CHAPTER 10

BUDGETARY CONTROL AND

RESPONSIBILITY ACCOUNTING

CHAPTER LEARNING OBJECTIVES

1. Describe budgetary control and static budget reports. Budgetary control consists of (a) preparing periodic budget reports that compare actual results with planned objectives, (b) analyzing the differences to determine their causes, (c) taking appropriate corrective action, and (d) modifying future plans, if necessary.

Static budget reports are useful in evaluating the progress toward planned sales and profit goals. They are also appropriate in assessing a manager’s effectiveness in controlling costs when (a) actual activity closely approximates the master budget activity level, and/or (b) the behavior of the costs in response to changes in activity is fixed.

2. Prepare flexible budget reports. To develop the flexible budget it is necessary to do the following: (a) Identify the activity index and the relevant range of activity. (b) Identify the variable costs, and determine the budgeted variable cost per unit of activity for each cost. (c) Identify the fixed costs, and determine the budgeted amount for each cost. (d) Prepare the budget for selected increments of activity within the relevant range. Flexible budget reports permit an evaluation of a manager’s performance in controlling production and costs.

3. Apply responsibility accounting to cost and profit centers. Responsibility accounting involves accumulating and reporting revenues and costs on the basis of the individual manager who has the authority to make the day-to-day decisions about the items. The evaluation of a manager’s performance is based on the matters directly under the manager’s control. In responsibility accounting, it is necessary to distinguish between controllable and noncontrollable fixed costs and to identify three types of responsibility centers: cost, profit, and investment.

Responsibility reports for cost centers compare actual costs with flexible budget data. The reports show only controllable costs, and no distinction is made between variable and fixed costs. Responsibility reports show contribution margin, controllable fixed costs, and controllable margin for each profit center.

4. Evaluate performance in investment centers. The primary basis for evaluating performance in investment centers is return on investment (ROI). The equation for computing ROI for investment centers is Controllable margin ÷ Average operating assets.

^a5. Explain the difference between ROI and residual income. ROI is controllable margin divided by average operating assets. Residual income is the income that remains after subtracting the minimum rate of return on a company’s average operating assets. ROI sometimes provides misleading results because profitable investments are often rejected when the investment reduces ROI but increases overall profitability.

TRUE-FALSE STATEMENTS

1. Budget reports comparing actual results with planned objectives should be prepared only once a year.

2. If actual results are different from planned results, every difference must be investigated by management to achieve effective budgetary control.

3. Certain budget reports are prepared monthly while others are prepared more frequently depending on the activities being monitored.

4. The master budget is not used in the budgetary control process.

5. A master budget is most useful in evaluating a manager’s performance in controlling costs.

6. A static budget is one that is prepared for one level of activity.

7. A static budget is changed only when actual activity differs from the expected level of activity.

8. A static budget is most useful for evaluating a manager’s performance in controlling variable costs.

9. A flexible budget can be prepared for each of the types of budgets included in the master budget.

10. A flexible budget is a series of static budgets at different levels of activities.

11. Flexible budgeting relies on the assumption that unit variable costs will remain constant within the relevant range of activity.

12. Total budgeted fixed costs appearing on a flexible budget will be the same amount as total fixed costs on the master budget.

13. A flexible budget is prepared before the master budget.

14. The activity index used in preparing a flexible budget should not influence the total variable costs that are being budgeted.

15. One calculation used in developing a flexible budget is: Total budgeted cost = fixed cost + (total variable cost per unit × activity level).

16. Flexible budgets are widely used in production and service departments.

17. A flexible budget report shows both actual and budgeted cost based on the actual activity level achieved.

18. Management by exception means that management will investigate areas where actual results differ from planned results if the items are material and controllable.

19. Differences between actual and planned results are generally more likely to be investigated for noncontrollable items than for controllable items.

20. A distinction should be made between controllable and noncontrollable costs when reporting information under responsibility accounting.

21. Cost centers, profit centers, and investment centers can all be classified as responsibility centers.

22. More costs become controllable as one moves down to each lower level of managerial responsibility.

23. In a responsibility accounting reporting system, as one moves up each level of responsibility in an organization, the responsibility reports become more summarized and show less detailed information.

24. A cost center incurs costs and generates revenues and cost center managers are evaluated on the profitability of their centers.

25. The terms “direct fixed costs” and “indirect fixed costs” are synonymous with “traceable costs” and “common costs,” respectively.

26. Controllable margin is subtracted from controllable fixed costs to calculate net income for a profit center.

27. The denominator in the equation for calculating the return on investment includes operating and nonoperating assets.

28. The calculation for computing return on investment is controllable margin divided by average operating assets.

^a29. Residual income is a measure of the percentage return generated by the particular division being evaluated.

^a30. Residual income generates a dollar amount that is the increase in net income to the company beyond the cost necessary to pay for the financing of assets.

31. Budget reports provide feedback needed by management to see whether actual operations are on course.

32. A static budget is an effective means of evaluating a manager’s ability to control costs, regardless of the actual activity level.

33. The flexible budget report evaluates a manager’s performance in two areas: (1) production and (2) costs.

34. The terms controllable costs and noncontrollable costs are synonymous with variable costs and fixed costs, respectively.

35. Most direct fixed costs are not controllable by the profit center manager.

36. The manager of an investment center can improve ROI by reducing average operating assets.

^a37. Residual income and ROI are used as performance evaluation methods for profit center performance

MULTIPLE CHOICE QUESTIONS

38. What is budgetary control?

a. Another name for a flexible budget

b. The degree to which the CFO controls the budget

c. The use of budgets in controlling operations

d. The process of providing information on budget differences to lower level managers

39. A major element in budgetary control is

a. the preparation of long-term plans.

b. the comparison of actual results with planned objectives.

c. the valuation of inventories.

d. approval of the budget by the stockholders.

40. Budget reports should be prepared

a. daily.

b. monthly.

c. weekly.

d. as frequently as needed.

41. On the basis of the budget reports,

a. management analyzes differences between actual and planned results.

b. management may take corrective action.

c. management may modify the future plans.

d. All of these answers are correct.

42. The purpose of the departmental overhead cost report is to

a. control indirect labor costs.

b. control selling expense.

c. determine the efficient use of materials.

d. control overhead costs.

43. The purpose of the sales budget report is to

a. control selling expenses.

b. determine whether income objectives are being met.

c. determine whether sales goals are being met.

d. control sales commissions.

44. A comparison of differences between actual and planned results

a. is done by the external auditors.

b. appears on the company’s external financial statements.

c. is usually done orally in departmental meetings.

d. appears on periodic budget reports.

45. A static budget

a. should not be prepared in a company.

b. is useful in evaluating a manager’s performance by comparing actual variable costs and planned variable costs.

c. shows planned results at the original budgeted activity level.

d. is changed only if the actual level of activity is different than originally budgeted.

46. A static budget report

a. shows costs at only two or three different levels of activity.

b. is appropriate in evaluating a manager’s effectiveness in controlling variable costs.

c. should be used when the actual level of activity is materially different from the master budget activity level.

d. may be appropriate in evaluating a manager’s effectiveness in controlling costs when the behavior of the costs in response to changes in activity is fixed.

47. A static budget is appropriate in evaluating a manager’s performance if

a. actual activity closely approximates the master budget activity.

b. actual activity is less than the master budget activity.

c. the company prepares reports on an annual basis.

d. the company is a not-for-profit organization.

48. When budgeted and actual results are not the same amount, there is a budget

a. error.

b. difference.

c. anomaly.

d. by-product.

49. Top management’s reaction to a difference between budgeted and actual sales often depends on

a. whether the difference is favorable or unfavorable.

b. whether management anticipated the difference.

c. the materiality of the difference.

d. the personality of the top managers.

50. If costs are not responsive to changes in activity level, then these costs can be best described as

a. mixed.

b. flexible.

c. variable.

d. fixed.

51. Assume that actual sales exceed the budgeted sales for the second quarter. This favorable difference is greater than the unfavorable difference reported for the first quarter sales. Which of the following statements about the sales budget report on June 30 is true?

a. The year-to-date results will show a favorable difference.

b. The year-to-date results will show an unfavorable difference.

c. The difference for the first quarter can be ignored.

d. The sales report is not useful if it shows a favorable and unfavorable difference for the two quarters.

52. A static budget is appropriate for

a. variable overhead costs.

b. direct materials costs.

c. fixed overhead costs.

d. None of these answers are correct.

53. What is the primary difference between a static budget and a flexible budget?

a. The static budget includes only fixed costs while the flexible budget includes only variable costs.

b. The static budget is prepared for a single level of activity while a flexible budget is adjusted for different activity levels.

c. The static budget is constructed using input from only upper level management while a flexible budget obtains input from all levels of management.

d. The static budget is prepared only for units produced while a flexible budget reflects the number of units sold.

54. Another name for the static budget is the

a. master budget.

b. overhead budget.

c. permanent budget.

d. flexible budget.

55. The master budget of Windy Co. shows that the planned activity level for next year is expected to be 50,000 machine hours. At this level of activity, the following manufacturing overhead costs are expected:

Indirect labor $ 720,000

Machine supplies 180,000

Indirect materials 210,000

Depreciation on factory building 150,000

Total manufacturing overhead $1,260,000

A flexible budget for a level of activity of 60,000 machine hours would show total manufacturing overhead costs of

a. $1,482,000.

b. $1,260,000.

c. $1,512,000.

d. $1,362,000.

Ex. 180

Clark Company’s master budget reflects budgeted sales information for the month of June, 2022 as follows:

Budgeted Quantity Budgeted Unit Sales Price

Product A 40,000 $7

Product B 48,000 $9

During June, the company actually sold 39,000 units of Product A at an average unit selling price of $7.10 and 49,600 units of Product B at an average unit price of $8.90.

Instructions

Prepare a Sales Budget Report for the month of June for Clark Company which shows whether the company achieved its planned objectives.

Ex. 181

Beal Manufacturing Co.’s static budget at 12,000 units of production includes $72,000 for direct labor and $12,000 for direct materials. Total fixed costs are $48,000.

Instructions

a. Determine the total costs on Beal’s flexible budget for 2022 if 18,000 units are produced and sold.

b. How would this comparison differ if a static budget were used instead of a flexible budget for performance evaluation?

Ex. 182

Cody Co. developed its annual manufacturing overhead budget for its master budget for 2022 as follows:

Expected annual operating capacity 120,000 Direct Labor Hours

Variable overhead costs

Indirect labor $600,000

Indirect materials 120,000

Factory supplies 60,000

Total variable 780,000

Fixed overhead costs

Depreciation 240,000

Supervision 120,000

Property taxes 96,000

Total fixed 456,000

Total costs $1,236,000

The relevant range for monthly activity is expected to be between 8,000 and 12,000 direct labor hours.

Instructions

Prepare a flexible budget for a monthly activity level of 8,000 and 9,000 direct labor hours.

Ex. 183

Copper Manufacturing has prepared the following monthly flexible manufacturing overhead budget for its Mixing Department:

COPPER MANUFACTURING

Monthly Flexible Manufacturing Overhead Budget

Mixing Department

Activity level

Direct labor hours 3,000 4,000

Variable costs

Indirect materials $ 3,000 $ 4,000

Indirect labor 15,000 20,000

Factory supplies 4,500 6,000

Total variable 22,500 30,000

Fixed costs

Depreciation 20,000 20,000

Supervision 12,000 12,000

Property taxes 15,000 15,000

Total fixed 47,000 47,000

Total costs $69,500 $77,000

Instructions

Prepare a flexible budget at the 5,000 direct labor hours of activity.

Ex. 184

Berne, Inc. uses a flexible budget for manufacturing overhead based on machine hours. Variable manufacturing overhead costs per machine hour are as follows:

Indirect labor $5.00

Indirect materials 2.50

Maintenance .80

Utilities .30

Fixed overhead costs per month are:

Supervision $800

Insurance 200

Property taxes 300

Depreciation 900

The company believes it will normally operate in a range of 2,000 to 4,000 machine hours per month.

Instructions

Prepare a flexible manufacturing overhead budget for the expected range of activity using increments of 1,000 machine hours.

Ex. 185

Telemark Production’s budged manufacturing costs for July when production was projected to be 2,000 units appears below:

Direct materials $10 per unit

Factory depreciation $16,000

Variable overhead 10,000

Direct labor 4,000

Factory supervisory salaries 11,600

Other fixed factory costs 3,000

Instructions

What is the total flexible budget manufacturing cost for a month when 2,200 units are produced?

Ex. 186

Webb, Inc. uses a flexible budget for manufacturing overhead based on machine hours. Variable manufacturing overhead costs per machine hour are as follows:

Indirect labor $5.00

Indirect materials 2.50

Maintenance .50

Utilities .30

Fixed overhead costs per month are:

Supervision $1,200

Insurance 400

Property taxes 600

Depreciation 1,800

The company believes it will normally operate in a range of 4,000 to 8,000 machine hours per month. During the month of August, 2022, the company incurs the following manufacturing overhead costs:

Indirect labor $28,000

Indirect materials 16,200

Maintenance 2,800

Utilities 1,900

Supervision 1,440

Insurance 400

Property taxes 600

Depreciation 1,860

Instructions

Prepare a flexible budget report, assuming that the company used 6,000 machine hours during August.

Ex. 187

Lapp Manufacturing uses flexible budgets to control its selling expenses. Monthly sales are expected to be from $400,000 to $480,000. Variable costs and their percentage relationships to sales are:

Sales commissions 6%

Advertising 4%

Traveling 5%

Delivery 1%

Fixed selling expenses consist of sales salaries $80,000 and depreciation on delivery equipment $20,000.

Instructions

Prepare a flexible budget for increments of $40,000 of sales within the relevant range.

Ex. 188

Cadiz Co. uses flexible budgets to control its selling expenses. Monthly sales are expected to be from $300,000 to $360,000. Variable costs and their percentage relationships to sales are:

Sales commissions 5%

Advertising 4%

Traveling 7%

Delivery 1%

Fixed selling expenses consist of sales salaries $40,000 and depreciation on delivery equipment $10,000.

The actual selling expenses incurred in February, 2022, by Cadiz are as follows:

Sales commissions $17,200

Advertising 12,000

Traveling 23,700

Delivery 2,400

Fixed selling expenses consist of sales salaries $41,500 and depreciation on delivery equipment $10,000.

Instructions

Prepare a flexible budget performance report assuming that February sales were $330,000.

Ex. 189

A flexible budget graph for the Assembly Department shows the following:

1. At zero direct labor hours, the total budgeted cost line intersects the vertical axis at $120,000.

2. At normal capacity of 50,000 direct labor hours, the line drawn from the total budgeted cost line intersects the vertical axis at $360,000.

Instructions

Develop the budgeted cost calculation for the Assembly Department and identify the fixed and variable costs.

Ex. 190

Ace Production Co. has two production departments, Fabricating and Assembling. At a department managers’ meeting, the controller uses flexible budget graphs to explain total budgeted costs. Separate graphs based on direct labor hours are used for each department. The graphs show the following.

1. At zero direct labor hours, the total budgeted cost line and the fixed cost line intersect the vertical axis at $100,000 in the Fabricating Department and $80,000 in the Assembling Department.

2. At normal capacity of 100,000 direct labor hours, the line drawn from the total budgeted cost line intersects the vertical axis at $360,000 in the Fabricating Department and $290,000 in the Assembling Department.

Instructions

(a) State the total budgeted cost calculation for each department.

(b) Compute the total budgeted cost for each department, assuming actual direct labor hours worked were 106,000 and 94,000, in the Fabricating and Assembling Departments, respectively.

Ex. 191

Hubbard, Inc.’s static budget at 3,000 units of production includes $12,000 for direct labor, $3,000 for utilities (variable), and total fixed costs of $24,000. Actual production and sales for the year was 9,000 units, with an actual cost of $70,800.

Instructions

Determine if Hubbard is over or under budget.

Ex. 192

Campbell Clothing produces men’s athletic socks. The following budgeted and actual amounts are for 2022:

Cost Budget at 5,000 Units Actual Amounts at 5,800 Units

Direct materials $60,000 $71,000

Direct labor 75,000 86,500

Equipment depreciation 5,000 5,000

Indirect labor 7,500 8,600

Indirect materials 9,000 9,600

Rent and insurance 12,000 13,000

Instructions

Prepare a flexible budget report for Campbell Clothing for the year.

Ex. 193

Data concerning manufacturing overhead for Wilson Industries are presented below. The Mixing Department is a cost center.

An analysis of the overhead costs reveals that all variable costs are controllable by the manager of the Mixing Department and that 50% of supervisory costs are controllable at the department level.

The flexible budget calculation and the cost and activity for the months of July and August are as follows:

Flexible Budget per

Direct Labor Hour Actual Costs and Activity

July August

Direct labor hours 6,000 7,000

Overhead costs

Variable

Indirect materials $3.50 $ 20,500 $ 25,100

Indirect labor 6.00 39,500 40,700

Factory supplies 1.00 7,600 8,200

Fixed

Depreciation $20,000 15,000 15,000

Supervision 25,000 23,000 26,000

Property taxes 10,000 12,000 12,000

Total costs $117,600 $127,000

Instructions

(a) Prepare the responsibility reports for the Mixing Department for each month.

(b) Comment on the manager’s performance in controlling costs during the two month period.

Ex. 194

Strickland Corp.’s manufacturing overhead budget for the first quarter of 2022 contained the following data:

Variable Costs

Indirect materials $40,000

Indirect labor 24,000

Utilities 20,000

Maintenance 12,000

Fixed Costs

Supervisor’s salary $80,000

Depreciation 16,000

Property taxes 8,000

Actual variable costs for the first quarter were:

Indirect materials $37,200

Indirect labor 26,400

Utilities 21,000

Maintenance 10,600

Actual fixed costs were as expected except for property taxes which were $9,000. All costs are considered controllable by the department manager except for the supervisor’s salary.

Instructions

Prepare a manufacturing overhead responsibility report for the first quarter.

Ex. 195

The Deluxe Division, a profit center of Riley Manufacturing Company, reported the following data for the first quarter of 2022:

Sales $9,000,000

Variable costs 6,300,000

Controllable direct fixed costs 1,200,000

Noncontrollable direct fixed costs 530,000

Indirect fixed costs 300,000

Instructions

(a) Prepare a responsibility report for the manager of the Deluxe Division.

(b) What is the best measure of the manager’s performance? Why?

(c) How would the responsibility report differ if the division was an investment center?

Ex. 196

Danner Kicks Co. has three divisions which are operated as profit centers. Actual operating data for the divisions listed alphabetically are as follows.

Operating Data Women’s Shoes Men’s Shoes Children’s Shoes

Contribution margin $280,000 (3) $220,000

Controllable fixed costs 130,000 (4) (5)

Controllable margin (1) $ 90,000 96,000

Sales 800,000 480,000 (6)

Variable costs (2) 330,000 250,000

Instructions

(a) Compute the missing amounts. Show computations.

(b) Prepare a responsibility report for the Women’s Shoe Division assuming (1) the data are for the month ended June 30, 2022, and (2) all actual data equal budgeted data except variable costs which are $20,000 over budget.

Ex. 197

The Real Estate Products Division of McKenzie Co. is operated as a profit center. Sales for the division were budgeted for 2022 at $1,250,000. The only variable costs budgeted for the division were cost of goods sold ($610,000) and selling and administrative ($80,000). Fixed costs were budgeted at $130,000 for cost of goods sold, $120,000 for selling and administrative costs, and $95,000 for noncontrollable fixed costs. Actual results for these items were as follows:

Sales $1,175,000

Cost of goods sold

Variable 545,000

Fixed 140,000

Selling and administrative

Variable 82,000

Fixed 100,000

Noncontrollable fixed 105,000

Instructions

(a) Prepare a responsibility report for the Real Estate Products Division for 2022.

(b) Compute ROI assuming the division is an investment center, and average operating assets were $1,200,000.

Ex. 198

The Pacific Division of Henson Industries reported the following data for the current year:

Sales $4,000,000

Variable costs 2,600,000

Controllable fixed costs 800,000

Average operating assets 5,000,000

Top management is unhappy with the investment center’s return on investment. It asks the manager of the Pacific Division to submit plans to improve ROI in the next year. The manager believes it is feasible to consider the following independent courses of action.

1. Increase sales by $400,000 with no change in the contribution margin percentage.

2. Reduce variable costs by $120,000.

3. Reduce average operating assets by 4%

Instructions

(a) Compute the return on investment for the current year.

(b) Compute the ROI under each of the proposed courses of action. (Round to one decimal.)

Ex. 199

The Medford Burkett Company uses a responsibility reporting system to measure the performance of its three investment centers: Planes, Taxis, and Limos. Segment performance is measured using a system of responsibility reports and return on investment calculations. The allocation of resources within the company and the segment managers’ bonuses are based in part on the results shown in these reports.

Recently, the company was the victim of a computer virus that deleted portions of the company’s accounting records. This was discovered when the current period’s responsibility reports were being prepared. The actual operating results appeared as follows.

Ex. 199 (Cont’d)

Instructions

Determine the missing pieces of information above.

Ex. 200

Perez Corp. reported the following:

Beginning of year operating assets $3,200,000

End of year operating assets 3,000,000

Contribution margin 1,000,000

Sales 5,000,000

Controllable fixed costs 643,000

Its required return is 10%.

Instructions

Compute the company’s ROI.

Ex. 201

Lombard, Inc. has two investment centers and has developed the following information:

Instructions

1. What was the amount of Department A’s average operating assets? $____________.

2. What was the amount of Department B’s controllable margin? $____________.

3. If Department B is able to reduce its operating assets by $100,000, Department B’s new ROI would be ____________.

4. If Department A is able to increase its controllable margin by $60,000 as a result of reducing variable costs, Department A’s new ROI would be _________________.

Ex. 202

The Atlantic Division of Stark Productions Company reported the following results for 2022:

Sales $4,000,000

Variable costs 3,200,000

Controllable fixed costs 300,000

Average operating assets 2,500,000

Management is considering the following independent alternative courses of action in 2023 in order to maximize the return on investment for the division.

1. Reduce controllable fixed costs by 10% with no change in sales or variable costs.

2. Reduce average operating assets by 10% with no change in controllable margin.

3. Increase sales $500,000 with no change in the contribution margin percentage.

Instructions

(a) Compute the return on investment for 2022.

(b) Compute the expected return on investment for each of the alternative courses of action.

Ex. 203

Data for the following subsidiaries of Olive Manufacturing, which are operated as investment centers, are as follows:

Fleming Company Oak Company

Sales $3,000,000 $2,000,000

Controllable margin (1) (3)

Average operating assets (2) 4,000,000

Contribution margin 1,200,000 800,000

Controllable fixed costs 500,000 200,000

Return on Investment 10% (4)

Instructions

Compute the missing amounts using the ROI calculation.

Ex. 204

The data for an investment center is given below.

1/1/22 12/31/22

Current assets $ 300,000 $ 700,000

Plant assets 3,000,000 4,000,000

Idle plant assets 250,000 330,000

Land held for future use 1,200,000 1,200,000

The controllable margin is $760,000.

Instructions

What is the return on investment for the center for 2022?