.
*Residual Income
LECTURE OUTLINE
A. The Concept of Budgetary Control.
2. Budgetary control consists of:
a. Preparing periodic budget reports that compare actual results with
planned objectives.
3. Budgetary control works best when a company has a formalized reporting
system. This system does the following:
4. A static budget is a projection of budget data at one level of activity. This
budget does not consider data for different levels of activity. As a result,
B. The Flexible Budget.
1. 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.
2. To develop the flexible budget, management should:
SERVICE COMPANY INSIGHT
When the number of viewers of the television show “House,” a medical drama,
declined by almost 20%, Fox Broadcasting said it wanted to cut the license fee
that it paid to NBCUniversal by 20%. How could NBCUniversal deal with the
20% cut in revenue? Choices include cutting the size of the cast or reducing the
number of episodes, among other choices.
Explain how the use of flexible budgets might help to identify the best solution to
this problem.
3. Flexible budget reports are another type of internal report. The flexible
budget report consists of two sections:
4. The flexible budget report provides a basis for evaluating a manager’s
performance in two areas:
5. Flexible budget reports are appropriate for evaluating performance since
both actual and budgeted costs are based on the actual activity level
achieved.
SERVICE COMPANY INSIGHT
When the Exotic Newcastle Disease (an infectious bird disease) broke out in
Southern California in 2003, it could have spelled disaster for the San Diego Zoo.
The zoo spent almost half a million dollars on quarantine measures in 2003. It
worked: no birds got sick and the damage to the zoo’s budget was minimized by
a monthly budget reforecast.
What is the major benefit of tying a budget to the overall goals of the company?
C. Responsibility Accounting.
1. Responsibility accounting involves accumulating and reporting costs
(and revenues) on the basis of the manager who has the authority to
make the day–to-day decisions about the items.
b. The costs and revenues can be controlled by employees at the level
of responsibility with which they are associated.
MANAGEMENT INSIGHT
While many compensation and promotion programs encourage competition and
hard work, it does not foster collaboration, and can lead to distrust and disloyalty.
As a consequence, many companies now explicitly include measures of collabo–
ration in their performance measures.
How might managers of separate divisions be able to reduce division costs
through collaboration?
5. A cost over which a manager has control is called a controllable cost. It
follows that:
a. All costs are controllable by top management because of the broad
range of its activity.
D. Principles of Performance Evaluation.
1. 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.
3. The human factor is critical in evaluating performance. Behavioral
principles include:
4. Performance evaluation under responsibility accounting should be
based on certain reporting principles. Performance reports should:
MANAGEMENT INSIGHT
Among automobile manufacturing facilities in the U.S., nobody has more flexible
plants than Honda. At the Honda plant, the switch from the production of one
type of vehicle to a different type of vehicle takes only minutes instead of months
like for most plants. This ability to adjust quickly to changing demand gave
Honda a huge advantage when demand for more fuel-efficient cars increased
quickly.
What implications do these improvements in production capabilities have for
management accounting information and performance evaluation within the
organization?
E. Types of Responsibility Centers.
1. There are three basic types of responsibility centers: cost centers, profit
centers, and investment centers.
a. A cost center incurs costs (and expenses) but does not directly
generate revenues.
2. Responsibility Reports.
a. The evaluation of a manager’s performance for cost centers is based
on his or her ability to meet budgeted goals for controllable costs.
c. The primary basis for evaluating the performance of a manager of
an investment center is return on investment (ROI).
ACCOUNTING ACROSS THE ORGANIZATION
No matter how you slice the movie business, by far the best return on investment
comes from the not-so-glamorous world of G-rated films. However, these movies
represent only 3% of the total films made in a typical year.
What might be the reason that movie studios do not produce G-rated movies as
often as R-rated ones?
*F. Residual Income Compared To ROI.
1. 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.
20 MINUTE QUIZ
Circle the correct answer.
True/False
1. In a static budget, the data may be modified or adjusted if activity changes more than a specified
amount during the year.
True False
2. Flexible budgets can be prepared for each of the types of budgets included in the master budget.
True False
3. With a flexible budget, if production increases, budget allowances for variable costs should
increase both directly and proportionately.
True False
4. Flexible budget reports consist of two sections: production data and cost data.
True False
5. Under responsibility accounting, the evaluation of a manager’s performance is based on the
matters directly under that manager’s control.
True False
6. The terms “controllable costs” and “noncontrollable costs” are synonymous with variable costs
and fixed costs, respectively.
True False
7. Only controllable costs are included in a responsibility performance report, and there is no
distinction made between variable and fixed costs.
True False
8. A responsibility reporting system begins with the lowest level of responsibility in an
organization and moves upward to each higher level.
True False
9. There are three types of responsibility centers: cost, segment, and investment.
True False
10. The primary basis for evaluating the performance of a manager of an investment center is return
on investment.
True False
Multiple Choice
1. A static budget report is appropriate for
a. evaluating a manager’s performance in controlling variable costs.
b. fixed manufacturing costs and fixed selling and administrative expenses.
c. variable costs and fixed costs.
d. none of the above.
2. The flexible budget report includes all of the following sections except
a. cost data for variable and fixed costs .
b. data for excess of contribution margin over controllable fixed costs (controllable
margin).
c. production data for a selected activity index.
d. All of the choices are included in a flexible budget report.
3. At 40,000 direct labor hours, the flexible budget for indirect labor is $160,000. If $172,000
of indirect labor costs are incurred at 44,000 direct labor hours, the flexible budget report
should show the following difference for indirect labor.
a. $12,000 favorable.
b. $4,000 unfavorable.
c. $4,000 favorable.
d. $12,000 unfavorable.
4. Controllable fixed costs are deducted from the contribution margin to arrive at
a. income from operations.
b. net income.
c. controllable margin.
d. realized income.
5. The numerator in computing return on investment is
a. controllable margin.
b. average operating assets.
c. contribution margin.
d. net assets.
ANSWERS TO QUIZ
True/False
Multiple Choice