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Master Budget & Responsibility accounting

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					   Master Budget and
Responsibility Accounting

       Chapter 6



                            6-1
              Introduction

 Budgeting is the most widely used accounting
  tool for planning and controlling organizations.
 A budget is the quantitative expression of a
  proposed plan of action by management for
  a future time period and an aid to the
  coordination and implementation of the plan.



                                              6-2
           Learning Objectives

1   Define master budget and explain its major
    benefits to an organization
2   Describe major components of the master
    budget
3   Prepare the operating budget and its supporting
    schedules
4   Use computer-based financial planning models
    in sensitivity analysis
                                               6-3
           Learning Objectives

5   Explain Kaizen budgeting and its importance
    for cost management
6   Illustrate an activity-based budgeting approach
7   Describe responsibility centers and
    responsibility accounting
8   Explain how controllability relates to
    responsibility accounting

                                                6-4
  Learning Objective 1

Define master budget and
explain its major benefits
   to an organization




                             6-5
             Budgeting Cycle

–   Planning the performance of the organization
–   Providing a frame of reference, a set of
    specific expectations against which actual
    results can be compared
–   Investigating variations from plans
–   Correcting action follows, if necessary
–   Planning again

                                              6-6
    What is the Master Budget?

 It is a comprehensive expression of
  management’s operating and financial plans
  for a future time period (usually one year).
 The master budget is summarized in a set of
  budgeted financial statements.




                                             6-7
        The Master Budget...

– embraces the impact of both operating
  decisions and financing decisions.
 Operating decisions center on the use of
  scarce resources.
 Financing decisions center on how to obtain
  the funds to acquire those resources.



                                            6-8
     What are the Advantages
           of Budgets?

 Budgets compel planning, including the
  implementation of plans.
 They provide performance criteria.
 They promote coordination and
  communication within the organization.




                                           6-9
                  Budgets

 Budgeting is most useful when done as an
  integral part of an organization’s strategy
  analysis.
 Strategy describes how an organization
  matches its own capabilities with the
  opportunities in the market place to
  accomplish its overall objectives.


                                                6 - 10
                   Budgets

   Budgeted performance measures can
    overcome two key limitations of using
    past performance:
1   Past results incorporate past miscues and
    sub-standard performance.
2   The future may be expected to be very
    different from the past.

                                                6 - 11
                  Budgets

 Coordination is the meshing and balancing of
  all factors of production or service and of all
  the departments and business functions so that
  the company can meet its objectives.
 Communication is getting those objectives
  understood and accepted by all the employees
  in the various departments and functions.


                                              6 - 12
        Management Support

 Top management has the ultimate
  responsibility for budgets of the organization
  they manage.
 Management at all levels should understand
  and support the budget and all aspects of the
  management control system.



                                              6 - 13
    Time Coverage of Budgets

 Budgets typically have a set time period
  (month, quarter, year).
 This time period can itself be broken into
  sub-periods.
 The most frequently used budget period is
  one year.
 Businesses are increasingly
  using rolling budgets.
                                               6 - 14
   Learning Objective 2

Describe major components
   of the master budget




                            6 - 15
Master Budget Components


         Master Budget



 Operating               Financial
  Budget                  Budget


                                     6 - 16
     Master Budget Components

   Operating budget
–   Supporting budget schedules
–   Revenue budget
–   Production budget in units
–   Direct materials purchase budget



                                       6 - 17
     Master Budget Components

–   Direct labor budget
–   Cost of goods sold budget
–   Nonmanufacturing costs budget
–   Budgeted income statement




                                    6 - 18
     Master Budget Components

   Financial budget
–   Capital budget
–   Cash budget
–   Budgeted balance sheet
–   Budgeted statement of cash flows



                                       6 - 19
    Learning Objective 3

Prepare the operating budget
and its supporting schedules




                               6 - 20
          Operating Budget

 The foundation of the operating budget is the
  revenue budget.
 The operating budget ends with the budgeted
  income statement.




                                             6 - 21
            Operating Budget

   The following data relates to Maui Diving,
    a producer of diving equipment.




                                                 6 - 22
          Operating Budget
 Two pounds of direct materials are
  budgeted per unit at a cost of $2.00 per
  pound, $4.00 per unit.
 Three direct labor hours are budgeted per
  unit at $7.00 per hour, $21.00 per unit.
 Variable overhead is budgeted at $8.00 per
  direct labor hour, $24.00 per unit.
 Fixed overhead is budgeted at $5,400 per
  month.
                                               6 - 23
          Operating Budget

 Variable nonmanufacturing costs are expected
  to be $0.14 per revenue dollar.
 Fixed nonmanufacturing costs are $7,800 per
  month.




                                           6 - 24
           Operating Budget

 Maui Diving expects 1,100 units to be sold
  during the month of August 2000.
 Selling price is expected to be $240 per unit.
 How much are budgeted revenues for the
  month?
 1,100 × $240 = $264,000




                                              6 - 25
          Production Budget

 Budgeted sales (units)
+ Target ending finished goods inventory (units)
– Beginning finished goods inventory (units)
= Budgeted production (units)




                                            6 - 26
         Production Budget

 Assume that target ending finished goods
  inventory is 80 units.
 Beginning finished goods inventory is 100
  units.
 How many units need to be produced?




                                              6 - 27
       Production Budget

     Maui Diving Production Budget
      for the Month of August 2000
Units required for sales           1,100
Add ending inv. of finished units     80
Total finished units required      1,180
Less beg. inv. of finished units     100
Units to be produced               1,080


                                           6 - 28
    Direct Materials Usage Budget

 Each finished unit requires 2 pounds of direct
  materials at a cost of $2.00 per pound.
 Desired ending inventory equals 15 percent
  of the materials required to produce next
  months sales.
 September sales are forecasted to be 1,600
  units.
 What is the ending inventory in August?
 480 pounds
                                             6 - 29
    Direct Materials Usage Budget

 September sales: 1,600 × 2 pounds per unit
  = 3,200 pounds
 3,200 × 15% = 480 pounds (the desired ending
  inventory)
 What is the beginning inventory in August?
 1,100 units × 2 × 15% = 330 units




                                          6 - 30
    Direct Materials Usage Budget

 How many pounds are needed to produce
  1,080 units in August?
 1,080 × 2 = 2,160 pounds




                                          6 - 31
               Direct Materials
              Purchases Budget
   Maui Diving Direct Material Purchases Budget
          for the Month of August 2000
    Units needed for production     2,160
    Target ending inventory           480
    Total material to provide for  2,640
    Less beginning inventory          330
    Units to be purchased          2,310
    Unit purchase price            $2.00
    Total purchase cost           $4,620
                                              6 - 32
          Direct Manufacturing
              Labor Budget

   Each unit requires 3 direct labor hours at
    $7.00 per hour.




                                                 6 - 33
       Direct Manufacturing
           Labor Budget

     Maui Diving Direct Labor Budget
        for the Month of August 2000
 Units Produced:                 1,080
 Direct labor hours/unit             3
 Total direct labor hours:       3,240
 Total budget @ $7.00/hour:    $22,680


                                          6 - 34
Manufacturing Overhead Budget

 Variable overhead is budgeted at $8.00 per
  direct labor hour.
 Fixed overhead is budgeted at $5,400 per
  month.




                                               6 - 35
Manufacturing Overhead Budget

   Maui Diving Manufacturing Overhead Budget
          for the Month of August 2000
    Variable Overhead:
    (3,240 x $8.00)         $25,920
    Fixed Overhead            5,400
    Total                   $31,320



                                          6 - 36
     Ending Inventory Budget

 Cost per finished unit:
 Materials                         $ 4
  Labor                              21
  Variable manufacturing overhead    24
  Fixed manufacturing overhead        5*
  Total                             $54
 *$5,400 ÷ 1,080 = $5


                                           6 - 37
     Ending Inventory Budget

 What is the cost of the target ending inventory
  for materials?
 480 × $2 = $960
 What is the cost of the target finished goods
  inventory?
 80 × $54 = $4,320




                                              6 - 38
    Cost of Goods Sold Budget

 Direct materials used:
  2,160 × $2.00                $ 4,320
 Direct labor                  22,680
 Total overhead                31,320
 Cost of goods manufactured   $58,320




                                         6 - 39
    Cost of Goods Sold Budget

 Assume that the beginning finished goods
  inventory is $5,400.
 Ending finished goods inventory is $4,320.
 What is the cost of goods sold?




                                               6 - 40
    Cost of Goods Sold Budget

 Beginning finished goods inventory: $ 5,400
+ Cost of goods manufactured:         $58,320
= Goods available for sale:           $63,720
– Ending finished goods inventory:    $ 4,320
= Cost of goods sold:                 $59,400



                                           6 - 41
    Cost of Goods Sold Budget

 Cost of goods manufactured
+ Finished goods beginning inventory
= Cost of goods available for sale
– Finished goods ending inventory
= Cost of goods sold



                                       6 - 42
Nonmanufacturing Costs Budget

   Maui Diving Other Expenses Budget
       for the Month of August 2000
    Variable Expenses:
    ($0.14 × $264,000)      $36,960
    Fixed Expenses             7,800
    Total                   $44,760



                                        6 - 43
    Budgeted Statement of Income

 Maui Diving has budgeted sales of $264,000
  for the month of August.
 Cost of goods sold are budgeted at $59,400.
 What is the budgeted gross margin?




                                           6 - 44
    Budgeted Statement of Income

 Maui Diving Budgeted Income Statement
  for the Month ending August 31, 2000
 Sales                   $264,000 100%
 Less cost of sales        59,400 22%
 Gross margin            $204,600 78%
 Other expenses            44,760 17%
 Operating income        $159,840 61%

                                          6 - 45
    Learning Objective 4

Use computer-based financial
planning models in sensitivity
          analysis




                                 6 - 46
      Financial Planning Models

   Financial planning models are mathematical
    representations of the interrelationships among
    operating activities, financial activities, and
    other factors that affect the master budget.




                                               6 - 47
                Software

 Software packages are now readily available
  to reduce the computational burden and time
  required to prepare budgets.
 These packages assist managers to do
  sensitivity analysis.




                                           6 - 48
    What is Sensitivity Analysis?

   It is a “what-if” technique that examines how
    a result will change if the original predicted
    data are not achieved or if an underlying
    assumption changes.




                                                6 - 49
        Sensitivity Analysis

 Consider Maui Diving.
 What if some parameters in the budget model
  were to change?
 For example, what if the selling price is
  expected to be $230 instead of $240?
 What are expected revenues?
 1,100 × $230 = $253,000 instead of $264,000


                                          6 - 50
         Sensitivity Analysis

 What if the materials cost is expected to
  increase to $2.50 per pound instead of $2.00.
 What is the cost of goods sold?
 1,100 × $55 = $60,500 instead of $59,400
 Why the increase?
 Because materials cost per unit become $5.00
  instead of $4.00.

                                            6 - 51
         Sensitivity Analysis

 Another important use of sensitivity analysis
  is in cash budgeting.
 What is a cash budget?




                                             6 - 52
              Cash Budget

 A cash budget shows expected cash receipts
  and disbursements; it indicates the months
  having cash shortages and excesses.
 The following example assumes that all
  revenues are from charge sales.
 It is assumed that Maui Diving pays for all of
  its purchases: labor, manufacturing overhead,
  and other expenses during the month.
                                             6 - 53
             Cash Budget

 Maui Diving has the following collection
  pattern:
 50% in the month of sale
 27% in the month following sale
 20% in the second month following sale
   3% uncollectible
 100%

                                             6 - 54
              Cash Budget

 Budgeted charge sales are as follows:
 June          $200,000
  July          $250,000
  August        $264,000
  September     $260,000
 What are the expected cash collections in
  August?

                                              6 - 55
             Cash Budget

 Budgeted Cash Receipts for the Month
         Ending August 31, 2000
 August sales: $264,000 × 50%      $132,000
 July sales:   $250,000 × 27%         67,500
 June sales:   $200,000 × 20%         40,000
 Total                             $239,500


                                          6 - 56
           Cash Budget

   Budgeted Cash Disbursements for the
        Month Ending August 31, 2000
August purchases             $ 4,620
Direct labor                   22,680
Total overhead                 31,320
Other expenses                 39,760*
Total                        $98,380
*Other expenses exclude depreciation
                                         6 - 57
           Cash Budget

   Cash Budget for the Month Ending
               August 31, 2000
Budgeted receipts              $239,500
   Budgeted disbursements             98,380
Net increase in cash           $141,120




                                        6 - 58
  Learning Objective 5

Explain Kaizen budgeting
and its importance for cost
       management




                              6 - 59
             What is Kaizen?

   The Japanese use the term “kaizen” for
    continuous improvement.




                                             6 - 60
          Kaizen Budgeting...

–   is a budgetary approach that explicitly
    incorporates continuous improvement during
    the budget period into the budget numbers.




                                            6 - 61
          Kaizen Budgeting

 It was previously estimated that it should
  take 3 labor hours for Maui Diving to
  manufacture its product.
 A Kaizen budgeting approach would
  incorporate future improvements.




                                               6 - 62
       Kaizen Budgeting

                   Budgeted Hours/Item
January-March 2000          3.00
April-June 2000             2.95
July-September 2000         2.90
October-December 2000       2.85




                                         6 - 63
   Learning Objective 6

Illustrate an activity-based
    budgeting approach




                               6 - 64
     Activity-Based Budgeting

 Activity-based costing reports and analyzes
  past and current costs.
 Activity-based budgeting (ABB) focuses on
  the budgeted cost of activities necessary to
  produce and sell products and services.




                                             6 - 65
     Activity-Based Budgeting

 Maui Diving included the cost of setup
  activity in developing the overhead budget.
 In an ABB, the costs of the setup activity
  (as well as other activity areas) would be
  separately predicted.
 Assume that Maui Diving produces two
  products: Product A and Product B.

                                                6 - 66
     Activity-Based Budgeting

                 Product A       Product B
  Units produced:    880              200
 Labor hours
  per unit:            3                3
 Budgeted
  setup hours          5                5
 Total budgeted machine setup related cost is
  $25,920 per month.
                                             6 - 67
     Activity-Based Budgeting

 Total budgeted labor hours are:
 Product A: 880 × 3         2,640
  Product B: 200 × 3           600
  Total                      3,240
 What is the allocation rate per labor-hour?
 $25,920 ÷ 3,240 = $8.00




                                                6 - 68
     Activity-Based Budgeting

                    Product A   Product B
  Total cost
  allocated to each
  product line:
  $8.00 × 2,640        $21,120
  $8.00 × 200                     $1,600
 Cost per unit: $8.00



                                           6 - 69
    Activity-Based Budgeting

 Under ABB, the number of setups is the cost
  driver.
 $25,920 budgeted machine setup cost ÷ 10
  budgeted machine setup hours = $2,592
  allocation rate per machine setup-hour.
 How much machine setup related costs are
  allocated to each product line?

                                           6 - 70
     Activity-Based Budgeting

                  Product A Product B
  $2,592 × 5        $12,960
  $2,592 × 5                 $12,960
 Machine
  setup-related
  cost per unit:
  $12,960 ÷ 880        $14.73
 $12,960 ÷ 200                  $64.80
                                         6 - 71
    Learning Objective 7

Describe responsibility centers
and responsibility accounting




                              6 - 72
         What is Responsibility
            Accounting?

   It is a system for evaluating the performance
    of managers based on activities under their
    supervision.




                                               6 - 73
What is a Responsibility Center?

   It is any part, segment, or subunit of a
    business that needs control.
–   Production
–   Service




                                               6 - 74
 Types of Responsibility Centers

 Cost center – reports costs only while a
  revenue center reports only revenues.
 Profit center – reports revenues, expenses,
  and net income or net loss.
 Investment center – reports revenues,
  expenses, income or loss, and the investment
  used by the center.

                                            6 - 75
    Feedback and Fixing Blame

 Budgets coupled with responsibility
  accounting provide systematic help for
  managers, particularly if managers interpret
  the feedback carefully.
 How should managers use variances?




                                             6 - 76
   Learning Objective 8

Explain how controllability
 relates to responsibility
        accounting




                              6 - 77
      What is Controllability?

 It is the degree of influence that a specific
  manager has over costs, revenues, or other
  items in question.
 A controllable cost is any cost that is
  primarily subject to the influence of a given
  responsibility center manager for a given
  time period.


                                              6 - 78
             Controllability

 Responsibility accounting focuses on
  information and knowledge, not control.
 A responsibility accounting system could
  exclude all uncontrollable costs from a
  manager’s performance report.
 In practice, controllability is difficult to
  pinpoint.

                                                 6 - 79
End of Chapter 6




                   6 - 80

				
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