Chapter 6:
Master Budget and
Responsibility Accounting
Coordinating Actions and Tuning them
according to Strategic Goals
and
Evolutions in the External Environment
1
Budgeting Cycle
z
z
z
z
z
Performance planning
Providing a frame of reference
Investigating variations
Corrective action
Planning again
Figure: from Anthony, Robert N.(1988)
The Management Control Function,
Harvard Business School Press,
Boston (Mass.), p.80.
2
The Master Budget
Master Budget
Operating
Decisions
based on one
expected scenario
Financial
Decisions
3
Why Budgets?
Budgets
z Convey understanding of strategy to
managers and other employees
z
Provide a framework for judging performance
z
Motivate employees and managers by setting
targets as a basis of performance
measurement
z
Promote coordination and communication
4
Time Coverage of Budgets
z
z
z
Budgets typically concern a definite time
period (month, quarter, year).
This time period can itself be broken into
sub-periods with extended or refined
targets
The most frequently used budget period
is one year.
Œ
Businesses are increasingly using rolling
horizon budgets: a coarse budget for a long
period is decomposed in a sequence of finer
budgets for consecutive sub-periods
5
Example: Operating Budget
Materials
Inventory Budget
Sales Budget
Procurement Budget
Production Budget
Requirements
Budget:
- Materials
- Labor
- Capacities
Finished Goods
Inventory Budget
Revenue Budget
Non-Production
Cost Budget
Production Cost Budget
- direct
- overhead
6
Revenues and Cost of Goods Sold Budget
z
Hawaii Diving expects 1,600 units of surfboards to
be sold during the month of August 2004.
Œ
⇒
Selling price is expected to be $240 per unit.
budgeted revenues for the month: 1,600 × $240 =
$384,000
Œ
Œ
Œ
Œ
Œ
Œ
Two pounds of direct materials are budgeted per unit at a
cost of $2.00 per pound, $4.00 per unit
$ 6,400
Three direct labor-hours are budgeted per unit
at $7.00 per hour, $21.00 per unit
$ 33,600
Variable overhead is budgeted at $8.00 per direct laborhour, $24.00 per unit.
$ 38,400
Fixed overhead is budgeted at $8,000 per month*) $ 8,000
Budgeted Cost of goods sold:
86,400
i.e. 54.00 per unit.
*) at normal capacity of 1600
7
Production Budget, Example
Budgeted sales (units): 1 600
+
–
Target ending finished goods inventory (units): 580
=
Budgeted production (units): 1080
Beginning finished goods inventory (units): 1 100
8
Direct Materials Usage Budget
z
Data requirements:
Œ
Œ
Œ
Œ
Œ
Œ
Œ
Œ
z
materials content of product per unit
+ budgeted allowance for waste and scrap
= material required per unit
× budgeted production (from production budget)
= budgeted material usage
× budgeted purchase price per unit of material
summed over all kinds of direct material
= budgeted materials cost
For each material:
Œ
Budgeted material usage
Π+ desired ending inventory
Π= budgeted materials procurement
procurement volume
× purchase price
summed over all kinds of material
+ change in accounts payable
= budgeted financial requirements
for direct materials
9
Direct Materials Usage Budget
z
z
z
z
Each finished unit requires 2 pounds of direct
materials at a cost of $2.00 per pound.
Desired ending inventory equals 15% of the
materials required to produce next month’s sales.
September sales are forecasted to be 1,600 units.
Budgeted Ending inventory in August: 480 pounds
10
Direct Materials Usage Budget
z
z
z
z
Budgeted September sales 1,600
× 2 pounds per unit = 3,200 pounds
desired ending inventory: 3,200 × 15% = 480 pounds
budgeted beginning inventory in August
1,100 units × 2 × 15% = 330 units
Pounds needed to produce 1,080 units in August:
1,080 × 2 = 2,160 pounds
11
Material Purchases Budget
z
Hawaii Diving Direct Material Purchases Budget for
the Month of August 2004
Units needed for production
Target ending inventory
Total material to provide for
Less beginning inventory
Units to be purchased
Unit purchase price
$ 2.00
Total purchase cost
2,160
480
2,640
330
2,310
$4,620
12
Direct Manufacturing Labor Budget
z
z
Each unit requires 3 direct labor-hours at $7.00 per
hour.
Hawaii Diving Direct Labor Budget for the Month of
August 2004
Units produced:
Direct labor-hours/unit
Total direct labor-hours:
Total budget at $7.00/hour:
1,080
3
3,240
$22,680
13
Manufacturing Overhead Budget
z
z
z
Variable overhead is budgeted at $8.00 per direct
labor-hour.
Fixed overhead is budgeted at $5,400 per month.
Hawaii Diving Manufacturing Overhead Budget for
the Month of August 2004:
Variable Overhead: (3,240 × $8.00) $25,920
Fixed Overhead
5,400
Total
$31,320
14
Ending Inventory Budget
z
Cost per finished unit:
Œ
Œ
Œ
Œ
Œ
z
z
Materials
$ 4
Labor
21
Variable manufacturing overhead
24
Fixed manufacturing overhead
5*
Total
$54
• * $8,000 ÷ 1,600 = $5
• Notice that only the cost of utilized capacity are
inventoriable. (1,600 – 1080)·5 = 2,600 go
directly into period costs.
Cost of the target ending inventory for materials:
480 × $2 = $960
Cost of the target finished goods inventory:
580 × $54 = $31,320
15
Cost of Goods Sold Budget
Œ
Direct materials used 2,160 × $2.00
ΠDirect labor
Œ Total overhead (= 24 + 5)·1,080 =
ΠCost of goods manufactured
z
4,320
22,680
31,320
$58,320
Assume:
Œ
beginning finished goods inventory: 1100@54 = $59,400
ΠEnding finished goods inventory is
580@54 = 31,320.
z
Cost of goods sold
Beginning finished goods inventory
+ Cost of goods manufactured
= Goods available for sale
– Ending finished goods inventory
= Cost of goods sold (cf. p.7)
$59,400
$58,320
$117,720
$ 31,320
$ 86,400
16
Nonmanufacturing Costs Budget
z
Hawaii Diving Other Expenses Budget for the Month
of September 2004
Variable Expenses:
Fixed expenses*)
Total
($0.14 × $264,000)
$36,960
7,800
$44,760
*) Includes the unabsorbed capacity cost of 5,200, see p.15
17
Cost of Goods Sold Budget
z
z
z
z
Hawaii 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?
Hawaii Diving Budgeted Income Statement for the
Month ending August 31, 2004
Sales
Less cost of sales
Gross margin
Other expenses
Operating income
$264,000
59,400
$204,600
44,760
$159,840
100%
22%
78%
17%
61%
18
Financial Planning Models
z
Financial planning models are
mathematical representations of the
interrelationships among operating
activities, financial activities, and other
factors that affect the master budget.
Œ
see also: Budget.xls at the course web
site.
19
Example: Cash Budget
z
Depends on collection pattern:
z
In the month of sale:
In the month following sale:
In the second month following sale:
Uncollectible:
z
z
z
50%
27%
20%
3%
20
Cash Budget
z
Budgeted sales are as follows:
Œ
June
ΠJuly
ΠAugust
ΠSeptember
z
$200,000
$250,000
$264,000
$260,000
What are the expected cash collections in
August?
21
Cash Budget
z
Budgeted Cash Receipts
z
for the Month Ending August 31, 2004
z
z
August sales:
July sales:
June sales:
z
Total
z
$264,000 × 50%
$250,000 × 27%
$200,000 × 20%
$132,000
$67,500
$40,000
$239,500
22
Cash Budget
z
Budgeted Cash Disbursements
z
for the Month Ending August 31, 2004
August purchases
Direct labor
Total overhead
Other expenses
Total
z
z
z
z
z
$ 4,620
$22,680
$31,320
$ 9,760*
$68,380
*Other expenses exclude depreciation
23
Cash Budget
Cash Budget
for the Month Ending August 31, 2004
Budgeted receipts
Budgeted disbursements
Net increase in cash
$239,500
68,380
$171,120
24
Exercise:
Prepare a purchases budget in pounds for July, August, and September,
and give total purchases in both pounds and dollars for each month.
Lubriderm Corporation has the following budgeted sales for the
next six-month period:
Month
June
July
August
September
October
November
Unit Sales
90,000
120,000
210,000
150,000
180,000
120,000
There were 30,000 units of finished goods in inventory at the
beginning of June. Plans are to have an inventory of finished
products that equal 20% of the unit sales for the next month.
Five pounds of materials are required for each unit produced.
Each pound of material costs $8. Inventory levels for materials
are equal to 30% of the needs for the next month. Materials
inventory on June 1 was 15,000 pounds
25
What is Kaizen?
z
z
The Japanese use the term “kaizen” for
continuous improvement.
Kaizen budgeting is an approach that
explicitly incorporates continuous
improvement during the budget period into
the budget numbers.
26
Kaizen Budgeting
A kaizen budgeting approach would
incorporate future improvements.
Budgeted Hours/Item
January – March 2004
3.00
April – June 2004
2.95
July – September 2004
2.90
October – December 2004
2.85
27
Controlling achievement
Budgeted
fixed cost
Budgeted
variable Costs
Actual
123
Kaizen Costing Effect
14243
Costs
volume
Actual volume
Budgeted volume
See: Monden, Y.,
Japanese management accounting : a world class approach to profit management
28
3rd print. - Cambridge, Mass. [u.a.] : Productivity Press, 1992 Ch. 28
Activity-Based Budgeting
Activity-based Costing (ABC)
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.
29
Activity-Based Budgeting
z
z
z
z
z
z
z
z
z
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.
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?
Œ
$25,920 ÷ 3,240 = $8.00
30
Activity-Based Budgeting
z
z
z
z
z
z
z
z
Total cost allocated to each product line:
Product A: $8.00 × 2,640
=
$21,120
Product B: $8.00 × 600
=
$ 4,800
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?
31
Activity-Based Budgeting
Product A
$12,960
$2,592 × 5
Product B
$12,960
$2,592 × 5
Setup-related cost per unit:
Product A: $12,960 ÷ 880
$14.73
Product B: $12,960 ÷ 200
$64.80
32
Responsibility Accounting
z
Responsibility accounting tries to figure out the
causal relationship between managers‘ actions and
the achievement of organization‘s objectives as
clearly as possible
Œ
isolating other influences
Πaccounting for known outside effects
Πconsiderable noise in the measures will remain
z
Responsibility center (Definition)
Œ
z
any part, segment, or subunit of a business that needs
control.
Types of Responsibility Centers
Œ
Cost Center
ΠProfit Center
ΠInvestment Center
33
Controllability
z
Definition
Œ
z
property of a performance measure such as
• costs
• revenues
• department profit
• return ob investment;
A performance measure is controllable to the degree the
responsible manager can exert influence on it.
Controllability is less relevant a property for
responsibility accounting than is informativeness on
the actions of the manager
Œ
any (costlessly available) performance measure that is
informative on the manager‘s action should enter his or her
performance evaluation
Πe.g. benchmarking information
34
Human aspects of Budgeting
z
z
z
Budgeting should not be considered as a
„mechanical tool“
Quality of the budget depends on the information
that is fed into the process
There are incentives for dishonest reports
Œ
Budgetary slack
ΠEmpire building
z
Management aims to ensure honest reporting by
lower level management
Œ
Via appropriate performance measures
ΠMonitoring
35