chapter 11: budgetary control and responsibility accounting Flashcards
budgetary control
the use of budgets in controlling operations
what do budget reports do?
give management feedback on operations
why are budget reports used?
because planned objectives often lose much of their potential value if progress is not monitored along the way
Budgetary control activities
- develop budget
- analyze differences between actual and budget
- take corrective action
- modify future plans
- develop budget
when does a budget control work best?
when a company has a formalized reporting system
what does a a formalized reporting system do?
- Identifies the name of the budget report (ex: sales budget)
- States the frequency of the report (ex: weekly or monthly)
- Specifies the purpose of the report
- Indicates the primary recipient(s) of the report
what does a master budget do?
formalizes management’s planned objectives for the coming year
how is each budget in the master budget viewed when used in budgetary control?
as being static
static budget
A projection of budget data at one level of activity
do not consider data for different levels of activity
why do companies always compare actual results with budget data at the activity level that was used in developing the master budget?
because of the static budget
budget variance
The difference between budgeted numbers and actual results
when is a static budget appropriate in evaluating how well a manager controls costs?
(1) the actual level of activity closely approximates the master budget activity level
and/or
(2) the behaviour of the costs in response to changes in activity is fixed
flexible budget
projects budget data for various levels of activity
basically a series of static budgets at different levels of activity
recognizes that the budgetary process is more useful if it can be adapted to changes in operating conditions
true or false
Flexible budgets can be prepared for each of the types of budgets included in the master budget
true
why are flexible budgets more relevant with more variable costs?
because as production increases, the budget allowances for variable costs should increase both directly and proportionately
flexible budget indicates whether cost changes resulting from different production volumes are reasonable
when a static budget useless for performance evaluation?
when a company has substantial variable costs
what does flexible budget use as basis?
the master budget
steps to develop flexible budget
- Identify the activity index and the relevant range of activity.
- Identify the variable costs, and determine the budgeted variable cost per unit of activity for each cost.
- Identify the fixed costs, and determine the budgeted amount for each cost.
- Prepare the budget for selected increments of activity within the relevant range
Formula for total budgeted costs
fixed costs + variable costs
= total budgeted costs
Flexible budget reports
a type of internal report
provides a basis for evaluating a manager’s performance in two areas:
production control and cost control
the two sections from flexible budget reports
(1) production data for a selected activity index, such as direct labour hours,
(2) cost data for variable and fixed cost
where are flexible budget reports widely used?
in production and service departments
Responsibility accounting
involves accumulating and reporting costs (and revenues, where relevant) that involve the manager who has the authority to make the day-to-day decisions about the cost items
do all companies use responsibility accounting?
ye bruv
how is the manager’s performance evaluated under responsibility accounting?
based on matters that are directly under that manager’s control
what conditions are needed so that responsibility accounting can be used at every level of management?
- Costs and revenues can be directly associated with the specific level of management responsibility
- The costs and revenues are controllable at the level of responsibility that they are associated with
- Budget data can be developed for evaluating the manager’s effectiveness in controlling the costs and revenues
when is responsibility accounting especially valuable?
in a decentralized company
Decentralization
the control of operations is given to many managers throughout the organization
segmentation of power
Under responsibility accounting, how often are segment reports prepared? why?
periodically
monthly, quarterly, and annually
to evaluate a manager’s performance
in which ways do the reporting of costs and revenues under responsibility accounting differ from budgeting?
- A distinction is made between controllable and non controllable items.
- Performance reports either emphasize or include only the items that the individual manager can control
controllable cost at a particular level of managerial responsibility
the manager has the power to incur it in a specific period of time
to whom are all costs controllable?
top management
when do costs becomes lesser and lesser controllable?
as one moves down to each lower level of managerial responsibility because the manager’s authority decreases at each level
non controllable costs at a certain level
costs that are incurred indirectly and allocated to a responsibility level
Performance evaluation
at the centre of responsibility accounting
management function that compares actual results with budget goals
Management by exception
top management’s review of a budget report is focused either entirely or mostly on differences between actual results and planned objectives
helps top management focus on problem areas
criteria so that management by exception be effective?
materiality and controllability
materiality
usually expressed as a percentage difference from the budget
quantitative guideline
Behavioural principles in evaluating performance
- Managers of responsibility centres should be directly involved in setting budget goals for their areas of responsibility
- The evaluation of performance should be based entirely on matters that can be controlled 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
reporting principles for performance evaluation
- Performance reports should contain only data that are controllable by the manager of the responsibility centre
- Performance reports should provide accurate and reliable budget data to measure performance
- Performance reports should highlight significant differences between actual results and budget goals
- Performance reports should be tailor-made for the intended evaluation
- Performance reports should be prepared at reasonable intervals
responsibility reporting system
preparing a report for each level of responsibility in the company’s organization chart
help to hold individual managers accountable for the costs and revenues under their control
where does responsibility reporting system start?
begins with the lowest level of responsibility for controlling costs and moves upward to each higher level
Types of Responsibility Centres
cost centres
profit centres
investment centres
cost centre
incurs costs (and expenses) but does not directly generate revenues
usually either production departments or service departments
Managers of cost centres
have the authority to incur costs
are evaluated on their ability to control costs
evaluated on ability to meet budgeted goals for controllable costs
profit centre
incurs costs (and expenses) and also generates revenues
Ex: departments of a retail store, such as clothing, furniture, and automotive products, and branch offices of banks
Managers of profit centres
are judged on the profitability of their centres
to better evaluate, we have to see the direct and indirect fixed costs
investment centre
incurs costs (and expenses) and generates revenues
has control over the investment funds that are available for use
often associated with product lines and subsidiary companies
Managers of investment centres
evaluated on both the profitability of the centre and the rate of return earned on the funds invested
what are the only costs included in the cost centre reports? what distinction is made between variable and fixed costs
only controllable costs are included in the report
no distinction is made between variable and fixed costs
direct fixed costs
costs that are specifically for one centre and are incurred for the benefit of that centre alone
also called traceable costs
Most direct fixed costs are controllable by the profit centre manager
indirect fixed costs
are for a company’s overall operating activities
are incurred for the benefit of more than one profit centre
also called common costs
Most indirect fixed costs cannot be controlled by the profit centre manager
how are indirect fixed costs allocated in profit centres?
according to some type of equitable basis
managers in profit centres control better direct or indirect fixed costs?
direct fixed costs
responsibility report for a profit centre
shows the budgeted and actual controllable revenues and costs
how is the responsibility report for a profit centre prepared?
what are its features?
prepared using the cost-volume-profit income statement
- Controllable fixed costs are deducted from the contribution margin
- The amount by which the contribution margin is greater than the controllable fixed costs is identified as the controllable margin
- Noncontrollable fixed costs are not reported
controllable margin
The amount by which the contribution margin is greater than the controllable fixed costs
considered to be the best measure of the manager’s performance in controlling revenues and costs
the main basis for evaluating the performance of a manager of an investment centre
why?
return on investment (ROI)
it shows how effectively the manager uses the assets at his or her disposal
ROI formulas
Controllable Margin / Average Operating Assets
= Return on Investment (ROI)
(Operating Income / Sales) · (Sales / Operating Assets)
= Return on Investment (ROI)
Operating Income / Sales = Profit Margin
Sales / Operating Assets = Investment Turnover
in an investment centre, are all fixed costs controllable by its manager?
yeeee
difference between profit centre and investment centre responsibility reports?
compared to performance reports for profit centre managers, more fixed costs are classified as controllable in performance reports for investment centre managers
The return on investment approach includes which two judgemental factors’
- Valuation of operating assets
2. Margin (income) measure
profit margin
focuses on profitability
shows how the operating margin can be improved by increasing the margin on each dollar of sales
measures managers’ abilities to control the operating expenses that are related to sales during a specific period
investment turnover
focuses on efficiency
shows how investment turnover can be improved by generating more sales for each dollar invested
DuPont profitability analysis
expanded formula for ROI
(Operating Income / Sales) · (Sales / Operating Assets)
= Return on Investment (ROI)
Operating Income / Sales = Profit Margin
Sales / Operating Assets = Investment Turnover
in which two ways can a manager of an investment centre improve the ROI?
(1) increase the controllable margin
and/or
(2) reduce the average operating assets
how to increase the controllable margin?
increasing sales
reducing the variable and controllable fixed costs
benefits and dangers of reducing the average operating assets?
It is good to eliminate excessive inventories and to dispose of unneeded plant assets
it is unwise to reduce inventories below expected needs or to dispose of essential plant assets
The problem with some ROI analysis
the minimum rate of return on a company’s operating assets is ignored
the minimum rate of return
the rate at which one can cover their costs and earn a profit
Residual income approach
used to evaluate performance using the minimum rate of return
Residual income
the income that remains after subtracting from the controllable margin the minimum rate of return on a company’s average operating assets
Economic Value Added (EVA)
similar to residual income
unlike residual income, EVA uses the weighted-average cost of capital instead of the minimum rate of return on the invested assets
unlike residual income, EVA calculates an investment centre’s profit after tax
Basically, the EVA is calculated by deducting the total cost of capital (equity and borrowing) from the net income after tax
Economic Value Added (EVA) formula
Investment Centre’s Operating Profit after Tax - (Weighted-Average Cost of Capital · Total Capital Used)
= Economic Value Added (EVA)
positive EVA result
the company has added economic value
negative EVA result
the company has lost capital
