TEST BANK managerial accounting by 5e kieso weygand ch010

CHAPTER 10 Budgetary Control and Responsibility Accounting ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises Exercises A Problems B Problems Describe the concept of budgetary control 1, 2 Evaluate the usefulness of static budget reports 3, 4, 1, 1, 2, 3A 3B Explain the development of flexible budgets and the usefulness of flexible budget reports 6, 7, 8, 9, 10, 11, 12 3, 4, 1, 3, 4, 5, 6, 7, 8, 9, 10 1A, 2A, 3A 1B, 2B, 3B Describe the concept of responsibility accounting 13, 14, 15, 16, 17, 18, 24 11 6A Indicate the features of responsibility reports for cost centers 19 7, 9, 12 Identify the content of responsibility reports for profit centers 20, 21 13, 14 4A 4B Explain the basis and formula used in evaluating performance in investment centers 22, 23, 24 8, 9, 10 14, 15, 16, 17 5A 5B 25, 26 11, 12 18, 19 7A *8 Explain the difference between ROI and residual income *Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix to the chapter 10-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) Simple 20–30 Moderate 30–40 Simple 20–30 1A Prepare flexible budget and budget report for manufacturing overhead 2A Prepare flexible budget, budget report, and graph for manufacturing overhead 3A State total budgeted cost formula, and prepare flexible budget reports for two time periods 4A Prepare responsibility report for a profit center Moderate 20–30 5A Prepare responsibility report for an investment center, and compute ROI Moderate 40–50 6A Prepare reports for cost centers under responsibility accounting, and comment on performance of managers Moderate 40–50 Compare ROI and residual income Moderate 35–45 Simple 20–30 Moderate 30–40 Simple 20–30 *7A 1B Prepare flexible budget and budget report for manufacturing overhead 2B Prepare flexible budget, budget report, and graph for manufacturing overhead 3B State total budgeted cost formula, and prepare flexible budget reports for two time periods 4B Prepare responsibility report for a profit center Moderate 20–30 5B Prepare responsibility report for an investment center, and compute ROI Moderate 40–50 10-2 10-3 Broadening Your Perspective E10-18 E10-19 P10-7A E10-15 E10-17 E10-16 E10-17 E10-13 P10-4A P10-4B P10-3A P10-1B P10-3B Synthesis P10-5A P10-5B BE10-3 E10-8 P10-2A P10-2B E10-8 Evaluation Exploring the Web Real-World Focus Communication All About You Manag Analysis Decision Making Ethics Case Decision Making Across the Communication Organization Across the Ethics Case Organization Manag Analysis Real-World Focus BE10-11 BE10-12 BE10-8 BE10-9 BE10-10 E10-14 Q10-22 Q10-23 Q10-24 Explain the basis and formula used in evaluating performance in investment centers *8 Explain the difference between ROI and residual income BE10-7 E10-14 Q10-20 Q10-21 Q10-25 Q10-26 P10-6A Q10-17 E10-11 Q10-18 Q10-24 E10-12 E10-7 BE10-5 E10-9 E10-4 E10-10 E10-6 P10-1A Q10-11 BE10-4 E10-3 E10-5 BE10-6 E10-7 E10-9 E10-2 P10-3A P10-3B Analysis Q10-5 BE10-1 BE10-2 Application Identify the content of responsibility reports for profit centers Indicate the features of responsibility reports for cost centers Q10-19 Q10-6 Q10-7 Q10-8 Q10-10 Q10-9 Q10-12 E10-1 Explain the development of flexible budgets and the usefulness of flexible budget reports Q10-13 Q10-14 Q10-15 Q10-16 Q10-3 Q10-4 E10-1 Evaluate the usefulness of static budget reports Describe the concept of responsibility accounting Q10-1 Q10-2 E10-1 Knowledge Comprehension Describe the concept of budgetary control Study Objective Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems BLOOM’S TAXONOMY TABLE STUDY 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 IDENTIFY THE CONTENT OF RESPONSIBILITY REPORTS FOR PROFIT CENTERS EXPLAIN THE BASIS AND FORMULA USED IN EVALUATING PERFORMANCE IN INVESTMENT CENTERS *8 EXPLAIN THE DIFFERENCE BETWEEN ROI AND RESIDUAL INCOME 10-4 CHAPTER REVIEW Budgetary Control (S.O 1) 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 budget reports provide management with feedback on operations Budgetary control involves: a Developing budgets b Analyzing the differences between actual and budgeted results c Taking corrective action d Modifying future plans, if necessary Budgetary control works best when a company has a formalized reporting system The system should a Identify the name of the budget report such as the sales budget or the manufacturing overhead budget b State the frequency of the report such as weekly, or monthly c Specify the purpose of the report d Indicate the primary recipient(s) of the report Static Budget Reports (S.O 2) 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 A static budget is appropriate in evaluating a manager’s effectiveness in controlling costs when (a) the actual level of activity closely approximates the master budget activity level, and/or (b) the behavior of the costs in response to changes in activity is fixed Flexible Budgets (S.O 3) 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 To develop the flexible budget, the following steps are taken: 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 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 10-5 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) 10 Total budgeted costs at each level of activity can be shown graphically a In a graph, the activity index is shown on the horizontal axis and costs are shown on the vertical axis b The total budgeted costs for each level of activity are then identified from the total budgeted cost line 11 Flexible budget reports are another type of internal report produced by managerial accounting The flexible budget report consists of two sections: (a) production data such as direct labor hours and (b) cost data for variable and fixed costs It also shows differences between budget and actual results 12 Management by exception means that top management’s review of a budget report is focused either entirely or primarily to differences between actual results and planned objectives The guidelines for identifying an exception are based on materiality and controllability Responsibility Accounting 13 (S.O 4) 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 14 Responsibility accounting can be used at every level of management in which the following conditions exist: a Costs and revenues can be directly associated with the specific level of management responsibility b The costs and revenues are controllable at the level of responsibility with which they are associated c Budget data can be developed for evaluating the manager’s effectiveness in controlling the costs and revenues 15 Responsibility accounting is especially valuable in a decentralized company Decentralization means that the control of operations is delegated to many managers throughout the organization A segment is an identified area of responsibility in decentralized operations 16 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 17 A cost is considered controllable at a given level of managerial responsibility if that manager has the power to incur it within a given period of time Costs incurred indirectly and allocated to a responsibility level are considered to be noncontrollable at that level 18 A responsibility reporting system involves the preparation of a report for each level of responsibility shown in the company’s organization chart A responsibility reporting system permits management by exception at each level of responsibility within the organization 10-6 19 Responsibility centers may be classified into one of three types A cost center incurs costs (and expenses) but does not directly generate revenues A profit center incurs costs (and 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 20 (S.O 5) A responsibility report for cost centers compares actual controllable costs with flexible budget data Only controllable costs are included in the report, and no distinction is made between variable and fixed costs 21 Direct fixed costs or traceable costs are costs that relate specifically to a responsibility center and are incurred for the sole benefit of the center Indirect fixed costs or common costs pertain to a company’s overall operating activities and are incurred for the benefit of more than one profit center Profit Centers 22 (S.O 6) 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 23 In the responsibility report for a profit center: a Controllable fixed costs are deducted from contribution margin b The excess of contribution margin over controllable fixed costs is identified as controllable margin c Noncontrollable fixed costs are not reported 24 Controllable margin is considered to be the best measure of the manager’s performance in controlling revenues and costs Investment Centers 25 (S.O 7) 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: Investment Center Controllable Margin (in dollars) ÷ Average Investment Center Operating Assets = Return on Investment a Operating assets consist of current assets and plant assets used in operations by the center Nonoperating assets such as idle plant assets and land held for future use are excluded b Average operating assets are usually based on the beginning and ending cost or book values of the assets 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 28 Performance evaluation is a management function that compares actual results with budget goals Performance evaluation includes both behavioral and reporting principles 10-7 *Residual Income *29 (S.O 8) To evaluate performance using the minimum rate of return, companies use the residual income approach 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 The residual income would be computed as follows: Controllable Margin – Minimum Rate of Return X Average Operating Assets 10-8 = Residual Income LECTURE OUTLINE A The Concept of 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 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 d Modifying future plans, if necessary Budgetary control works best when a company has a formalized reporting system This system does the following: TEACHING TIP Use ILLUSTRATION 10-1 to emphasize the importance of a formalized reporting system for effective budgetary control Point out that different activities need to be monitored at different times by those who are responsible for the activities a Identifies the name of the budget report (i.e sales budget) b States the frequency of the report, such as weekly or monthly c Specifies the purpose of the report d Indicates the primary recipient(s) of the report 10-9 A static budget is a projection of budget data at one level of activity These budgets 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 appropriate in evaluating a manager’s effectiveness in controlling costs when: a The actual level of activity closely approximates the master budget activity level, and/or b The behavior of the costs in response to changes in activity is fixed A static budget report is appropriate for fixed manufacturing costs and for fixed selling and administrative expenses B The Flexible Budget 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 TEACHING TIP Use ILLUSTRATION 10-2 to demonstrate the preparation of a flexible budget Point out that once a flexible budget formula is developed, a flexible budget can be prepared for any level of activity Emphasize that fixed costs are not calculated on a per unit basis because they are not expected to change in total with changes in activity within the relevant range To develop the flexible budget, management should: a Identify the activity index and the relevant range of activity 10-10 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 are another type of internal report The flexible budget report consists of two sections: a Production data for a selected activity index, such as direct labor hours b Cost data for variable and fixed costs TEACHING TIP ILLUSTRATION 10-3 provides an example of a flexible budget report Emphasize that the actual costs are reported as incurred at the actual activity level achieved, and the flexible budget is developed at the same actual level of activity The flexible budget report provides a basis for evaluating a manager’s performance in two areas: a Production control b Cost control Flexible budget reports are appropriate for evaluating performance since both actual and budgeted costs are based on the actual activity level achieved 10-11 C 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 For management by exception to be effective, there must be guidelines for identifying an exception The usual criteria are: D a Materiality—usually expressed as a percentage difference from budget b Controllability of the item—exception guidelines are more restrictive for controllable items than for items the manager cannot control The Concept of Responsibility Accounting 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 Under responsibility accounting, a manager’s performance is evaluated on matters directly under that manager’s control Responsibility accounting can be used at every level of management in which the following conditions exist: a Costs and revenues can be directly associated with the specific level of management responsibility b The costs and revenues can be controlled by employees at the level of responsibility with which they are associated c Budget data can be developed for evaluating the manager’s effectiveness in controlling the costs and revenues 10-12 The reporting of costs and revenues under responsibility accounting 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 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 b Fewer costs are controllable as one moves down to each lower level of managerial responsibility because of the manager’s decreasing authority Noncontrollable costs are costs incurred indirectly and allocated to a responsibility level A responsibility reporting system involves the preparation of a report for each level of responsibility in the company’s organization chart Responsibility reports for cost centers compare actual controllable costs with flexible budget data The reports show only controllable costs and no distinction is made between variable and fixed costs There are three basic types of responsibility centers: cost centers, profit centers, and investment centers TEACHING TIP ILLUSTRATION 10-4 identifies the three types of responsibility centers, the bases for evaluating the managers’ performance in the centers, and the type of performance report prepared for each center 10-13 a A cost center incurs costs (and expenses) but does not directly generate revenues b A profit center incurs costs (and expenses) and also generates revenues c Like a profit center, an investment center incurs costs (and expenses) and generates revenues In addition, an investment center has control over decisions regarding the assets available for use 10 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 b To evaluate the performance of a profit center manager, upper management needs detailed information about both controllable revenues and controllable costs The report is prepared using the cost-volume-profit income statement In the report: (1) Controllable fixed costs are deducted from contribution margin (2) The excess of contribution margin over controllable fixed costs is identified as controllable margin (3) Noncontrollable fixed costs are not reported c The primary basis for evaluating the performance of a manager of an investment center is return on investment (ROI) TEACHING TIP ILLUSTRATION 10-5 provides the formula for calculating return on investment (ROI) Since the performance of managers of investment centers are evaluated by ROI, suggest ways that a manager might increase ROI 10-14 E d Return on investment is computed by dividing controllable margin by average operating assets e Judgmental factors in ROI are (1) valuation of operating assets and (2) margin (income) measure Principles of Performance Evaluation The human factor is critical in evaluating performance Behavioral principles include: a Managers of responsibility centers should have direct input into the process of establishing budget goals of their area of responsibility b The evaluation of performance should be based entirely on matters that are controllable by the manager being evaluated c Top management should support the evaluation process d The evaluation process must allow managers to respond to their evaluations e The evaluation should identify both good and poor performance Performance evaluation under responsibility accounting should be based on certain reporting principles Performance reports should: a Contain only data that are controllable by the manager of the responsibility center b Provide accurate and reliable budget data to measure performance c Highlight significant differences between actual results and budget goals d Be tailor-made for the intended evaluation e Be prepared at reasonable intervals 10-15 *F Residual Income Compared To ROI 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 Residual income is computed as follows: Controllable Margin – (Minimum Rate of Return X Average Operating Assets) ROI sometimes provides misleading results because profitable investments are often rejected when the investment reduces ROI but increases overall profitability 10-16 20 MINUTE QUIZ Circle the correct answer True/False In a static budget, the data may be modified or adjusted if activity changes more than a specified amount during the year True Flexible budgets can be prepared for each of the types of budgets included in the master budget True False There are three types of responsibility centers: cost, segment, and investment True 10 False A responsibility reporting system begins with the lowest level of responsibility in an organization and moves upward to each higher level True False Only controllable costs are included in a responsibility performance report, and there is no distinction made between variable and fixed costs True False The terms “controllable costs” and “noncontrollable costs” are synonymous with variable costs and fixed costs, respectively True False Under responsibility accounting, the evaluation of a manager’s performance is based on the matters directly under that manager’s control True False Flexible budget reports consist of two sections: production data and cost data True False With a flexible budget, if production increases, budget allowances for variable costs should increase both directly and proportionately True False False The primary basis for evaluating the performance of a manager of an investment center is return on investment True False 10-17 Multiple Choice 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 The manufacturing overhead budget (1) provides the basis for computing the predetermined overhead rate for the year, and (2) is used in costing work in process and finished goods inventories Is the above statement true for a (1) only b (2) only c both (1) and (2) d neither (1) nor (2) 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 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 The numerator in computing return on investment is a controllable margin b average operating assets c contribution margin d net assets 10-18 ANSWERS TO QUIZ True/False False True True True True 10 False True True False True Multiple Choice b c c c a 10-19 ILLUSTRATION 10-1 BUDGETARY CONTROL REPORTING SYSTEM Name of Report Frequency Purpose Primary Recipient(s) Sales Weekly Determine whether sales goals are being met Top management and sales manager Labor Weekly Control direct and indirect labor costs Scrap Daily Departmental overhead costs Selling expenses Income statement Monthly Determine efficient use of materials Control overhead costs Control selling expenses Determine whether income objectives are being met Vice president of production and production department managers Production manager Monthly Monthly and quarterly 10-20 Department manager Sales manager Top management ILLUSTRATION 10-2 THE FLEXIBLE BUDGET EXAMPLE COMPANY EXAMPLE COMPANY Manufacturing Overhead Budget (Static) For the Year Ended December 31, 2008 Flexible Manufacturing Overhead Budget Monthly Per Machine Hour Relevant Range Machine hours 60,000 Variable costs: Indirect materials $120,000 $2.00 Indirect labor 360,000 6.00 60 Supplies 36,000 Total variable costs 516,000 $8.60 Fixed costs: Depreciation Property taxes Supervision Total fixed costs Total costs 4,000 $ 5,000 6,000 8,000 $ 10,000 $ 12,000 24,000 30,000 36,000 2,400 3,000 3,600 34,400 43,000 51,600 300,000 60,000 480,000 840,000 – – – – 25,000 5,000 40,000 70,000 25,000 5,000 40,000 70,000 25,000 5,000 40,000 70,000 $1,356,000 – $104,400 $113,000 $121,600 Flexible Budget Formula Fixed Costs + Total Variable Cost Per Unit of Activity $70,000 + $8.60 × 10-21 × Activity Level = Total Budgeted Cost 4,000 = $104,400 5,000 = $113,000 6,000 = $121,600 ILLUSTRATION 10-3 FLEXIBLE BUDGET REPORT EXAMPLE COMPANY Manufacturing Overhead Budget Report (Flexible) For the Month Ended October 31, 2008 Budget at Actual Cost 6,000 MH 6,000 MH Machine hours Variable costs: $ 12,000 Indirect materials 36,000 Indirect labor 3,600 Supplies 51,600 Total variable costs Fixed costs: 25,000 Depreciation 5,000 Property taxes 40,000 Supervision 70,000 Total fixed costs $121,600 Total costs Difference Favorable F Unfavorable U $ 14,000 31,000 2,800 47,800 $2,000 5,000 800 3,800 25,000 5,000 40,000 70,000 $117,800 – – – – $3,800 F U F F F A Flexible Budget Report is appropriate for evaluating a manager's performance in cost control BUDGETARY CONTROL Determine differences between actual and planned results (Periodic budget reports) Planned Objectives (Budget) Modify future plans Take corrective action 10-22 Analyze differences ILLUSTRATION 10-4 RESPONSIBILITY CENTERS TYPE BASIS FOR EVALUATION Cost Center Incurs costs but does not directly generate revenues Ability to control costs Report compares actual controllable costs with flexible budget data Profitability of center Report shows budgeted and actual controllable revenues and costs in a contribution margin format Profitability of center and return on investment (ROI) Report shows budgeted and actual controllable revenues and expenses and budgeted and actual return on investment Profit Center Incurs costs and also generates revenues Investment Center Incurs costs, generates revenues, and has control over investment funds PERFORMANCE REPORT 10-23 ILLUSTRATION 10-5 RETURN ON INVESTMENT ROI FORMULA ROI = Controllable Margin Average Operating Assets To Improve Return on Investment: Increase sales * Reduce costs * Reduce average operating assets * * All other factors remaining constant 10-24 ... budgeted cost line 11 Flexible budget reports are another type of internal report produced by managerial accounting The flexible budget report consists of two sections: (a) production data such... investment centers are evaluated by ROI, suggest ways that a manager might increase ROI 10-14 E d Return on investment is computed by dividing controllable margin by average operating assets e Judgmental... reports either emphasize or include only items controllable by the individual manager 17 A cost is considered controllable at a given level of managerial responsibility if that manager has the power