In this chapter, the learning objectives are: 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.
Chapter 24-1 CHAPTER 24 BUDGETARY CONTROL AND RESPONSIBILITY ACCOUNTING Accounting Principles, Eighth Edition Chapter 24-2 Study Objectives 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 Chapter 24-3 Study Objectives Study Objectives Identify the content of responsibility reports for profit centers Explain the basis and formula used in evaluating performance in investment centers Chapter 24-4 Preview of Chapter Preview of Chapter Considers how budgets are used by management to control operations Focuses on two aspects of management control: Budgetary control Responsibility accounting Chapter 24-5 Budgetary Control and Budgetary Control and Responsibility Accounting Responsibility Accounting The TheConcept Concept of ofBudgetary Budgetary Control Control Budget reports Control activities Reporting systems Static StaticBudget Budget Reports Reports Examples Use and limitations Why flexible budgets? Development Chapter 24-6 The TheConcept Conceptof of Responsibility Responsibility Accounting Accounting Case study Controllable vs noncontrollable Reporting system Flexible Flexible Budgets Budgets Reports Managemen t by exception Types Typesof of Responsibility Responsibility Centers Centers Cost centers Profit centers Investment centers Performance evaluation The Concept of Budgetary Control The Concept of Budgetary Control A major function of management is to control operations Takes place by means of budget reports which compare actual results with planned objectives Provides management with feedback on operations Budget reports can be prepared as frequently as needed Analyze differences between actual and planned results and determines causes Chapter 24-7 LO 1: Describe the concept of budgetary control The Concept of Budgetary Control The Concept of Budgetary Control Budgetary control involves the following activities Chapter 24-8 LO 1: Describe the concept of budgetary control The Concept of Budgetary Control The Concept of Budgetary Control Works best when a company has a formalized reporting system which: Identifies the name of the budget report (such as the sales budget or the manufacturing overhead budget) States the frequency of the report (such as weekly or monthly) Specifies the purpose of the report Indicates recipient of the report Chapter 24-9 LO 1: Describe the concept of budgetary control The Concept of Budgetary Control The Concept of Budgetary Control Schedule below illustrates a partial budgetary control system for a manufacturing company Note the frequency of reports and their emphasis on control Chapter 24-10 LO 1: Describe the concept of budgetary control Responsibility Accounting for Responsibility Accounting for Investment Centers Investment Centers Return on Investment (ROI) Chapter 24-58 Primary basis for evaluating the performance of a manager of an investment center Shows the effectiveness of the manager in using the assets at his/her disposal Useful performance measure Factors in ROI formula are controllable by manager LO 7: Explain the basis and formula used in evaluating performance in investment centers Responsibility Accounting for Responsibility Accounting for Investment Centers Investment Centers Computation of ROI (example data assumed) : Operating assets include current assets and plant assets used in operations by the center and controlled by manager. Exclude nonoperating assets such as idle plant assets and land held for future use Base average operating assets on the beginning and ending cost or book values of the assets Chapter 24-59 LO 7: Explain the basis and formula used in evaluating performance in investment centers Responsibility Accounting for Responsibility Accounting for Investment Centers Investment Centers Responsibility Report Scope of manager’s responsibility affects content Investment center is an independent entity for operating purposes All fixed costs controllable by center manager Shows budgeted and actual ROI below controllable margin Chapter 24-60 LO 7: Explain the basis and formula used in evaluating performance in investment centers Responsibility Accounting for Investment Centers Responsibility Accounting for Investment Centers Example – Mantle Manufacturing Company Chapter 24-61 LO 7: Explain the basis and formula used in evaluating performance in investment centers Judgmental Factors in ROI Judgmental Factors in ROI ROI approach includes two judgmental factors: Valuation of operating assets May be valued at acquisition cost, book value, appraised value, or market value Each alternative provides a reliable basis for evaluating performance as long as it is consistently applied between periods Margin (income) measure May be controllable margin, income from operations, or net income Only controllable margin is a valid basis for evaluating performance of investment center manager Chapter 24-62 LO 7: Explain the basis and formula used in evaluating performance in investment centers Improving ROI – Increasing Controllable Margin Improving ROI – Increasing Controllable Margin Increase ROI by increasing sales or by reducing variable and controllable fixed costs Increase sales by 10% Sales increase $200,000 and contribution margin ($200,000 X .45) increases $90,000 Thus, controllable margin increases to $690,000 ($600,000 + $90,000) New ROI is 13.8% Chapter 24-63 LO 7: Explain the basis and formula used in evaluating performance in investment centers Improving ROI – Improving ROI – Reducing Average Operating Assets Reducing Average Operating Assets Reduce average operating assets by 10% or $500,000 Average operating assets become $4,500,000 10%)] [$5,000,000 ($5,000,000 X Controllable margin remains unchanged at $600,000 New ROI becomes 13.3% Chapter 24-64 LO 7: Explain the basis and formula used in evaluating performance in investment centers Let’s Review Let’s Review In the formula for return on investment (ROI), the factors for controllable margin and operating assets are, respectively: a Controllable margin percentage and total operating assets b. Controllable margin dollars and average operating assets. c. Controllable margin dollars and total assets d. Controllable margin percentage and average operating assets Chapter 24-65 LO 7: Explain the basis and formula used in evaluating performance in investment centers Principles of Performance Evaluation Principles of Performance Evaluation Management function that compares actual results with budget goals At center of responsibility accounting Includes both behavioral and reporting principles Chapter 24-66 Principles of Performance Evaluation Principles of Performance Evaluation Behavioral Principles Behavioral Principles Behavioral principles – human factor critical in evaluating performance: Managers should have direct input into the process of establishing budget goals for their area of responsibility Without this input, managers may view goals as unrealistic or arbitrary Affects motivation to meet targets The evaluation should be based entirely on matters that are controllable by the manager Criticism of noncontrollable matters reduces effectiveness of evaluation May lead to negative reactions by manager and doubts about fairness of evaluation Chapter 24-67 Principles of Performance Evaluation Principles of Performance Evaluation Behavioral Principles Behavioral Principles Top management should support the evaluation process Managers lose faith in process when top management ignores, overrules, or bypasses established procedures The evaluation process must allow managers to respond to their evaluations Evaluation is not a oneway street Managers must be able to defend their performance Evaluation without feedback is impersonal and ineffective The evaluation should identify both good and poor performance Praise is a powerful motivator Manager compensation should include rewards for meeting goals Chapter 24-68 Principles of Performance Evaluation Principles of Performance Evaluation Reporting Principles Reporting Principles Reporting principles for performance reports include reports which Contain only data that are controllable by the manager of the responsibility center Provide accurate and reliable budget data to measure performance Highlight significant differences between actual results and budget goals Are tailormade for the intended evaluation Are prepared at reasonable intervals Chapter 24-69 Chapter Review Brief Exercise 248 Chapter Review Brief Exercise 248 For the year ending December 31, 2008, Kaspar Company accumulates the following data for the Plastics Division which it operates as an investment center: contribution margin $700,000 budget, $715,000 actual; controllable fixed costs $300,000 budget, $309,000 actual. Average operating assets for the year were $2,000,000 Prepare a responsibility report for the Plastics Division beginning with contribution margin Chapter 24-70 Chapter Review Brief Exercise 248 Chapter Review Brief Exercise 248 Kaspar Company Responsibility Report For Year Ending December 31, 2008 Budget Actual Difference Contribution Margin $700,000 $715,000 $15,000 F Controllable Fixed Costs 300,000 309,000 9,000 U Controllable Margin $400,000 $406,000 $ 6,000 F Favorable – F Unfavorable U Chapter 24-71 Copyright Copyright Copyright © 2008 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make backup copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Chapter 24-72 ... Considers how budgets are used by management to? ?control? ?operations Focuses on two aspects of management? ?control: Budgetary? ?control Responsibility? ?accounting Chapter 24-5 Budgetary? ?Control? ?and? ? Budgetary? ?Control? ?and? ? Responsibility? ?Accounting. . .CHAPTER? ? 24 BUDGETARY CONTROL AND RESPONSIBILITY ACCOUNTING Accounting? ?Principles, Eighth Edition Chapter 24-2 Study Objectives Study Objectives Describe the concept of? ?budgetary? ?control. .. between actual? ?and? ?planned results? ?and? ? determines causes Chapter 24-7 LO 1: Describe the concept of? ?budgetary? ?control The Concept of? ?Budgetary? ?Control The Concept of? ?Budgetary? ?Control Budgetary? ?control? ?involves the following activities