Master Budget and Responsibility Accounting

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Master Budget and Responsibility Accounting. Chapter 6. Learning Objective 1. Understand what a master budget is and explain its benefits. Budgeting Cycle. Performance planning. Providing a frame of reference. Investigating variations. Corrective action. Planning again.

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## Master Budget and Responsibility Accounting

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### Master Budget andResponsibility Accounting

Chapter 6

Learning Objective 1

Understand what a master budget

is and explain its benefits.

Budgeting Cycle

Performance planning

Providing a frame of reference

Investigating variations

Corrective action

Planning again

The Master Budget

Master Budget

Operating

Decisions

Financial

Decisions

Learning Objective 2

of budgets.

#1

Compels strategic planning

#2

Provides a framework

for judging performance

#3

Motivates employees

and managers

#4

Promotes coordination

and communication

Strategy, Planning, and Budgets

Long-run

Planning

Long-run

Budgets

Strategy

Analysis

Short-run

Planning

Short-run

Budgets

Time Coverage of Budgets

Budgets typically have a set time

period (month, quarter, year).

This time period can itself be broken

into subperiods.

The most frequently used budget

period is one year.

rolling budgets.

Learning Objective 3

Prepare the operating budget

and its supporting schedules.

Operating Budget Example

Hawaii Diving expects 1,100 units to be sold

during the month of August 2004.

Selling price is expected to be \$240 per unit.

How much are budgeted revenues for the month?

1,100 × \$240 = \$264,000

Operating Budget Example

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.

Operating Budget Example

Variable nonmanufacturing costs are

expected to be \$0.14 per revenue dollar.

Fixed nonmanufacturing costs are

\$7,800 per month.

Production Budget Example

Budgeted sales (units)

+

Target ending finished goods inventory (units)

Beginning finished goods inventory (units)

=

Budgeted production (units)

Production Budget Example

Assume that target ending finished goods

inventory is 80 units.

Beginning finished goods inventory is 100 units.

How many units need to be produced?

Production Budget Example

Hawaii Diving Production Budget

for the Month of August 2004

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

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% of the

materials required to produce next month’s sales.

September sales are forecasted to be 1,600 units.

What is the ending inventory in August?

480 pounds

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

Direct Materials Usage Budget

How many pounds are needed to produce

1,080 units in August?

1,080 × 2 = 2,160 pounds

Material Purchases Budget

Hawaii Diving Direct Material Purchases Budget for the Month of August 2004

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

Direct ManufacturingLabor Budget

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: 1,080

Direct labor-hours/unit 3

Total direct labor-hours: 3,240

Total budget @ \$7.00/hour: \$22,680

Variable overhead is budgeted at \$8.00

per direct labor-hour.

Fixed overhead is budgeted at \$5,400 per month.

Budget for the Month of August 2004

(3,240 × \$8.00) \$25,920

Total \$31,320

Ending Inventory Budget

Cost per finished unit:

Materials \$ 4

Labor 21

Total \$54

*\$5,400 ÷ 1,080 = \$5

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

Cost of Goods Sold Budget

Direct materials used:

2,160 × \$2.00 \$ 4,320

Direct labor 22,680

Cost of goods manufactured \$58,320

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?

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

Nonmanufacturing Costs Budget

Hawaii Diving Other Expenses Budget

for the Month of August 2004

Variable Expenses:

(\$0.14 × \$264,000) \$36,960

Fixed expenses 7,800

Total \$44,760

Cost of Goods Sold Budget

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?

Budgeted Statement of Income

Hawaii Diving Budgeted Income Statement

for the Month ending August 31, 2004

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%

Learning Objective 4

Use computer-based financial

planning models in

sensitivity analysis.

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.

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.

Sensitivity Analysis

Consider Hawaii 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

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

Cash Budget

Hawaii Diving has the following

collection pattern:

In the month of sale: 50%

In the month following sale: 27%

In the second month following sale: 20%

Uncollectible: 3%

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?

Cash Budget

Budgeted Cash Receipts

for the Month Ending August 31, 2004

August sales: \$264,000 × 50% \$132,000

July sales: \$250,000 × 27% 67,500

June sales: \$200,000 × 20% 40,000

Total \$239,500

Cash Budget

Budgeted Cash Disbursements

for the Month Ending August 31, 2004

August purchases \$ 4,620

Direct labor 22,680

Other expenses 9,760*

Total \$68,380

*Other expenses exclude depreciation

Cash Budget

Cash Budget

for the Month Ending August 31, 2004

Budgeted receipts \$239,500

Budgeted disbursements 68,380

Net increase in cash \$171,120

Learning Objective 5

Explain kaizen budgeting

and how it is used for

cost management.

What is Kaizen?

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.

Kaizen Budgeting

It was previously estimated that it should take 3 labor-hours for Hawaii Diving to manufacture its product.

A kaizen budgeting approach would

incorporate future improvements.

Kaizen Budgeting

Budgeted Hours/Item

January – March 2004 3.00

April – June 2004 2.95

July – September 2004 2.90

October – December 2004 2.85

Learning Objective 6

Prepare an activity-based

budget.

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.

Activity-Based Budgeting

Product AProduct 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.

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

Activity-Based Budgeting

Total cost allocated to each product line:

Product A: \$8.00 × 2,640 = \$21,120

Product B: \$8.00 × 600 = \$ 4,800

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?

Activity-Based Budgeting

Product AProduct B

\$2,592 × 5 \$12,960

\$2,592 × 5 \$12,960

Setup-related cost per unit:

Product A: \$12,960 ÷ 880 \$14.73

Product B: \$12,960 ÷ 200 \$64.80

Learning Objective 7

Describe responsibility centers

and responsibility accounting.

What is a Responsibility Center?

It is any part, segment, or subunit

of a business that needs control.

– production

– service

Types of Responsibility Centers

Cost center

Investment center

Profit center

Learning Objective 8

Explain how controllability

relates to responsibility

accounting.

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 giventime period.

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.