23 Budgetary Control and

Responsibility Accounting

Learning Objectives
1 Describe budgetary control and static budget reports.

2 Prepare flexible budget reports.

Apply responsibility accounting to cost and profit

3 centers.

4 Evaluate performance in investment centers.

1
LEARNING Describe budgetary control and static
1
OBJECTIVE budget reports.

The use of budgets in controlling operations is known as

budgetary control.
 Takes place by means of budget reports which
c________ actual results with planned objectives.
 Provides management with feedback on operations.
 Budget reports can be prepared as frequently as
needed.
 Management analyzes d____________ between actual
and planned results and determines causes.

2 LO 1
 Budgetary Control

Budgetary control involves the following activities.

3 LO 1
 Budgetary Control

Works best when a company has a formalized reporting

system which:
1. Identifies the name of the budget report.

2. States the frequency of the report.

3. Specifies the purpose of the report.

4. Indicates the primary recipient(s) of the report.

4 LO 1
 Budgetary Control

Partial budgetary control system for manufacturing company.

5 LO 1
 Static Budget Reports

A Static budget is a projection of budget data at _____

level of activity.
 When used in budgetary control, each budget included
in the master budget is considered to be static.
 Ignores data for different levels of activity.
 Compares actual results with budget data at the activity
level used in the master budget.

6 LO 1
 Static Budget Reports
Eg) Budget and actual sales data for the Rightride product in
the first and second quarters of the year are as follows.

Budget report for first quarter:

2023

7 LO 1
 Static Budget Reports

Budget report for the second quarter contains one new

feature: cumulative year-to-date information.

2023

8 LO 1
 Static Budget Reports

USES AND LIMITATIONS

 Appropriate for evaluating a manager’s
effectiveness in controlling costs when:
► Actual level of activity closely
approximates master budget
activity level, and/or
► Behavior of costs is fixed in
response to changes in activity.
 Appropriate for fixed costs.
 Not appropriate for variable costs.

9 LO 1
LEARNING
OBJECTIVE
2 Prepare flexible budget reports.

Flexible budget projects budget data for various levels of

activity.
 Essentially a series of static budgets
at different activity levels.
 Budgetary process more useful if it is
adaptable to changes in operating
conditions.
 Can be prepared for each type of
budget in the master budget.

10 LO 2
 Why Flexible Budgets?

Illustration: Barton Robotics static budget based on a production

volume of 10,000 units of robotic controls.

2020
2023

11 LO 2
 Illustration: Overhead Static Budget report assuming 12,000
units were actually produced, rather than 10,000 units.

202
2023

12 Illustration 24-7 LO 2
 Why Flexible Budgets?

 Over budget in three of six overhead costs.

► Unfavorable difference of $132,000 – 12% over budget.
 Comparison based on budget data for 10,000 units - the
original activity level which is not relevant.
► Meaningless to compare actual variable costs for 12,000
units with budgeted variable costs for 10,000 units.
► Variable costs increase with production.

Budgeted variable amounts should increase

proportionately with production.

13 LO 2
 Why Flexible Budgets?

Illustration: Analyzing the budget data for these costs at 10,000

units, you arrive at the following per unit results.

Variable costs
per unit

Budgeted variable
costs for 12,000
units

14 LO 2
 Illustration: Prepare the budget report based on the flexible budget
for 12,000 units of production.

2023

15
 Illustration: Prepare the budget report based on the flexible budget
for 12,000 units of production.

2023

16
 Developing the Flexible Budget

1. Identify the activity index and the relevant range of

activity.

2. Identify the variable costs and determine the budgeted

variable cost per unit of activity for each cost.

3. Identify the fixed costs and determine the budgeted

amount for each cost.

4. Prepare the budget for selected increments of activity

within the relevant range.

17 LO 2
 Flexible Budget – A Case Study

Illustration: Fox Company’s management uses a flexible

budget for monthly comparisons of actual and budgeted
manufacturing overhead costs of the Finishing Department. The
master budget for the year ending December 31, 2023, shows
expected annual operating capacity of 120,000 direct labor hours
and the following overhead costs.

18 LO 2
 Flexible Budget – A Case Study

Four steps for developing the flexible budget.

1. Identify the activity index and the relevant range of activity.
► Activity index: direct labor hours.
► Relevant range: 8,000 – 12,000 direct labor hours per month.

2. Identify variable costs and determine the budgeted variable

cost per unit of activity for each cost.

19 LO 2
 Flexible Budget – A Case Study

Four steps for developing the flexible budget.

3. Identify the fixed costs and determine the budgeted amount
for each cost.
► Three fixed costs per month:
 Depreciation $15,000.
 Supervision $10,000.
 Property taxes $5,000.

4. Prepare the budget for selected increments of activity within

the relevant range.
► Prepared in increments of 1,000 direct labor hours.

20 LO 2
 Monthly overhead flexible budget

2020
2023

21 LO 2
 Monthly overhead flexible budget

2023

22 LO 2
 Flexible Budget Reports

 Widely used in production and service departments.

 A type of internal report.
 Consists of two sections:
► Production data for a selected activity index, such
as direct labor hours.
► Cost data for variable and fixed costs.
 Widely used in production and service departments to
evaluate a manager’s performance.

23 LO 2
 2023

24 LO 2
LEARNING Apply responsibility accounting to cost
3
OBJECTIVE and profit centers.

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.
Conditions:
1. Costs and revenues can be directly associated with the
specific level of management responsibility.

2. Costs and revenues can be controlled by employees at

the level of responsibility with which they are associated.

3. Budget data can be developed for evaluating the

manager’s effectiveness in controlling the costs and
revenues.
25 LO 3
 Responsibility Accounting

Levels of responsibility for controlling costs.

26 LO 3
 Responsibility Accounting

 Responsibility center - any individual who has control and

is accountable for activities.
 May extend to any level of management.
 Especially valuable in a decentralized company.
► Control of operations delegated to many managers
throughout the organization.
► Segment – area of responsibility for which reports are
prepared.

27 LO 3
 Responsibility Accounting

 Two differences from budgeting in reporting costs and

revenues:
1. Distinguishes between controllable and
noncontrollable costs.
2. Emphasizes or includes o______ items
c___________by the individual manager in
performance reports.
 Applies to both profit and not-for-profit entities.
► Profit entities: maximize net income.
► Not-for-profit: minimize cost of providing services.

28 LO 3
 Management Insight Proctor & Gamble

Competition versus Collaboration

Many compensation and promotion programs encourage competition
among employees for pay raises. To get ahead, you have to perform
better than your fellow employees. While this may encourage hard
work, it does not foster collaboration, and it can lead to distrust and
disloyalty. Such negative effects have led some companies to believe
that cooperation and collaboration, not competition, are essential in
order to succeed in today’s work environment. As a consequence, many
companies now explicitly include measures of collaboration in their
performance measures. For example, Procter & Gamble measures
collaboration in employees’ annual performance reviews. At Cisco
Systems, the assessment of an employee’s teamwork can affect the
annual bonus by as much as 20%.
Source: Carol Hymowitz, “Rewarding Competitors Over Collaboration No Longer
Makes Sense,” Wall Street Journal (February 13, 2006).
29 LO 3
 Controllable Versus Noncontrollable
Revenues and Costs

Critical issue is whether the cost or revenue is controllable at

the level of responsibility with which it is associated. A cost
over which a manager has control is called a controllable
cost.
1. All costs are controllable by top management.
2. Fewer costs are controllable as one moves down to each
lower level of managerial responsibility.

Costs incurred indirectly and allocated to a responsibility level

are noncontrollable costs.

30 LO 3
 Principles of Performance Evaluations

 Management function that compares actual results

with budget goals.
 Includes both behavioral and reporting principles.

31 LO 3
 Principles of Performance Evaluation

MANAGEMENT BY EXCEPTION
Management by exception means that top management’s
review of a budget report is focused primarily on differences
between actual results and planned objectives.
 MATERIALITY - Without quantitative guidelines,
management would have to investigate every budget
difference regardless of the amount.
 CONTROLLABILITY OF THE ITEM - Exception guidelines
are more restrictive for controllable items than for items the
manager cannot control.

32 LO 3
 Principles of Performance Evaluation

BEHAVIORAL PRINCIPLES
1. Managers of responsibility centers should have direct
i________into the process of establishing budget goals of
their area of responsibility.
2. The evaluation of performance should be based entirely on
matters that are c________ by the manager being
evaluated.
3. Top management should support the evaluation process.
4. The evaluation process must allow managers to r________
to their evaluations.
5. The evaluation should identify both good and poor
performance.
33 LO 3
 Principles of Performance Evaluation

REPORTING PRINCIPLES
1. Contain only data controllable by manager of responsibility
center.
2. Provide accurate and reliable budget data to measure
performance.
3. Highlight significant differences between actual results and
budget goals.
4. Be tailor-made for intended evaluation.
5. Be prepared at reasonable intervals.

34 LO 3
 Responsibility Report A

Reporting President sees

summary
data of vice
presidents.

Responsibility reporting system

Report B
Vice president sees
summary of controllable
costs in his/her functional
 Permits comparative area.

evaluations.
 Plant manager can rank
each department
Report C
manager’s effectiveness Plant manager sees
summary of controllable
in controlling costs for each department
in the plant.
manufacturing costs.
 Comparative rankings
provide incentive for a
manager to control costs. Report D
Department manager sees
controllable costs of his/her
department.

35
 Report A
President sees
summary data of
vice presidents.

Report B
Vice president sees
summary of
controllable costs in
his/her functional
area.

36
 Report B
Vice president
sees summary of
controllable costs
in his/her
functional area.

Report C
Plant manager sees
summary of
controllable costs
for each
department in the
plant.

37
 Report C
Plant manager
sees summary of
controllable costs
for each
department in the
plant.

Report D
Department
manager sees
controllable costs of
his/her department.

38 LO 3
 Types of Responsibility Centers

Three basic types:

 Cost center
► Incurs costs but does not directly generate revenues.
► Managers have authority to incur costs.
► Managers evaluated on ability to control costs.
► Usually a production department or a service
department.
 Profit center
 Investment center

39 LO 3
 Types of Responsibility Centers
 Profit center
► Incurs costs and generates revenues.
► Managers judged on profitability of center.
► Examples include individual departments of a retail store or
branch bank offices.
 Investment center
► Incurs costs, generates revenues, and has investment
funds available for use.
► Manager evaluated on profitability of the center and rate of
return earned on funds.
► Often a subsidiary company or a product line.
► Manager able to control or significantly influence
investment decisions such as plant expansion.
40 LO 3
 Types of Responsibility Centers

41 LO 3
 RESPONSIBILITY ACCOUNTING FOR COST CENTERS

 Based on a manager’s ability to meet budgeted goals

for controllable costs.
 Results in responsibility reports which compare actual
controllable costs with flexible budget data.
► Include only controllable costs in reports.
► No distinction between variable and fixed costs.

42 LO 3
RESPONSIBILITY ACCOUNTING FOR PROFIT CENTERS

 Based on information about both controllable revenues

and controllable costs.
 Manager controls operating revenues earned (such as
sales) and Manager controls all variable costs incurred
by the center because they vary with sales.

43 LO 3
 RESPONSIBILITY ACCOUNTING FOR PROFIT CENTERS

DIRECT AND INDIRECT FIXED COSTS

 Direct fixed costs
► Relate specifically to one responsibility center.
► Incurred for the sole benefit of the center.
► Called traceable costs since they can be traced directly to one
center.
► Most direct fixed costs are controllable by the profit center manager.
 Indirect fixed costs
► Pertain to a company's overall operating activities.
► Incurred for the benefit of more than one profit center.
► Called common costs since they apply to more than one center.
► Most are not controllable by the profit center manager.
44
RESPONSIBILITY ACCOUNTING FOR PROFIT CENTERS

RESPONSIBILITY REPORT
 Budgeted and actual controllable revenues and costs.
 Uses cost-volume-profit income statement format:
► Deduct controllable fixed costs from the contribution
margin.
► Controllable margin - excess of contribution margin
over controllable fixed costs.
► Noncontrollable fixed costs are not reported.

45 LO 3
 2023

Note the report does not show the noncontrollable fixed costs of $60,000. These
costs would be included in a report on the profitability of the profit center.
46 LO 3
Example Profit Center Responsibility Report

Midwest Division operates as a profit center. It reports the following for

the year:

Prepare a responsibility report for December 31, 2023.

47
LEARNING Evaluate performance in investment
4
OBJECTIVE centers.

Return on investment (ROI) is the 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.
 Factors in ROI formula are controllable by manager.

48 LO 4
 Return on Investment (ROI)

 Operating assets include current assets and plant

assets used in operations by the center and controlled
by the manager.
 Base average operating assets on the beginning and
ending cost or book values of the assets.

49 LO 4
 Responsibility Report

 Scope of manager’s responsibility affects content.

 Investment center is an independent entity for operating
purposes.
 All fixed costs are controllable by center manager.
 Shows budgeted and actual ROI below controllable
margin.

50 LO 4
 2023

Illustration: The Marine Division is an investment center. It has budgeted

51 and actual average operating assets of $2,000,000. LO 4
 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.
► Controllable margin, income from operations, or net
income.
► Only controllable margin is a valid basis for evaluating
performance of investment center manager.

52 LO 4
 Improving ROI

Improve ROI by increasing controllable margin, and/or

reducing average operating assets.

53 LO 4
 INCREASING CONTROLLABLE MARGIN

Increase ROI by increasing sales or by reducing variable

and controllable fixed costs.
1. Increase sales by 10%.
► Sales increase $200,000 and contribution margin
increases $90,000 ($200,000 X .45).
► Thus, controllable margin increases to $690,000
($600,000 + $90,000).
► New ROI is 13.8%.

54 LO 4
 INCREASING CONTROLLABLE MARGIN

Increase ROI by increasing sales or by reducing variable and

controllable fixed costs.
2. Decrease variable and fixed costs 10%.
► Total costs decrease $140,000 [($1,100,000 + $300,000)
X 10%].
► Controllable margin becomes $740,000.
► New ROI becomes 14.8%.

55 LO 4
 REDUCING AVERAGE OPERATING
ASSETS

► Assume that average operating assets are reduced 10%

or $500,000 ($5,000,000 x .10).
► Average operating assets become $4,500,000.
► Controllable margin remains unchanged at $600,000.
► New ROI is 13.3%.

56 LO 4