_Chapter_6_Notes_

Chapter 6: Budgetary Control and Responsibility Accounting

6.1 The Concept of Budgetary Control and Static Budget Reports

• Budgetary Control:

  • Essential management responsibility for controlling company operations through budgeting.

  • Purpose: Ensures alignment with initial goals and guides cash and funds allocation.

  • Regular budget reports facilitate consistent progress analysis.

6.2 Budgetary Control Activities

• Effective when supported by a formalized reporting system, which includes:

  1. Name of the budget report (e.g., sales budget).

  2. Frequency of the report (e.g., weekly, monthly).

  3. Purpose of the report.

  4. Primary recipient(s) of the report.

6.3 Static Budget Reports

• Definition: A static budget is a projection of budget data for one activity level.

• Comparison of budgeted vs actual results constitutes a budget variance.

• Useful for evaluating managerial performance against budgeted projections.

6.4 Flexible Budgets

• A flexible budget adapts to various activity levels, offering a more comprehensive analysis than static budgets.

• Steps to develop a flexible budget:

  1. Identify the activity index & relevant range.

  2. Identify and determine budgeted variable costs per activity unit.

  3. Identify fixed costs & budgeted amounts.

  4. Prepare budgets for selected activity increments within relevant range.

6.5 Flexible Budget - A Case Study

• Example: Fox Manufacturing Company

  • Step 1: Identify activity index as direct labor hours (8,000 to 12,000 per month).

  • Steps 2-4 involve identifying costs and preparing budgets.

6.6 Flexible Budget Reports

• Two sections in flexible budget reports:

  1. Production data for selected activity index.

  2. Cost data for variable and fixed costs.

6.7 The Responsibility Accounting Concept

• Involves tracking costs/revenues associated with managerial authority.

• Applicable conditions:

  1. Direct association with management level.

  2. Controllable costs and revenues at management levels.

  3. Budget data available for evaluating management effectiveness.

• Especially beneficial in decentralized organizations.

6.8 Segments Reporting

• Responsibility accounting differentiates controllable vs noncontrollable items in reports.

• Essential for effective budgetary control.

6.9 Controllable Versus Noncontrollable Revenues and Costs

• Controllable if the manager has authority over it in the reporting period.

  • Top management controls all costs; fewer as authority descends.

6.10 Performance Evaluation Principles

• Compares actual results to budget goals.

• Involves management-by-exception focusing on significant variances.

• Materiality expressed as a percentage difference from the budget.

6.11 Reporting Principles

• Performance reports should:

  1. Contain controllable data.

  2. Ensure accurate budget data for performance measurement.

  3. Highlight substantial differences from budget goals.

  4. Be tailored for evaluations.

  5. Prepared at reasonable intervals.

6.12 Responsibility Centers

• Types include:

  1. Cost Centers: No direct revenue generation; responsible for costs.

  2. Profit Centers: Incur costs and generate revenue.

  3. Investment Centers: Evaluated based on return on investment (ROI).

  • Judgment Factors in ROI:

    1. Valuation of operating assets.

    2. Margin income measure (e.g., controllable margin).

6.13 Residual Income

• Income remaining after subtracting minimal return from controllable margin.