CHAPTER 6
MASTER BUDGET AND RESPONSIBILITY ACCOUNTING
LEARNING OBJECTIVES
1. Understand what a master budget is and explain its benefits
2. Describe the advantages of budgets
3. Prepare the operating budget and its supporting schedules
4. Use computer-based financial planning models in sensitivity analysis
5. Explain kaizen budgeting and how it is used for cost management
6. Prepare an activity-based budget
7. Describe responsibility centers and responsibility accounting
8. Explain how controllability relates to responsibility accounting
CHAPTER OVERVIEW
Chapter 6 describes a major feature of management planning and control systems, budgets. The importance of satisfying customers and succeeding in the marketplace compels the use of a common accounting tool for planning and controlling, budgeting. As noted in the chapter, “Few businesses plan to fail, but many of those that flop, failed to plan.” The chapter describes how budgeting is used in implementing plans developed through strategic planning, assisting managers in their planning function. Chapter 7 will describe how budgets aid managers in their control function. The wise and skillful administration of the budget is what gives budgets value because budgets, in themselves, are neither good nor bad.
The report models used in budgeting are familiar, as they are the basic financial statements. The statements are approached from a different perspective, as typically projected sales are the starting point for preparing a budget. In costing systems studied in the previous two chapters, sales are the result of operations rather than the beginning consideration. Preparation of an operating budget is illustrated. Cash budgeting, a part of financial budgeting, is illustrated in the appendix to the chapter.
The theme of continuous improvement is featured through a description of kaizen budgeting. For organizations that use activity-based costing and activity-based management, activity-based budgeting works back through the activity-based costing system using the same defined activities and relationships.
Responsibility accounting is introduced as a means of coordinating the efforts of all employees in an organization to attain the goals described in the master budget. The notion of controllability is addressed.
The chapter closes with a crucial aspect of budgeting – the human factor. The importance of the role of people in the budgeting process is acknowledged throughout the chapter.
CHAPTER OUTLINE
I. Budgeting – common accounting tool companies use for planning and controlling to satisfy customers and succeed in the marketplace
A. Budgets and the budgeting cycle
1. Budgets—assisting managers in their planning function
a. Quantitative expression of a proposed plan of action by management for a specified period
b. An aid to coordinating what needs to be done to implement that plan
2. Budgeting cycle: guide to well-managed organizations {thought process/decision making}
a. Planning the performance of company as a whole as well as subunits: management at all levels agree on what is expected
b. Providing a frame of reference, a set of specific expectations for use in comparing actual results
c. Investigating variations from plans: makes possible corrective action after investigation
d. Planning again in light of feedback and changing conditions
3. Terms used
Learning Objective 1:
Understand what a master budget is and explain its benefits
a. Master budget
i. Summarizes financial projections of all of company’s budgets and plans
ii. Expresses management’s operating and financing plans with formalized outline of financial objectives and how to attain
iii. Provides a tool that is neither good nor bad, but valuable when administered skillfully
b. Pro forma statements: term used for budgeted financial statements
Do multiple choice 1 and 2. Assign Problem 6-31.
Learning Objective 2:
Describe the advantages of budgets
B. Advantages and benefits of budgeting: big part of most management control systems
(Prepared when expected benefits exceed expected costs)
1. Compels strategic planning and implementation of plans
a. Considers strategy questions integral to company’s strategic analysis
b. Effects both long-run and short-run planning
c. Provides feedback that can signal revisions to plan and possibly strategies
2. Provides framework for judging performance
a. Can overcome limitation of using past results that incorporate miscues and substandard performance
b. Can overcome limitation of using past performance when future conditions may be expected to differ from the past
3. Motivates managers and employees
a. Individuals likely to work more intensely to avoid failure than to achieve success
b. A little anxiety improves performance
4. Promotes coordination and communication among subunits within the company
a. Need to think of relationships among individual operations, departments, company as a whole, and across companies during budgeting process as well as production process for satisfying customers
b. Need to have goals understood and accepted by all employees
C. Administration of budgets [Surveys of Company Practice]
1. Benefits of budgeting comes when management at all levels of company understand and support the budget and all aspects of management control system
2. Top management support critical for obtaining active line-management participation
3. Attainment of budget should not be an end in itself
D. Time coverage of budgets
1. Purpose of budget should guide time period chosen
2. Ongoing coverage through use of rolling budget
Do multiple choice 3. Assign Exercise 6-16.
II. The master budget
A. Financial budget: includes capital expenditures, cash, balance sheet, and cash flows
Learning Objective 3:
Prepare the operating budget and its supporting schedules
B. Steps in developing an operating budget: budgeted income statement and its supporting budget schedules [Exhibit 6-2]
1. Step 1: Prepare the revenues budget: usual starting point in budgeting
2. Step 2: Prepare the production budget (in units)
3. Step 3: Prepare the direct materials usage and purchases budgets
4. Step 4: Prepare the direct manufacturing labor budget
5. Step 5: Prepare the manufacturing overhead budget
6. Step 6: Prepare the ending inventories budget
7. Step 7: Prepare the cost of goods sold budget
8. Step 8: Prepare the nonmanufacturing costs budget
9. Step 9: Prepare the budgeted income statement [Exhibit 6-3] [Concepts in Action]
Do multiple choice 4 and 5. Assign Exercises 6-17 through 6-19 and Problems 6-30 and 6-34.
Learning Objective 4:
Use computer-based financial planning models in sensitivity analysis
C. Computer-based financial planning models – assist in sensitivity analysis
Do multiple choice 6. Assign Problem 6-29.
D. Variations [Exhibit 6-4]
Learning Objective 5:
Explain kaizen budgeting and how it is used for cost management
1. Kaizen budgeting: based on idea it is possible to continuously reduce costs over time
Do multiple choice 7. Assign Exercise 6-25 (a continuation of 6-24—and of 5-24).
Learning Objective 6:
Prepare an activity-based budget
2. Activity-based budgeting: focuses on budgeted costs of activities needed to produce and sell products and services—emphasizes future costs and future use of activity areas
Do multiple choice 8. Assign Exercise 6-24 (see 5-24).
Learning Objective 7:
Describe responsibility centers and responsibility accounting
III. Responsibility accounting: system that measures the plans and actions of each responsibility center
A. Structure of organization shapes efforts of coordination—assigning responsibility to managers who are accountable for actions in planning and controlling human and physical resources
1. Organization structure: an arrangement of lines of responsibility within the organization
a. Responsibility center: part , segment, or subunit of an organization whose manager is accountable for a specified set of activities
i. Cost center – manager accountable for costs only
ii. Revenue center – manager accountable for revenues only
iii. Profit center – manager accountable for revenues and costs
iv. Investment center – manager accountable for investments, revenues, and costs
b. Responsibility accounting: system that measures plans by budgets and actions by actual results of each responsibility center
2. Feedback, use of variances—early warning, performance evaluation, and evaluating strategy
Do multiple choice 9. Assign Exercises 6-25 and 6-26 and Problem 6-29.
Learning Objective 8:
Explain how controllability relates to responsibility accounting
B. Controllability: degree of influence that a specific manager has over costs, revenues, and related items for which responsible
1. Difficult to pinpoint
a. Few costs clearly under influence of one manager
b. Long enough time span, all costs come under somebody’s control
2. Emphasis on information and behavior
a. Responsibility focuses on whom to ask to obtain information, not on whom to blame
b. Performance reports may include uncontrollable items because could change behavior in directions top management desire
Do multiple choice 10. Assign Problem 6-32.
IV. Human aspects of budgeting—human factors are a crucial part of budgeting
V. Cash budgeting [appendix]
Do multiple choice 11 and 12. Assign Exercise 6-27 and Problem 6-35.
CHAPTER QUIZ SOLUTIONS: 1.d 2.a 3.b 4.d 5.c 6.b 7.c 8.a 9.d 10.b 11.c 12.b
CHAPTER QUIZ
1. Budgeting is the common accounting tool companies use for planning and controlling. Budgets
a. provide a measure of planned financial results.
b. focus managers’ energies on exploiting opportunities.
c. help managers anticipate potential problems.
d. enable managers to control through a set of specific activities with defined corrective actions.
2. [AICPA Adapted] Dewitt Co. budgeted its activity for October 2002 from the following information:
§ Sales are budgeted at $750,000. All sales are credit sales and a provision for doubtful accounts is made monthly at the rate of 2% of sales.
§ Merchandise inventory was $120,000 at September 30, 2002, and an increase of $10,000 is planned for the month.
§ All merchandise is marked up to sell at invoice cost plus 50%.
§ Estimated cash disbursements for selling and administrative expenses for the month are $105,000.
§ Depreciation for the month is projected at $25,000.
Dewitt is projecting operating income for October 2002 in the amount of
a. $105,000. b. $119,000. c. $129,000. d. $230,000.
3. Which of the following is not a major benefit of budgets?
a. compels planning c. provides performance criteria
b. eliminates innovation d. promotes coordination and communication
The following data apply to questions 4 and 5.
Hester Company budgets on an annual basis for its fiscal year. The following beginning and ending inventory levels (in units) are planned for the fiscal year of July 1, 2001, through June 30, 2002.
July 1, 2001 June 30, 2002
Raw material1 40,000 10,000
Work in process 8,000 8,000
Finished goods 30,000 5,000
1 Three (3) units of raw material are needed to produce each unit of finished product.
4. [CMA Adapted] If Hester Company plans to sell 500,000 units during the 2001-2002 fiscal year, the number of units it would have to manufacture during the year would be
a. 505,000 units. b. 500,000 units. c. 480,000 units. d. 475,000 units.
5. [CMA Adapted] If 450,000 finished units were to be manufactured during the 2001-2002 fiscal year by Hester Company, the units of raw material needed to be purchased would be
a. 1,350,000 units. b. 1,360,000 units. c. 1,320,000 units. d. 1,330,000 units.
6. Which of the following does not pertain to financial planning models in software form?
a. Reduces computational burden and time required to prepare budgets
b. Eliminates need to update budgets as uncertainty resolved
c. Assists managers with sensitivity analysis
d. Performs calculations that are mathematical representations of relationships in master budget
7. The major cost management concept used in kaizen budgeting is that of
a. eliminating inventories of every type but materials.
b. refinements in the indirect-cost categories for costing systems.
c. continuous improvement.
d. sensitivity analysis using computer-based financial planning models.
8. Activity-based budgeting for a setup activity would require budgeting costs
a. separately for the setup activity.
b. for the department in which the setup activity would occur.
c. on a per unit basis for the number of units involved in the setup.
d. separately for variable and fixed categories for the setup activity.
9. Which of the following statements does not describe responsibility accounting?
a. It measures the plans and actions of each responsibility center.
b. It budgets to emphasize that for which each responsibility center is accountable.
c. It calculates variances between budgeted and actual for each responsibility center.
d. It identifies managers at fault for operating problems by reports for each responsibility center.
10. The important question to ask in explaining how controllability relates to responsibility accounting is:
a. Whom to blame? c. Whom to hold responsible?
b. Whom to ask? d. Who has control?
The following data apply to questions 11 and 12 [Appendix]:
Information pertaining to Brenton Corporation's sales revenue is presented in the following table:
February March April
Cash sales $160,000 $150,000 $120,000
Credit sales 300,000 400,000 280,000
Total sales $460,000 $550,000 $400,000
Management estimates that 5% of credit sales are not collectible. Of the credit sales that are collectible, 60% are collected in the month of sale and the remainder in the month following the sale. Cost of purchases of inventory each month are 70% of the next month's projected total sales. All purchases of inventory are on account; 25% are paid in the month of purchase, and the remainder is paid in the month following the purchase.
11. [CMA Adapted] Brenton's budgeted total cash receipts in April are
a. $448,000. b. $437,000. c. $431,600. d. $328,000.
12. [CMA Adapted] Brenton's budgeted total cash payments in March for inventory purchases are
a. $385,000. b. $358,750. c. $306,250. d. $280,000.
WRITING/DISCUSSION EXERCISES
1. Understand what a master budget is and explain its benefits
Describe the evolution of a management control system, including how budgets became a major feature of that system. In a small, new organization, personal observation is usually the dominant means of control. A manager sees, touches, and hears the relationship between inputs and outputs; he or she oversees the work and actions of various personnel.
Over time, managers add historical records to their personal observations. Historical records allow managers to compare current performance with past performance. How well were customer needs satisfied in the current year compared with last year? Analyses of past performance can help improve future performance. Managers must deal with a series of periods, not just one at a time.
As the organization matures, budgeting becomes an important step in the growth and improvement of the accounting system. A manager would find it helpful to compare actual performance in the current year with the plans prepared for the current year. Budgeting systems help promote this future perspective.
2. Describe the advantages of budgets
If budgeting is filling in the financial statements with “what-if” numbers, why is budgeting considered such a major task and so important to an organization? The mechanics of preparing a budget may seem simplistic. What lies behind the numbers is of consequence. A budget is similar to a blueprint. Before the process of drawing out the blueprints for a building or piece of equipment, many factors have to be considered. Of particular importance for a company are the objectives and the strategy to accomplish those. If the objectives are clear and the strategy determined, people must make it happen over a period of time in a variety of environments. And even the nicest of blueprints must give way to events and unforeseen circumstances. Blueprints, as initially developed, do not often become floor plans. For who would not want to take advantage of having better materials used or a slightly different design if the opportunity arose. An ancient proverb expresses some of the problem in developing a budget, “Many a slip ‘twixt cup and lip.” It is not possible to plan for everything, and yet the process of budgeting requires thinking about most things and incorporating all possibilities to the extent they are cost/beneficial.