Chapter 10

• The use of budgets to control operations.
• Such control takes place by means of budget reports that compare actual results with planned objectives.

• Develop budget.
• Analyze differences between budget and actual.
• Take corrective actions.
• Modify future plans.

• (1) Identify the name of the budget report, such as the sales budget or the manufacturing overhead budget.
• (2) State the frequency of the report, such as weekly or monthly.
• (3) Specify the purpose of the report.
• (4) indicate the primary recipient(s) of the report.

A projection of budget data at one level of activity.

• 1. The actual level of activity closely approximates the master budget activity level.
• 2. The behavior of the costs in response to changes in activity is fixed.
• 3. A static budget report is appropriate for fixed manufacturing costs and for fixed selling and administrative expenses.

• Projects budget data for various levels of activity.
• Flexible budget is a series of static budgets at different levels of activity.

• 1. Identify the activity index and the relevant range of activity.
• 2. Identify the variable costs, and determine the budgeted variable cost per unit of activity for each cost.
• 3. Identify the fixed costs, and determine the budgeted amount for each cost.
• 4. Prepare the budget for selected increments of activity within the relevant range.

Fixed costs + variable costs (total variable costs per unit * activity level) = total budgetted costs.

• (1) production data for a selected activity index, such as direct labor hours.
• (2) cost data for variable and fixed costs.
• The report provides a basis for evaluating a manager's performance in two areas:
• production control and cost control.

• Means that top management's review of a budget report is focused either entirely or primarily on differences between actual results and planned objectives.
• The usual criteria are materiality and controllability (materiality is usually expressed as a percentage difference from budget, exception guidelines are more restrictive for controllable items than for items that are not controllable by the manager, there may be no guidelines for noncontrollable items).

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.

• 1. Costs and revenues can be directly associated with the specific level of management responsibility.
• 2. The costs and revenues are controllable at the level of responsibility with which they are associated.
• 3. Budget data can be developed for evaluating the manager's effectiveness in controlling the costs and revenues.

The control of operations is delegated to many managers throughout the organization.

An area of responsibility in decentralized operations.

• 1. A distinction is made between controllable and noncontrollable items.
• 2. Performance reports either emphasize or include only items controllable by the individual manager.

Whether the cost or revenue is controllable at the level of responsibility with which it is associated.

• A cost over which a manager has control.
• All costs are controllable by top management because of the broad range of its authority.
• Fewer costs are controllable as one moves down to each lower level of managerial responsibility because of the manager's decreasing authority.
• Costs incurred directly by a level of responsibility are controllable at that level.

Costs incurred indirectly and allocated to a responsibility center that are not controllable at that level.

The preparation of a report for each level of responsibility in the company's organization chart.

• Incurs costs (and expenses) but does not directly generate revenues.
• Managers of cost centers have the authority to incur costs.
• They are evaluated on their ability to control costs.
• Cost centers are usually either production departments or service departments.

• Incurs costs (and expenses) and also generates revenues.
• Managers of profit centers are judged on the profitability of their centers.

• Incurs costs (and expenses) and generates revenues.
• Has control over the investment funds available for use.
• Managers of investment centers are evaluated on both the profitability of the center and the rate of return earned on the funds invested.

• Is a management function that compares actual results with budget goals.
• Performance evaluation involves both behavioral and reporting principles.

• 1. Managers of responsibility centers should have direct input into the process of establishing budget goals of their area of responsibility.
• 2. The evaluation of performance should be based entirely on matters that are controllable by the manager being evaluated.
• 3. Top management should support the evaluation process.
• 4. The evaluation process must allow managers to respond to their evaluations.
• 5. The evaluation should identify both good and poor performance.

• 1. Contain only data that are controllable by the manager of the responsibility center.
• 2. Provide accurate and reliable budget data to measure performance.
• 3. Highlight significant differences between actual results and budget goals.
• 4. Be tailor-made for the intended evaluation.
• 5. Be prepared at reasonable intervals.

• Compare 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.

• Costs that relate specifically to a responsibility center and are incurred for the sole benefit of the center.
• Most direct fixed costs are controllable by the profit center manager.

• Incurred for the benefit of more than one profit center.
• Most indirect fixed costs are not controllable by the profit center manager.

• Shows budgeted and actual controllable revenues and costs.
• The report is prepared using the cost-volume-profit income statement.
• In the report:
• 1. Controllable fixed costs are deducted from contribution margin.
• 2. The excess of contribution margin over controllable fixed costs is identified as controllable margin.
• 3. 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.

• A measure of management's effectiveness in utilizing assets at its disposal in an investment center.
• The formula for computing ROI for an investment center:
• Controllable margin / average operating assets (current assets and plant assets used by center and controlled by manager) = return on inverstment.
• Responsibility report shows:
• 1. All fixed costs are controllable by its manager.
• 2. Budgeted and actual ROI below controllable margin.
• The return on investment approach includes two judgmental factors:
• 1. Valuation of operating assets. Operating assets may be valued at acquisition cost, book value, appraised value, or market value.
• 2. Margin (income) measure. This measure may be controllable margin, income from operations, or net income.

The rate at which the division can cover its costs and earn a profit.

• Income that remains after subtracting from the controllable margin the minimum rate of return on a company's average operating assets.
• Formula:
• Controllable margin - average operating assets * minimum rate of return (%) = residual income.