MPA 602: Cost and Managerial Accounting

8-1
MPA 602: Cost and

Managerial
Accounting
Preparation of Budget and

Responsibility Accounting
8-2
Budgets and the Organization
Budgets
A budget provides a comprehensive financial

overview of planned company operations.
8-3
The Basic Framework of Budgeting
A budget is a detailed quantitative plan for

acquiring and using financial and other resources
over a specified forthcoming time period.
1. The act of preparing a budget is called
budgeting.
2. The use of budgets to control an
organization’s activities is known
as budgetary control.
8-4
Difference Between Planning and Control
Planning – Control –
involves developing involves the steps taken by
objectives and management to increase the
preparing various likelihood that the objectives
budgets to achieve set down while planning are
those objectives. attained and that all parts of
the organization are working
together toward that goal.
8-5
Advantages of Budgeting
8-6
Responsibility Accounting
Managers should be held

responsible for those items - and
only those items - that they can
actually control
to a significant extent.
Responsibility accounting enables
organizations to react quickly to
deviations from their plans and to
learn from feedback.
8-7
Types of Budgets
Strategic plan Long-range planning
Master budget
Capital budget Continuous budget

8-8
Strategic Plan
The most forward-looking budget is the

strategic plan, which sets the overall
goals and objectives of the organization.
The strategic plan leads to long-range

planning, which produces
forecasted financial statements
for five- to ten-year periods.
8-9
Long-range Plans
Long-range plans…
are coordinated with capital budgets,

which detail the planned expenditures
for facilities, equipment, new products,
and other long-term investments.
Master budgets link to both long-range

plans and short-term budgets.
8-10
Master Budget
The master budget

is a detailed and
comprehensive analysis
of the first year of the
long-range plan.
It summarizes the
planned activities
of all subunits of
an organization.
8-11
Continuous Budget
Rolling budgets...
8-12
Master Budget
Operating budget Financial budget. . .

(Profit plan). . .
Focuses on the Income

Statement and supporting Focuses on the effects that the
schedules or budgeted operating budget and other plans
expenses. will have on cash balances.
8-13
The Master Budget: An Overview

Sales budget
Selling and
Ending inventory administrative
Production budget
budget budget
Direct materials Direct labor Manufacturing

budget budget overhead budget
Cash Budget
Budgeted
Budgeted
income
balance sheet
statement
8-14
The Master Budget: An Overview
A master budget is based on various estimates and

assumptions. For example, the sales budget
requires three estimates/assumptions as follows:
1.What are the budgeted unit sales?
2.What is the budgeted selling price per unit?
3.What percentage of accounts receivable will be
collected in the current and subsequent periods.
8-15
Prepare a sales budget,

including a schedule of
expected cash collections.
8-16
Budgeting Example
 Royal Company is preparing budgets for the
quarter ending June 30th.
 Budgeted sales for the next five months are:
 April 20,000 units
 May 50,000 units
 June 30,000 units
 July 25,000 units
 August 15,000 units
 The selling price is $10 per unit.
8-17
The Sales Budget

The individual months of April, May, and June are
summed to obtain the total budgeted sales in units
and dollars for the quarter ended June 30th
8-18
Expected Cash Collections
• All sales are on account.

• Royal’s collection pattern is:
70% collected in the month of sale,
25% collected in the month following sale,
 5% uncollectible.
• In April, the March 31st accounts receivable
balance of $30,000 will be collected in full.
8-19

8-20

8-21

8-22

8-23
Prepare a production
budget.
8-24
The Production Budget
Sales Production
Budget Budget
ed
and l et
p
Expected
o m
C
Cash
Collections
The production budget must be adequate to

meet budgeted sales and to provide for
the desired ending inventory.
8-25

• The management at Royal Company wants ending inventory to be equal to
20% of the following month’s budgeted sales in units.
• On March 31st, 4,000 units were on hand.
If Royal was a merchandising company it would prepare a

merchandise purchase budget instead of a production budget.
8-26

8-27
Budgeted May sales 50,000

Desired ending inventory % 20%
Desired ending inventory 10,000
8-28
Assumed ending inventory.

8-29
Prepare a direct materials

budget, including a
schedule of expected cash
disbursements for
purchases of materials.
8-30
The Direct Materials Budget
• At Royal Company, five pounds of material are required per unit of

product.
• Management wants materials on hand at the end of each month equal
to 10% of the following month’s production.
• On March 31, 13,000 pounds of material are on hand. Material cost is
$0.40 per pound.
8-31
From production budget.

8-32

8-33
Calculate the materials to

be purchased in May.
8-34

8-35
Assumed ending inventory.

8-36
Expected Cash Disbursement for Materials
• Royal pays $0.40 per pound for its materials.

• One-half of a month’s purchases is paid for in the month of purchase; the
other half is paid in the following month.
• The March 31 accounts payable balance is $12,000.
8-37

8-38
Compute the expected cash

disbursements for materials
for the quarter.
8-39

8-40
Prepare a direct labor

budget.
8-41
The Direct Labor Budget

• At Royal, each unit of product requires 0.05 hours (3 minutes) of direct labor.
• The Company has a “no layoff” policy so all employees will be paid for 40
hours of work each week.
• For purposes of our illustration assume that Royal has a “no layoff” policy,
workers are paid at the rate of $10 per hour regardless of the hours worked.
• For the next three months, the direct labor workforce will be paid for a
minimum of 1,500 hours per month.
8-42

8-43

8-44

8-45

8-46
Prepare a manufacturing
overhead budget.
8-47
Manufacturing Overhead Budget
• At Royal, manufacturing overhead is applied to units of product on the basis

of direct labor hours.
• The variable manufacturing overhead rate is $20 per direct labor hour.
• Fixed manufacturing overhead is $50,000 per month, which includes
$20,000 of noncash costs (primarily depreciation of plant assets).
8-48

8-49

8-50
Depreciation
Depreciation is
is aa noncash
noncash charge.
charge.
8-51
Ending Finished Goods Inventory Budget
Production costs per unit Quantity Cost Total

Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $ 10.00 0.50
Manufacturing overhead 0.05 hrs. $ 49.70 2.49
$ 4.99
Budgeted finished goods inventory
Ending inventory in units 5,000
Unit product cost $ 4.99
Ending finished goods inventory $ 24,950
Direct
Direct materials
materials
budget
budget and
and information.
information.
8-52

$ 4.99
Direct
Direct labor
labor budget.
budget.
8-53

Direct labor 0.05 hrs. $10.00 0.50
Manufacturing overhead 0.05 hrs. $49.70 2.49
$ 4.99
Ending finished goods inventory ?
Total mfg. OH for quarter $251,000

= $49.70 per hour
Total labor hours required 5,050
8-54

$ 4.99
Production Budget.
8-55
Prepare a selling and

administrative expense
budget.
8-56
Selling and Administrative Expense Budget
• At Royal, the selling and administrative expense budget is divided into

variable and fixed components.
• The variable selling and administrative expenses are $0.50 per unit sold.
• Fixed selling and administrative expenses are $70,000 per month.
• The fixed selling and administrative expenses include $10,000 in costs –
primarily depreciation – that are not cash outflows of the current month.
Let’s prepare the company’s selling and administrative expense budget.

8-57
Selling and Administrative Expense Budget
Calculate the selling and administrative

cash expenses for the quarter.
8-58
Selling Administrative Expense Budget

8-59
Prepare a cash budget.

8-60
Format of the Cash Budget
The cash budget is divided into four sections:

1. Cash receipts section lists all cash inflows excluding cash
received from financing;
2. Cash disbursements section consists of all cash payments
excluding repayments of principal and interest;
3. Cash excess or deficiency section determines if the company
will need to borrow money or if it will be able to repay funds
previously borrowed; and
4. Financing section details the borrowings and repayments
projected to take place during the budget period.
8-61
The Cash Budget

Assume the following information for Royal:
Maintains a 16% open line of credit for $75,000.
Maintains a minimum cash balance of $30,000.
Borrows on the first day of the month and repays
loans on the last day of the month.
Pays a cash dividend of $49,000 in April.
Purchases $143,700 of equipment in May and $48,300
in June (both purchases paid in cash).
Has an April 1 cash balance of $40,000.
8-62
The Cash Budget

8-63
The Cash Budget
Direct
Direct Labor
Labor
Budget.
Budget.
8-64
The Cash Budget

8-65
The Cash Budget
Ending
Ending cash
cash balance
balance for
for April
April
is
is the
the beginning
beginning May
May balance.
balance.
8-66
The Cash Budget

$50,000 × 16% × 3/12 = $2,000 8-67
Borrowings on April 1 and

The Cash Budget repayment on June 30.
8-68
The Budgeted Income Statement
Cash Budgeted
Budget Income
Statement
t ed
e
pl
om
C
With interest expense from the cash

budget, Royal can prepare the budgeted
income statement.
8-69
Prepare a budgeted income

statement.
8-70
The Budgeted Income Statement

Sales Budget.
Royal Company
Budgeted Income Statement
For the Three Months Ended June 30
Ending Finished
Sales (100,000 units @ $10) $ 1,000,000 Goods Inventory.
Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin 501,000
Selling and
Selling and administrative expenses 260,000
Operating income 241,000 Administrative
Interest expense 2,000 Expense Budget.
Net income $ 239,000
Cash Budget.
8-71
Prepare a budgeted balance

sheet.
8-72
The Budgeted Balance Sheet
Royal reported the following account balances prior to preparing its budgeted
financial statements:
• Land - $50,000
• Common stock - $200,000
• Retained earnings - $146,150 (April 1)
• Equipment - $175,000
8-73
Royal Company
Budgeted Balance Sheet
June 30
Assets:
Cash $ 43,000
Accounts receivable 75,000
Raw materials inventory 4,600
Finished goods inventory 24,950
Land 50,000
Equipment 367,000
Total assets 564,550
Liabilities and Stockholders' Equity

Accounts payable $ 28,400
Common stock 200,000
Retained earnings 336,150
Total liabilities and stockholders' equity $ 564,550
8-74
Royal Company
Budgeted Balance Sheet
June 30
Beginning balance $146,150
Assets: Add: net income 239,000
Cash $ 43,000 dividends
Deduct: (49,000)
Accounts receivable 75,000balance
Ending $336,150
Raw materials inventory 4,600
Finished goods inventory 24,950
Land 50,000
Equipment 367,000
Total assets 564,550
Liabilities and Stockholders' Equity

Accounts payable $ 28,400
Common stock 200,000
Retained earnings 336,150
Total liabilities and stockholders' equity $ 564,550
8-75
Budgetary Control
The use of budgets to control

operations. Compare
actual results with planned
objectives.
8-76
Static and Flexible Budgets
Planned level of
Based on output at start of
Static Budget the budget period
Budgeted revenues
Based on and cost based on
Flexible Budget actual level of output
8-77
Static Budgets and Performance Reports
Static budgets
are prepared for
a single, planned
level of activity.
Performance evaluation is difficult

when actual activity differs from the
planned level of activity.
8-78
Flexible Budgets
May be prepared for any activity
level in the relevant range.
Show costs that should have been

incurred at the actual level of
activity, enabling “apples to apples”
cost comparisons.
Reveal variances related to

cost control.
Improve performance evaluation.

8-79
CheeseCo
8-80
CheeseCo
Static Budgets and Performance Reports 8-81
U = Unfavorable variance CheeseCo

was unable to achieve the budgeted
level of activity.
CheeseCo
8-82

F = Favorable variance that occurs when
actual costs are less than budgeted costs.
CheeseCo
8-83

Since cost variances are favorable, have
we done a good job controlling costs?
CheeseCo
8-84
The
The relevant
relevant question
question isis .. .. ..
“How
“Howmuch
muchofofthe
thefavorable
favorablecost
costvariance
varianceisisdue
dueto
tolower
loweractivity,
activity,and
andhow
how
much
muchisisdue
dueto
togood
goodcost
costcontrol?”
control?”
To
To answer
answer thethe question,
question,
we
we must
must
the
the budget
budget to to the
the
actual
actual level
level of
of activity.
activity.
8-85
Preparing a Flexible Budget
To a budget we need to know that:

• Total variable costs change
in direct proportion to
changes in activity.
• Total fixed costs remain
unchanged within the
relevant range.
ble
a
V ari
Fixedfixed
8-86

CheeseCo
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs Variable costs are expressed as a
Indirect labor $ 4.00
Indirect material 3.00
constant amount per hour.
Power 0.50
Total variable cost $ 7.50 $40,000 ÷ 10,000 hours is
Fixed costs
$4.00 per hour.
Depreciation $ 12,000
Insurance 2,000
Total fixed cost
Fixed costs are
Total overhead costs expressed as a
total amount.
8-87

CheeseCo
Formula Fixed 8,000 10,000 12,000
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor $ 4.00 $ 32,000
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost $ 7.50 $ 60,000
Fixed costs $4.00 per hour × 8,000 hours = $32,000

Depreciation $ 12,000
Insurance 2,000
Total fixed cost
Total overhead costs
8-88

CheeseCo
Formula Fixed 8,000 10,000 12,000
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor $ 4.00 $ 32,000
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost $ 7.50 $ 60,000
Fixed costs
Depreciation $ 12,000 $ 12,000
Insurance 2,000 2,000
Total fixed cost $ 14,000
Total overhead costs $ 74,000
8-89

CheeseCo
Formula Fixed 8,000 10,000 12,000
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor $ 4.00 $ 32,000 $ 40,000
Indirect material 3.00 24,000 30,000
Power 0.50 4,000 5,000
Total variable cost $ 7.50 $ 60,000 $ 75,000
Fixed costs
Depreciation $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000
Total fixed cost $ 14,000 $ 14,000
Total overhead costs $ 74,000 $ 89,000 ?
8-90

Formula Fixed 8,000 10,000 12,000
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor $ 4.00 $ 32,000 $ 40,000 $ 48,000
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost $ 7.50 $ 60,000 $ 75,000 $ 90,000
Fixed costs
Depreciation $ 12,000 $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000 2,000
Total fixed cost $ 14,000 $ 14,000 $ 14,000
Total overhead costs $ 74,000 $ 89,000 $ 104,000
8-91
Flexible Budget Performance Report

CheeseCo
Cost Total
Formula Fixed Flexible Actual
per Hour Cost Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs
Indirect labor $ 4.00 $ 32,000 $ 34,000 $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable cost $ 7.50 $ 60,000 $ 63,300 $ 3,300 U
Fixed costs
Depreciation $ 12,000 $ 12,000 $ 12,000 $ 0
Insurance 2,000 2,000 2,050 50 U
Total fixed cost $ 14,000 $ 14,050 50 U
Total overhead costs $ 74,000 $ 77,350 $ 3,350 U
8-92
Standard Costs
Standards are benchmarks or “norms”

for measuring performance. Two types
of standards are commonly used.
Quantity standards Cost (price)

specify how much of an standards specify
input should be used to how much should be
make a product or paid for each unit
provide a service. of the input.
Exhibit
8-93
10-1
Variance Analysis Cycle
Prepare standard
Begin
cost performance
report
8-94
Setting Standard Costs
Accountants, engineers, purchasing

agents, and production managers
combine efforts to set standards that encourage efficient future
production.
8-95
Standards vs. Budgets
Are standards the

same as budgets?
A budget is set for
total costs.
8-96
Price and Quantity Standards

Price and and quantity standards are
determined separately for two reasons:
8-97
A General Model for Variance Analysis
Variance Analysis
8-98
Variance Analysis
Price Variance Quantity Variance
Materials price variance Materials quantity variance

Labor rate variance Labor efficiency variance
VOH spending variance VOH efficiency variance
8-99
Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

8-100

× × ×

8-101

× × ×

8-102

× × ×
Actual price is the amount actually

paid for the input used.
8-103

× × ×
Standard price is the amount that should

have been paid for the input used.
8-104

× × ×
(AQ × AP) – (AQ × SP) (AQ × SP) – (SQ × SP)

AQ = Actual Quantity SP = Standard Price
AP = Actual Price SQ = Standard Quantity
8-105
Material Variances Example
Glacier Peak Outfitters has the following direct material standard for the
fiberfill in its mountain parka.
0.1 kg. of fiberfill per parka at $5.00 per kg.

Last month 210 kgs of fiberfill were purchased and used to make 2,000
parkas. The material cost a total of $1,029.
8-106
Material Variances Summary

× × ×
210 kgs. 210 kgs. 200 kgs.
× × ×
$4.90 per kg. $5.00 per kg. $5.00 per kg.
= $1,029 = $1,050 = $1,000
8-107

× × ×
210 kgs. 210 kgs. 200 kgs.
× × ×
= $1,029 = $1,050 = $1,000
Price variance Quantity variance

$21 favorable $50 unfavorable
8-108

× × ×
210 kgs. 210 kgs. 200 kgs.
× × ×
= $1,029 = $1,050 = $1,000
Price variance Quantity variance

$21 favorable $50 unfavorable
8-109
Material Variances:
Using the Factored Equations
Materials price variance
MPV = AQ (AP - SP)
= 210 kgs ($4.90/kg - $5.00/kg)
= 210 kgs (-$0.10/kg)
= $21 F
Materials quantity variance
MQV = SP (AQ - SQ)
= $5.00/kg (210 kgs-(0.1 kg/parka 2,000 parkas))
= $5.00/kg (210 kgs - 200 kgs)
= $5.00/kg (10 kgs)
= $50 U
8-110
Labor Variances Example
Glacier Peak Outfitters has the following direct labor standard for its
mountain parka.
1.2 standard hours per parka at $10.00 per hour

Last month, employees actually worked 2,500 hours at a total labor cost of
$26,250 to make 2,000 parkas.
8-111
Labor Variances Summary

Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
2,500 hours 2,500 hours 2,400 hours
× × ×
$10.50 per hour $10.00 per hour. $10.00 per hour
= $26,250 = $25,000 = $24,000
8-112

× × ×
× × ×
= $26,250 = $25,000 = $24,000
$26,250  2,500 hours

= $10.50 per hour
8-113

× × ×
× × ×
= $26,250 = $25,000 = $24,000
1.2 hours per parka  2,000

parkas = 2,400 hours
8-114
Labor Variances:
Using the Factored Equations
Labor rate variance
LRV = AH (AR - SR)
= 2,500 hours ($10.50 per hour – $10.00 per hour)
= 2,500 hours ($0.50 per hour)
= $1,250 unfavorable
Labor efficiency variance
LEV = SR (AH - SH)
= $10.00 per hour (2,500 hours – 2,400 hours)
= $10.00 per hour (100 hours)
= $1,000 unfavorable
8-115
Variable Manufacturing Overhead Variances

Example
Glacier Peak Outfitters has the following direct variable manufacturing
overhead labor standard for its mountain parka.
1.2 standard hours per parka at $4.00 per hour

Last month, employees actually worked 2,500 hours to make 2,000 parkas.
Actual variable manufacturing overhead for the month was $10,500.
8-116

Summary
× × ×
× × ×
$4.20 per hour $4.00 per hour $4.00 per hour
= $10,500 = $10,000 = $9,600
8-117

Summary
× × ×
× × ×
= $10,500 = $10,000 = $9,600
8-118

Summary
× × ×
× × ×
= $10,500 = $10,000 = $9,600
8-119
Variable Manufacturing Overhead Variances:

Using Factored Equations
Variable manufacturing overhead spending variance
VMSV = AH (AR - SR)
= 2,500 hours ($4.20 per hour – $4.00 per hour)
= 2,500 hours ($0.20 per hour)
= $500 unfavorable
Variable manufacturing overhead efficiency variance
VMEV = SR (AH - SH)
= $4.00 per hour (2,500 hours – 2,400 hours)
= $4.00 per hour (100 hours)
= $400 unfavorable

MPA 602: Cost and Managerial Accounting

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8-1

MPA 602: Cost and

Preparation of Budget and

Budgets and the Organization

A budget provides a comprehensive financial

The Basic Framework of Budgeting

A budget is a detailed quantitative plan for

Difference Between Planning and Control

Managers should be held

Strategic plan Long-range planning

Capital budget Continuous budget

The most forward-looking budget is the

The strategic plan leads to long-range

are coordinated with capital budgets,

Master budgets link to both long-range

The master budget

Operating budget Financial budget. . .

Focuses on the Income

The Master Budget: An Overview

Direct materials Direct labor Manufacturing

The Master Budget: An Overview

A master budget is based on various estimates and

Prepare a sales budget,

The Sales Budget

Expected Cash Collections

• All sales are on account.

Expected Cash Collections

Expected Cash Collections

Expected Cash Collections

Expected Cash Collections

The Production Budget

The production budget must be adequate to

The Production Budget

• On March 31st, 4,000 units were on hand.

If Royal was a merchandising company it would prepare a

The Production Budget

The Production Budget

Budgeted May sales 50,000

The Production Budget

Assumed ending inventory.

Prepare a direct materials

The Direct Materials Budget

• At Royal Company, five pounds of material are required per unit of

The Direct Materials Budget

From production budget.

The Direct Materials Budget

The Direct Materials Budget

Calculate the materials to

The Direct Materials Budget

The Direct Materials Budget

Assumed ending inventory.

Expected Cash Disbursement for Materials

• Royal pays $0.40 per pound for its materials.

Expected Cash Disbursement for Materials

Expected Cash Disbursement for Materials

Compute the expected cash

Expected Cash Disbursement for Materials

Prepare a direct labor

The Direct Labor Budget

The Direct Labor Budget

The Direct Labor Budget

The Direct Labor Budget

The Direct Labor Budget