Accounting principles, 13th edition ch25

Accounting Principles Thirteenth Edition Weygandt Kimmel Kieso Chapter 25 Budgetary Control and Responsibility Accounting Prepared by Coby Harmon University of California, Santa Barbara Westmont College Chapter Outline Learning Objectives LO Describe budgetary control and static budget reports LO Prepare flexible budget reports LO Apply responsibility accounting to cost and profit centers LO Evaluate performance in investment centers Copyright ©2018 John Wiley & Son, Inc Budgetary Control and Static Budget Reports Use of budgets in controlling operations is known as budgetary control a Budget reports compare actual results with planned objectives b Provides management with feedback on operations c Budget reports prepared as frequently as needed d Management analyzes differences between actual and planned results and determines causes LO Copyright ©2018 John Wiley & Son, Inc Budgetary Control Develop budget Analyze differences between actual and budget Modify future plans Take corrective action ILLUSTRATION 25.1 Budgetary control activities LO Copyright ©2018 John Wiley & Son, Inc Budgetary Control Works best when a company has a formalized reporting system which: Identifies the name of the budget report States the frequency of the report Specifies the purpose of the report Indicates the primary recipient(s) of the report LO Copyright ©2018 John Wiley & Son, Inc Budgetary Control ILLUSTRATION 25.2 Budgetary control reporting system Name of Report Sales Frequency Weekly Purpose Primary Recipient(s) Determine whether sales Top management and sales goals are met manager Labor Weekly Control direct and indirect labor costs Scrap Daily Determine efficient use of Production manager materials Departmental overhead costs Weekly Control overhead costs Department manager Selling expenses Monthly Control selling expenses Sales manager Income statement Monthly and Determine whether quarterly income goals are met LO Copyright ©2018 John Wiley & Son, Inc Vice president of production and production department managers Top management Budgetary Control Budgetary control involves all but one of the following: a Modifying future plans b Analyzing differences c Using static budgets d Determining differences between actual and planned results LO Copyright ©2018 John Wiley & Son, Inc Static Budget Reports A Static budget is a projection of budget data at one level of activity a When used in budgetary control, each budget included in the master budget is considered to be static b Ignores data for different levels of activity c Compares actual results with budget data at the activity level used in the master budget LO Copyright ©2018 John Wiley & Son, Inc Static Budget Reports Illustration: Budget and actual sales data for the Rightride product in the first and second quarters of 2020 are as follows Sales Budgeted Actual First Quarter $180,000 179,000 Second Quarter $210,000 199,500 Total $390,000 378,500 Difference $ 1,000 $ 10,500 $ 11,500 ILLUSTRATION 25.3 Budget and actual sales data LO Copyright ©2018 John Wiley & Son, Inc Static Budget Reports ILLUSTRATION 25.3 Budget and actual sales data Sales Budgeted First Quarter $180,000 Second Quarter $210,000 Total $390,000 Actual Difference 179,000 $ 1,000 199,500 $ 10,500 378,500 $ 11,500 Sales Budget Report For the Quarter Ended March 31, 2020 Product Line Rightride LO Budget $180,000 Actual $179,000 Copyright ©2018 John Wiley & Son, Inc ILLUSTRATION 25.4 Difference Favorable F Unfavorable U $1,000 U 10 Judgmental Factors in ROI Valuation of operating assets  Acquisition cost, book value, appraised value, or fair value  Each provides a reliable basis for evaluating performance Margin (income) measure LO  Controllable margin, income from operations, or net income  Only controllable margin is a valid basis for evaluating performance of manager Copyright ©2018 John Wiley & Son, Inc 70 Improving ROI Improve ROI by increasing controllable margin, and/or reducing average operating assets Sales Variable costs Contribution margin Controllable fixed costs Controllable margin (a) Average operating assets (b) Return on investment (a) ÷ (b) $2,000,000 1,100,000 900,000 300,000 $ 600,000 $5,000,000 12% ILLUSTRATION 25.25 Assumed data for Laser Division LO Copyright ©2018 John Wiley & Son, Inc 71 Increasing Controllable Margin Improve ROI by increasing sales or by reducing variable and controllable fixed costs Increase sales by 10% ROI LO  Sales increase $200,000 and contribution margin increases $90,000 ($200,000 X 45)  Controllable margin increases to $690,000 ($600,000 + $90,000) = Controllable margin Average operating assets ILLUSTRATION 25.26 ROI computation $690,000 = $5,000,000 Copyright ©2018 John Wiley & Son, Inc = 13.8% 72 Increasing Controllable Margin Improve ROI by increasing sales or by reducing variable and controllable fixed costs Decrease variable and fixed costs 10% ROI LO  Total costs decrease $140,000 [($1,100,000 + $300,000) X 10%]  Controllable margin becomes $740,000 = Controllable margin Average operating assets ILLUSTRATION 25.27 ROI computation = $740,000 $5,000,000 Copyright ©2018 John Wiley & Son, Inc = 14.8% 73 Reducing Average Operating Assets a Assume that average operating assets are reduced 10% or $500,000 ($5,000,000 x 10) b Average operating assets become $4,500,000 c Controllable margin remains unchanged at $600,000 ROI = Controllable margin Average operating assets = $600,000 $4,500,000 = 13.3% ILLUSTRATION 25.28 ROI computation LO Copyright ©2018 John Wiley & Son, Inc 74 Improving ROI 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 LO d Controllable margin percentage and average operating assets Copyright ©2018 John Wiley & Son, Inc 75 DO IT! Performance Evaluation (1 of 4) The service division of Metro Industries reported the following results for 2020 Sales $400,000 Variable costs 320,000 Controllable fixed costs 40,800 Average operating assets 280,000 Management is considering the following independent courses of action in 2021 in order to maximize the return on investment Reduce average operating assets by $80,000, with no change in controllable margin Increase sales $80,000, with no change in the contribution margin percentage Copyright ©2018 John Wiley & Son, Inc LO 76 The service division reported the following results for 2020 (2 of 4) Sales $400,000 Variable costs 320,000 Controllable fixed costs 40,800 Average operating assets 280,000 a Compute controllable margin and return on investment for 2020 Sales $400,000 Variable costs 320,000 Contribution margin 80,000 Controllable fixed costs 40,800 Controllable margin (a) $39,200 Average operating assets (b) $280,000 Return on investment (a) ÷ (b) 14% LO Copyright ©2018 John Wiley & Son, Inc 77 The service division reported the following results for 2020 (3 of 4) Sales $400,000 Variable costs 320,000 Controllable fixed costs 40,800 Average operating assets 280,000 b Compute expected return on investment for alternative $39,200 $280,000 - $80,000 LO = Copyright ©2018 John Wiley & Son, Inc 19.6% 78 The service division reported the following results for 2020 (4 of 4) Sales $400,000 Variable costs 320,000 Controllable fixed costs 40,800 Average operating assets 280,000 b Compute controllable margin and expected return on investment for alternative Sales ($400,000 + $80,000) $480,000 Variable costs ($320,000/$400,000 × $480,000) 384,000 Contribution margin 96,000 Controllable fixed costs 40,800 Controllable margin (a) $55,200 Average operating assets (b) $280,000 Return on investment (a) ÷ (b) 19.7% LO Copyright ©2018 John Wiley & Son, Inc 79 Appendix 10A ROI vs Residual Income ILLUSTRATION 25A.1 Controllable Margin ÷ $1,000,000 ÷ Average Operating Assets $5,000,000 = = Return on Investment (ROI) 20% Illustration: Electronics Division of Pujols Company has an ROI of 20% Pujols is considering producing a new product, a GPS device (Tracker) for its boats Operating assets will increase $2,000,000 Tracker is expected to generate an additional $260,000 of controllable margin LO Copyright ©2018 John Wiley & Son, Inc 80 Appendix 10A ROI vs Residual Income How Tracker will effect ROI Without Tracker Contribution margin (a) $1,000,000 Average operating assets (b) $5,000,000 Return on investment [(a) ÷ (b)] 20% ILLUSTRATION 25A.2 Tracker $260,000 $2,000,000 13% With Tracker $1,260,000 $7,000,000 18% The problem with ROI analysis is that it ignores minimum rate of return on a operating assets Assuming a minimum rate of return of 10%, it should invest in Tracker because its ROI of 13% is greater than 10% LO Copyright ©2018 John Wiley & Son, Inc 81 Residual Income Compared to ROI To evaluate performance using the minimum rate of return, companies use the residual income approach Controllable Margin $260,000 - Minimum Rate of Return x Average Operating Assets 10% x $2,000,000 Without Tracker Contribution margin (a) $1,000,000 Average operating assets x 10% (b) 500,000 Residual income [(a) - (b)] $ 500,000 ILLUSTRATION 25A.4 Residual income comparison LO Copyright ©2018 John Wiley & Son, Inc ILLUSTRATION 25A.3 = Residual Income = $60,000 Tracker $260,000 200,000 $ 60,000 With Tracker $1,260,000 700,000 $ 560,000 82 Residual Income Weakness To evaluate performance using the minimum rate of return, companies use the residual income approach ILLUSTRATION 25A.5 Contribution margin (a) Average operating assets x 10% (b) Residual income [(a) - (b)] Tracker $260,000 200,000 $ 60,000 SeaDog $460,000 400,000 $ 60,000 If these two investments were evaluated using residual income, they would be considered equal This ignores the fact that SeaDog required twice as many operating assets to achieve the same level of residual income LO Copyright ©2018 John Wiley & Son, Inc 83 Copyright Copyright © 2018 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States 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 Copyright ©2018 John Wiley & Son, Inc 84 ... budgetary control and static budget reports LO Prepare flexible budget reports LO Apply responsibility accounting to cost and profit centers LO Evaluate performance in investment centers Copyright ©2018