Managerial Accounting

Weygandt, Kieso, & Kimmel

Chapter 7
Budgetary Control and
Responsibility Accounting

Budgetary Control
The use of budgets in controlling operations is
known as budgetary control.
The centerpiece of budgetary control is the use of
budget reports that compare actual results with
planned objectives.
The budget reports provide the feedback needed
by management to see whether actual operations
are on course.

Budgetary Control
Budgetary control involves:
Developing budgets.
Analyzing the differences between actual and
budgeted results.
Taking corrective action.
Modifying future plans, if necessary.
Repeating the cycle.

Static Budget Reports

A static budget is a projection of budget data
at one level of activity.
In such a budget, data for different levels of
activity are ignored.
As a result, actual results are always
compared with the budget data at the activity
level used in developing the master budget.

Static Budget Reports:

Illustration
To illustrate the role of a static budget in budgetary
control, we will use selected budget data for Hayes
Company prepared in Chapter 6.
Budget and actual sales data for the Kitchen-mate
product in the first and second quarters of 1999 are as
follows:
Sales
Budgeted
Actual
Difference

First Quarter
$180,000
179,000
$ 1,000

Second Quarter
$210,000
199,500
$ 10,500

Total
$390,000
378,500
$ 11,500

Static Budget Reports:

Illustration
Managements analysis should start by asking the sales
manager the cause(s) of the shortfall. The need for
corrective action should be considered.
For example, management may decide to spur sales by
offering sales incentives to customers or by increasing
advertising. On the other hand, if management
concludes that a downturn in the economy is responsible
for the lower sales, it may decide to modify planned
sales and profit goals for the remainder of the year.

Static Budget Reports

A static budget is appropriate in evaluating a
managers effectiveness in controlling costs
when:
the actual level of activity closely approximates
the master budget activity level, or
the behavior of the costs in response to changes
in activity is fixed.

Flexible Budgets
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.
The flexible budget recognizes that the budgetary
process has greater usefulness 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.

Why Flexible Budgets?

An Illustration
Barton Steel prepares the following static budget for
manufacturing overhead based on a production
volume of 10,000 units of steel ingots.
Barton Steel (Forging Department)
Manufacturing Overhead Budget (Static)
For the Year Ended December 31, 1999
Budgeted
BudgetedProduction
Productionin
inunits
units(steel
(steelingots)
ingots)
Budgeted
Costs
Budgeted Costs
Indirect
Indirectmaterials
materials
Indirect
labor
Indirect labor
Utilities
Utilities
Depreciation
Depreciation
Property
Propertytaxes
taxes
Supervision
Supervision

10,000
10,000
$$250,000
250,000
260,000
260,000
190,000
190,000
280,000
280,000
70,000
70,000
50,000
50,000
$1,100,000
$1,100,000

Why Flexible Budgets?

An Illustration
If demand for steel ingots has
increased and 12,000 units are
produced during the year, rather
than 10,000, the budget report
will show very large variances.

Barton Steel (Forging Department)

Manufacturing Overhead Budget Report (Static)
For the Year Ended December 31, 1999

Production
Productionin
inunits
units
Costs
Costs
Indirect
Indirectmaterials
materials
Indirect
labor
Indirect labor
Utilities
Utilities
Depreciation
Depreciation
Property
Propertytaxes
taxes
Supervision
Supervision

Budget
Budget
10,000
10,000

Actual
Actual
12,000
12,000

$$250,000
250,000 $295,000
$295,000
260,000
312,000
260,000
312,000
190,000
225,000
190,000
225,000
280,000
280,000
280,000
280,000
70,000
70,000
70,000
70,000
50,000
50,000
50,000
50,000
$1,100,000
$1,232,000
$1,100,000 $1,232,000

Difference
Difference
Favorable
FavorableFF
Unfavorable
UnfavorableUU
$$45,000
45,000UU
52,000
52,000UU
35,000
35,000UU
-0-0-0-0-0-0$132,000
$132,000UU

Why Flexible Budgets?

An Illustration
Since the comparison of actual variable costs with budgeted costs
is meaningless at different levels of activity, variable per unit costs
must be isolated so the budget can be adjusted. An analysis of the
budget data at 10,000 units produces the following per unit results:

The budgeted variable costs at 12,000

units are as shown on the right. Because
fixed costs do not change in total as
activity changes, the budgeted amounts
for these costs remain the same.

Item
Total Cost
Indirect materials $250,000
Indirect labor
260,000
Utilities
190,000
$700,000

Item
Indirect materials
Indirect labor
Utilities

Computation
$25 x 12,000
26 X 12,000
19 x 12,000

Per Unit
$25
26
19
$70

Total
$300,000
312,000
228,000
$840,000

Why Flexible Budgets?

An Illustration
The budget
report based
on the flexible
budget for
12,000 units
is shown.

Barton Steel (Forging Department)

Manufacturing Overhead Budget Report (Flexible)
For the Year Ended December 31, 1999

Budget
Budget
12,000
12,000

Actual
Actual
12,000
12,000

Production
Productionin
inunits
units
Variable
Variablecosts
costs
Indirect
Indirectmaterials
materials $$ 300,000
300,000 $$ 295,000
295,000
Indirect
labor
312,000
312,000
Indirect labor
312,000
312,000
Utilities
228,000
225,000
Utilities
228,000
225,000
Total
variable
840,000
832,000
Total variable
840,000
832,000
Fixed
Fixedcosts
costs
Depreciation
280,000
280,000
Depreciation
280,000
280,000
Property
taxes
70,000
70,000
Property taxes
70,000
70,000
Supervision
50,000
50,000
Supervision
50,000
50,000
Total
fixed
400,000
400,000
Total fixed
400,000
400,000
$1,240,000
$1,240,000 $1,232,000
$1,232,000

Difference
Difference
Favorable
FavorableFF
Unfavorable
UnfavorableUU
$5,000
$5,000FF
-0-03,000
3,000FF
8,000
8,000FF
-0-0-0-0-0-0-0-0$8,000
$8,000FF

Flexible Budget A Case Study

Master Budget Data
Fox Company wants to use a flexible budget for monthly
comparisons of actual and budgeted manufacturing overhead
costs. The master budget for the year ended December 31,
1999 is prepared using 120,000 direct labor hours and the
following overhead costs.
Variable Costs
Indirect materials
$180,000
Indirect labor
240,000
Utilities
60,000
Total
$480,000

Fixed Costs
Depreciation
$180,000
Supervision
120,000
Property taxes
60,000
Total
$360,000

STEP 1: Identify the activity index and the relevant range of

activity:
The activity index is direct labor hours and management concludes
that the relevant range is 8,000-12,000 direct labor hours.

Flexible Budget A Case Study

Variable Costs per Labor Hour
STEP 2: Identify the variable costs and determine the
budgeted variable cost per unit of activity for each cost.
For Fox, there are 3 variable costs and the per unit variable
cost is found by dividing each total budgeted cost by the
direct labor hours used in preparing the master budget
(120,000 hours).
Variable Costs
Indirect materials
Indirect labor
Utilities
Total

Computations
$180,000 120,000
240,000 120,000
60,000 120,000

Variable Cost per

Direct Labor Hour
$1.50
2.00
.50
$4.00

Flexible Budget A Case Study

Fixed Costs
Step 3: Identify the fixed costs and determine the
budgeted amount for each cost.
There are three fixed costs and since Fox
Manufacturing desires monthly budget data, the
budgeted amount is found by dividing each annual
budgeted cost by 12.
The monthly budgeted fixed costs are:
Depreciation $15,000,
Supervision $10,000, and
Property taxes $5,000.

Flexible Budget A Case Study

The Flexible Budget
Step 4: Prepare the budget for selected increments
of activity within the relevant range.
Fox Manufacturing Company (Finishing Department)
Flexible Monthly Manufacturing Overhead Budget
For the Month Ended January 31, 1999
Activity
Activitylevel
level
Direct
labor
Direct laborhours
hours
Variable
Variablecosts
costs
Indirect
Indirectmaterials
materials
Indirect
labor
Indirect labor
Utilities
Utilities
Total
Totalvariable
variable
Fixed
Fixedcosts
costs
Depreciation
Depreciation
Supervision
Supervision
Property
Propertytaxes
taxes
Total
Totalfixed
fixed
Total
Totalcosts
costs

8,000
8,000

9,000
9,000

10,000
10,000

11,000
11,000

12,000
12,000

$12,000
$12,000
16,000
16,000
4,000
4,000
32,000
32,000

$13,500
$13,500
18,000
18,000
4,500
4,500
36,000
36,000

$15,000
$15,000
20,000
20,000
5,000
5,000
40,000
40,000

$16,500
$16,500
22,000
22,000
5,500
5,500
44,000
44,000

$18,000
$18,000
24,000
24,000
6,000
6,000
48,000
48,000

15,000
15,000
10,000
10,000
5,000
5,000
30,000
30,000
$62,000
$62,000

15,000
15,000
10,000
10,000
5,000
5,000
30,000
30,000
$66,000
$66,000

15,000
15,000
10,000
10,000
5,000
5,000
30,000
30,000
$70,000
$70,000

15,000
15,000
10,000
10,000
5,000
5,000
30,000
30,000
$74,000
$74,000

15,000
15,000
10,000
10,000
5,000
5,000
30,000
30,000
$78,000
$78,000

Flexible Budget A Case Study

Formula for Total Budgeted Costs
From the budget, the formula shown below may be used to
determine total budgeted costs at any level of activity.
For Fox Manufacturing, fixed costs are $30,000, and
total variable costs per unit is $4.00.
Thus, at 8,622 direct labor hours, total budgeted costs
are:
Fixed Costs
$30,000

Variable Costs*

Total Budgeted
Costs

($4 x 8,622)

$64,488

*Total variable cost per unit times activity level.

Flexible Budget Reports

Flexible budget reports represent another type of
internal report produced by managerial accounting.
The flexible budget report consists of two sections:
Production data such as direct labor hours, and
Cost data for variable and fixed costs.
Flexible budgets are used to evaluate a managers
performance in production control and cost control.

Flexible Budget A Case Study

Flexible Budget Report
In this budget report, 8,800 DLH were expected but 9,000 hours
were worked. Budget data are based on the flexible budget for
9,000 hours.
Fox Manufacturing Company (Finishing Department)
Manufacturing Overhead Budget Report (Flexible)
For the Month Ended January 31, 1999

Direct
Directlabor
laborhours
hours(DLH)
(DLH)
Expected
8,800
Budget
Expected 8,800
Budgetat
at
Actual
9,000
9,000
Actual
9,000
9,000DLH
DLH
Variable
costs
Variable costs
Indirect
$13,500
Indirectmaterials
materials
$13,500
Indirect
labor
18,000
Indirect labor
18,000
Utilities
4,500
Utilities
4,500
Total
36,000
Totalvariable
variable
36,000
Fixed
costs
Fixed costs
Depreciation
15,000
Depreciation
15,000
Property
taxes
10,000
Property taxes
10,000
Supervision
5,000
Supervision
5,000
Total
30,000
Totalfixed
fixed
30,000
$66,000
$66,000

Actual
ActualCosts
Costs
9,000
9,000DLH
DLH

Difference
Difference
Favorable
FavorableFF
Unfavorable
UnfavorableUU

$14,000
$14,000
17,000
17,000
4,600
4,600
35,600
35,600

$$ 500
500UU
1,000
1,000FF
100
100UU
400
400FF

15,000
15,000
10,000
10,000
5,000
5,000
40,000
40,000
$65,600
$65,600

-0-0-0-0-0-0-0-0$$ 400
400FF

Management by Exception
Management by exception means focusing on major
differences.
For management by exception to be effective, there must
be some guidelines for identifying an exception. The usual
criteria are:

Materiality- usually expressed as a percentage difference

from budget; may also have a dollar limit.
Controllability - exception guidelines are more restrictive
for controllable items than for items that are not controllable
by the manager being evaluated.

The Concept of
Responsibility Accounting
Responsibility accounting involves accumulating
and reporting costs (and revenues, where relevant)
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 then
based on the costs directly under the manager's
control.

Responsibility Accounting
Responsibility accounting personalizes the managerial
accounting systems. Under responsibility accounting, any
individual who has control and is accountable for a specified set of
activities can be recognized as a responsibility center.
Responsibility accounting is especially valuable in a decentralized
company.
Decentralization means that the control of operations is delegated
by top management to many individuals (managers) throughout
the organization.
A segment is an identified area of responsibility in decentralized
operations.

Responsibility Accounting
versus Budgetary Control
Responsibility accounting is essential to any effective
system of budgetary control. It differs from
budgeting in two respects:
A distinction is made between controllable and noncontrollable items.
Performance reports either emphasize or include
only items controllable by the individual manager.

Controllable versus Noncontrollable Revenues and Costs

All costs and revenues are controllable at some level of
responsibility within the company. 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. In general, costs
incurred directly by a level of responsibility are
controllable at that level.
Costs incurred indirectly and allocated to a
responsibility level are considered to be noncontrollable at that level.

Responsibility Reporting
System
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.

Types of Responsibility
Centers
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.

Examples of Responsibility
Centers
Cost center: usually a
production center or service
department
Profit center: individual
departments of retail stores
and branch offices of banks
Investment center: subsidiary
companies

Responsibility Accounting
for Cost Centers
The evaluation of a managers performance for cost centers is based on the managers
ability to meet budgeted goals for controllable costs. Responsibility reports for
cost centers compare actual controllable costs with flexible budget data.
Only controllable costs are included in the report, and fixed and variable costs are not
distinguished.

Assume that the

Finishing Department
manager is able to
control the costs in the
report to the right.

Fox Manufacturing (Finishing Department)

Manufacturing Overhead Responsibility Report
For the Month Ended January 31, 1999

Controllable
ControllableCost
Cost

Indirect
Indirectmaterials
materials
Indirect
Indirectlabor
labor
Utilities
Utilities
Supervision
Supervision

Budget
Budget

Actual
Actual

$13,500
$13,500
18,000
18,000
4,500
4,500
4,000
4,000
$40,000
$40,000

$14,000
$14,000
17,000
17,000
4,600
4,600
4,000
4,000
$39,600
$39,600

Difference
Difference
Favorable
FavorableFF
Unfavorable
UnfavorableUU

$$ 500
500UU
1,000
1,000FF
100
100UU
-0-0$$ 400
400FF

Responsibility Accounting
To determine the controllability of fixed costs it is necessary to

distinguish between direct and indirect fixed costs.

Direct fixed costs (traceable costs) are costs that relate
specifically to a responsibility center and are incurred for
the sole benefit of the center. Most direct fixed costs are
controllable by the center manager.
Indirect fixed costs (common costs) pertain to a company's
overall operating activities and are incurred for the benefit
of more than one profit center. Thus, most indirect costs are
not controllable by the center manager.

Responsibility Report for

Profit Centers
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. In the report:
Controllable fixed costs are deducted from contribution
margin.
The excess of contribution margin over controllable
fixed costs is identified as controllable margin.
Non-controllable fixed costs are not reported.
Controllable margin is considered to be the best measure
of the managers performance in controlling revenues and
costs.

Responsibility Report for a

Profit Center
This manager was
below budgeted
expectations by
approximately 10%
($36,000/
$360,000).
Top management
would likely
investigate the
causes of this
unfavorable result.

Mantel Manufacturing Company (Marine Division)

Responsibility Report
For the Year Ended December 31, 1999
Difference
Difference
Favorable
FavorableFF
Budget
Actual
Budget
Actual Unfavorable
UnfavorableUU
$1,200,000
$50,000
$1,200,000 $1,150,000
$1,150,000
$50,000UU

Sales
Sales
Variable
VariableCosts
Costs
Cost
of
500,000
490,000
Cost ofgoods
goodssold
sold
500,000
490,000
Selling
&
administrative
160,000
156,000
Selling & administrative
160,000
156,000
Total
660,000
646,000
Total
660,000
646,000
Contribution
540,000
504,000
Contributionmargin
margin
540,000
504,000
Controllable
fixed
costs
Controllable fixed costs
Cost
100,000
100,000
Costof
ofgoods
goodssold
sold
100,000
100,000
Selling
&
administrative
80,000
80,000
Selling & administrative
80,000
80,000
Total
180,000
180,000
Total
180,000
180,000
Controllable
$$360,000
Controllablemargin
margin
360,000 $$324,000
324,000

10,000
10,000FF
4,000
4,000FF
14,000
14,000FF
36,000
36,000UU
-0-0-0-0-0-0$36,000
$36,000UU

Responsibility Accounting
for Investment Centers
An important characteristic of an investment center is
that the manager can control or significantly influence the
investment funds available for use.
Thus, the primary basis for evaluating the performance of
a manger of an investment center is return on investment
(ROI).
ROI is considered to be superior to any other performance
measurement because it shows the effectiveness of the
manager in utilizing the assets at the managers disposal.

Return on Investment
The formula for computing ROI for an investment center,
together with assumed illustrative data is shown below.
Operating assets consist of current assets and plant assets
used in operations by the center. Average operating assets
are usually based on the beginning and ending cost or
book values of the assets.
Investment Center
Controllable Margin
(in dollars)

$1,000,000

Average Investment
Center Operating
Assets

Return on
Investment
(ROI)

$5,000,000

20%

Responsibility Report for a

Profit Center
Since an investment
center is an
independent entity for
operating purposes, all
fixed costs are
controllable by the
investment center
manager.
Notice the report
shows budgeted and
actual ROI.

Mantel Manufacturing Company (Marine Division)

Responsibility Report
For the Year Ended December 31, 1999
Difference
Favorable F
Budget
Actual Unfavorable U
$1,200,000 $1,150,000
$50,000 U

Sales
Variable Costs
Cost of goods sold
500,000
Selling & administrative
160,000
Total
660,000
Contribution margin
540,000
Controllable fixed costs
Cost of goods sold
100,000
Selling & administrative
80,000
Other fixed costs
60,000
Total
240,000
Controllable margin
$ 300,000
Return on investment

15%

490,000
156,000
646,000
504,000

10,000 F
4,000 F
14,000 F
36,000 U

100,000
80,000
60,000
240,000
$ 264,000

-0-0-0-0$36,000 U

13.2%

1.8% U

Improving ROI
A manager can improve ROI by:
increasing controllable margin, and/or
reducing average operating assets.

Controllable margin can be increased by increasing sales or by

reducing variable and controllable fixed costs.

A reduction in operating assets should not adversely affect future growth
or operations

Judgmental Factors in ROI

The return on investment approach includes two
judgmental factors:
Valuation of operating assets Operating assets
may be valued at acquisition cost, book value,
appraised value, or market value.
Margin (income) measure This measure may be
controllable margin, income from operations, or net
income.

Principles of Performance
Evaluation
Performance evaluation is at the center of
responsibility accounting. Performance
evaluation is a management function that
compares actual results with budget goals.
Performance evaluation includes both
behavioral and reporting principles.

Principles of Performance
Evaluation: Behavioral
The human factor is critical in evaluating performance.
Behavioral principles include the following:
Managers of responsibility centers should have direct input into
the process of establishing budget goals for their area of
responsibility.
The evaluation of performance should be based entirely on
matters that are controllable by the manager being evaluated.
Top management should support the evaluation process.
The evaluation process must allow managers to respond to their
evaluations.
The evaluation should identify both good and poor performance.

Principles of Performance
Evaluation: Reporting
Performance reports (which are primarily internal)
should:
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.
Be tailor-made for the intended evaluation.
Be prepared at reasonable intervals.