WEEK 12

RESPONSIBILITY ACCOUNTING AND BUDGETARY CONTROL

Study objectives:
1. Describe the concept of budgetary control.
2. Evaluate the usefulness of static budget reports.
3. Explain the development of flexible budgets and the usefulness of flexible budget
reports.
4. Describe the concept of responsibility accounting.
5. Indicate the features of responsibility reports for cost centers.
6. Identify the content of responsibility reports for profit centers.
7. Explain the basis and formula used in evaluating performance in investment
centers.
8. Explain the difference between ROI and residual income.

Budgetary Control

The use of budgets in controlling operations is known as budgetary control. Such

control takes place by means of budget reports that compare actual results with planned
objectives. The budget reports provide management with feedback on operations.

Budgetary control involves:

a. Developing budgets.
b. Analyzing the differences between actual and budgeted results.
c. Taking corrective action.
d. Modifying future plans, if necessary.

Budgetary control works best when a company has a formalized reporting system. The
system should
a. Identify the name of the budget report such as the sales budget or the
manufacturing overhead budget.
a. State the frequency of the report such as weekly, or monthly.
b. Specify the purpose of the report.
c. Indicate the primary recipient(s) of the report.

Static Budget Reports

A static budget does not modify or adjust data regardless of changes in activity during
the year. As a result, actual results are always compared with the budget data at the
activity level used in developing the master budget.

A static budget is appropriate in evaluating a manager’s effectiveness in controlling costs

when (a) the actual level of activity closely approximates the master budget activity level,
and/or (b) the behavior of the costs in response to changes in activity is fixed.

Flexible Budgets

A flexible budget projects budget data for various levels of activity. The flexible budget
recognizes that the budgetary process is more useful if it is adaptable to changed
operating conditions. This type of budget permits a comparison of actual and planned
results at the level of activity actually achieved.

To develop the flexible budget, the following steps are taken:

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.

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 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.

For manufacturing overhead costs, the activity index is usually the same as the index
used in developing the predetermined overhead rate; that is, direct labor hours or
machine hours. For selling and administrative expenses, the activity index usually is
sales or net sales.

The following formula may be used to determine total budgeted costs at any level of
activity:

Total budgeted costs = Fixed costs + (Total variable cost per unit X activity level)

Total budgeted costs at each level of activity can be shown graphically.

a. In a graph, the activity index is shown on the horizontal axis and costs are shown
on the vertical axis.
a. The total budgeted costs for each level of activity are then identified from the total
budgeted cost line.

Flexible budget reports are another type of internal report produced by managerial
accounting. The flexible budget report consists of two sections: (a) production data such
as direct labor hours and (b) cost data for variable and fixed costs. It also shows
differences between budget and actual results.

Management by exception means that top management’s review of a budget report is

focused either entirely or primarily to differences between actual results and planned
objectives. The guidelines for identifying an exception are based on materiality and
controllability.

Responsibility Accounting

Responsibility accounting involves accumulating and reporting costs (and revenues,

where relevant) on the basis of the manager who has the authority to make the day-to-
day decisions about the items. A manager’s performance is evaluated on matters
directly under that manager’s control.

Responsibility accounting can be used at every level of management in which the

following
conditions exist:
a. Costs and revenues can be directly associated with the specific level of
management responsibility.
b. The costs and revenues are controllable at the level of responsibility with which
they are associated.
b. Budget data can be developed for evaluating the manager’s effectiveness in
controlling the costs and revenues.

Responsibility accounting is especially valuable in a decentralized company.

Decentralization means that the control of operations is delegated to many managers
throughout the organization. A segment is an identified area of responsibility in
decentralized operations.

Responsibility accounting is an essential part of any effective system of budgetary

control. It differs from budgeting in two respects:
a. A distinction is made between controllable and noncontrollable items.
b. Performance reports either emphasize or include only items controllable by the
individual manager.

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A cost is considered controllable at a given level of managerial responsibility if that
manager has the power to incur it within a given period of time. Costs incurred indirectly
and allocated to a responsibility level are considered to be noncontrollable at that level.

A responsibility reporting system involves the preparation of a report for each level of
responsibility shown in the company’s organization chart. A responsibility reporting
system
permits management by exception at each level of responsibility within the organization.

Responsibility centers may be classified into one of three types. A cost center incurs
costs (and expenses) but does not directly generate revenues. A profit center incurs
costs (and expenses) but also generates revenues. An investment center incurs costs
(and expenses), generates revenues, and has control over investment funds available
for use.

Cost Centers

A responsibility report for cost centers compares actual controllable costs with
flexible budget data. Only controllable costs are included in the report, and no distinction
is made between variable and fixed costs.

Direct fixed costs or traceable costs are costs that relate specifically to a responsibility
center and are incurred for the sole benefit of the center. Indirect fixed costs or
common costs pertain to a company’s overall operating activities and are incurred for
the benefit of more than one profit center.

Profit Centers

A responsibility report for a profit center shows budgeted and actual controllable
revenues and costs. The report is prepared using the cost-volume-profit income
statement format.

In the responsibility report for a profit center:

a. Controllable fixed costs are deducted from contribution margin.
b. The excess of contribution margin over controllable fixed costs is identified as
controllable margin.
c. Noncontrollable fixed costs are not reported.

Controllable margin is considered to be the best measure of the manager’s performance

in controlling revenues and costs.

Investment Centers

The primary basis for evaluating the performance of a manger of an investment center is
return on investment (ROI). The formula for computing return on investment is:
Investment Center Controllable Margin (in dollars) ÷ Average Investment Center
Operating Assets = Return on Investment.
a. Operating assets consist of current assets and plant assets used in operations
by the center. Nonoperating assets such as idle plant assets and land held for
future use are excluded.
a. Average operating assets are usually based on the beginning and ending cost or
book values of the assets.

A manager can improve ROI by (a) increasing controllable margin or (b) reducing
average
operating assets.

The return on investment approach includes two judgmental factors:

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 a. Valuation of operating assets—cost, book value, appraised value, or market
value.
b. Margin (income) measure—controllable margin, income from operations, or net
income.

Performance evaluation is a management function that compares actual results with

budget goals. Performance evaluation includes both behavioral and reporting
principles.

Residual Income

To evaluate performance using the minimum rate of return, companies use the residual
income approach. Residual income is the income that remains after subtracting from
the
controllable margin the minimum rate of return on a company’s average operating
assets.
The residual income would be computed as follows:

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 ACTIVITY 1
(Write your answers using sheet/s of yellow pad paper to be submitted next Monday, at the
beginning of the class.)
EXERCISE 1
Asahi Company's master budget reflects budgeted sales information for the month of
June 2020, as follows:
Budgeted Quantity Budgeted Unit Sales Price
Product A 20,000 ₱7
Product B 24,000 ₱9
During June, the company actually sold 19,500 units of Product A at an average unit
price of ₱7.10 and 24,800 units of Product B at an average unit price of ₱8.90.

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

EXERCISE 2
1. Write a journal about budgetary control.

Sources:
Cabrera & Cabrera / Management Accounting Concepts and Application, 2017 Edition
Hilton / Managerial Accounting, 9th Edition
IMA / Standards of Ethical Conduct for Management Accountants,
https://www.accountingverse.com/managerial-accounting/introduction/code-of-ethics.html
Kieso & Waygandt / Managerial Accounting, 4th Edition
Roque, Rogelio S. / Reviewer in Management Advisory Services, 2016 Edition

End of Week 12

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