Accounting 210 Chapter 10 Notes
Accounting 210 Chapter 10 Notes ACCT210
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This 10 page Class Notes was uploaded by Kristin Koelewyn on Tuesday April 12, 2016. The Class Notes belongs to ACCT210 at University of Arizona taught by Heather Altman in Spring 2016. Since its upload, it has received 19 views. For similar materials see Managerial Accounting in Accounting at University of Arizona.
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Date Created: 04/12/16
Accounting 210: Chapter 10 Notes Budgetary Control and Responsibility Accounting - The use of budgets in controlling operations is known as budgetary control. o Takes place by means of budget reports, which compare actual results with planned objectives. o Provides management with feedback on operations. o Budget reports can be prepared as frequently as needed. o Management analyzes differences between actual and planned results and determines causes. - Static Budget Reports: o A static budget is a projection of budget data at one level of activity. ▯ When used in budgetary control, each budget included in the master budget is considered to be static. ▯ Ignores data for different levels of activity. ▯ Compares actual results with budget data at the activity level used in the master budget. o Illustration: o Uses and Limitations: ▯ Appropriate for evaluating a manager’s effectiveness in controlling costs when: ▯ Actual level of activity closely approximates master budget activity level, and/or ▯ Behavior of costs is fixed in response to changes in activity. ▯ Appropriate for fixed costs. ▯ Not appropriate for variable costs. - Prepare Flexible Budget Reports: o Flexible budget projects budget data for various levels of activity. ▯ Essentially a series of static budgets at different activity levels. ▯ Budgetary process more useful if it is adaptable to changes in operating conditions. ▯ Can be prepared for each type of budget in the master budget. o Illustration: Barton Robotics, static budget based on a production volume of 10,000 units of robotic controls. - Why Flexible Budgets? o Over budget in three of six overhead costs. ▯ Unfavorable difference of $132,000 – 12% over budget. o Comparison based on budget data for 10,000 units - the original activity level. ▯ Meaningless to compare actual variable costs for 12,000 units with budgeted variable costs for 10,000 units. ▯ Variable cost increase with production. - Developing a Flexible Budget: o 1.Identify the activity index and the relevant range of activity. o 2.Identify the variable costs and determine the budgeted variable cost per unit of activity for each cost. o 3.Identify the fixed costs and determine the budgeted amount for each cost. o 4.Prepare the budget for selected increments of activity within the relevant range. - Flexible Budget Reports: o Widely used in production and service departments. o A type of internal report. o Consists of two sections: ▯ Production data for a selected activity index, such as direct labor hours. ▯ Cost data for variable and fixed costs. o Widely used in production and service departments to evaluate a manager’s performance. - Apply Responsibility Accounting to Cost and Profit Centers: o 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. o Conditions: ▯ 1.Costs and revenues can be directly associated with the specific level of management responsibility. ▯ 2.Costs and revenues can be controlled by employees 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. - Responsibility Accounting: o Responsibility center - any individual who has control and is accountable for activities. o May extend to any level of management. o Especially valuable in a decentralized company. ▯ Control of operations delegated to many managers throughout the organization. ▯ Segment– area of responsibility for which reports are prepared. o Two differences from budgeting in reporting costs and revenues: ▯ 1.Distinguishes between controllable and non-controllable costs. ▯ 2.Emphasizes or includes only items controllable by the individual manager in performance reports. o Applies to both profit and not-for-profit entities. ▯ Profit entities: maximize net income. ▯ Not-for-profit: minimize cost of providing services. - Controllable Versus Non-controllable Revenues and Costs: o Critical issue is 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 is called a controllable cost. ▯ 1.All costs are controllable by top management. ▯ 2.Fewer costs are controllable as one moves down to each lower level of managerial responsibility. o Costs incurred indirectly and allocated to a responsibility level are non-controllable costs. - Principles of Performance Evaluations: o Management function that compares actual results with budget goals. o Includes both behavioral and reporting principles. o Management by Exception: means that top management’s review of a budget report is focused primarily on differences between actual results and planned objectives. ▯ MATERIALITY - Without quantitative guidelines, management would have to investigate every budget difference regardless of the amount. ▯ CONTROLLABILITY OF THE ITEM - Exception guidelines are more restrictive for controllable items than for items the manager cannot control. o Behavioral 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. o Reporting Principles: 1. Contain only data controllable by manager of 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 intended evaluation. 5. Be prepared at reasonable intervals. - Responsibility Reporting System: o Involves preparation of a report for each level of responsibility in the company's organization chart. o Begins with the lowest level of responsibility and moves upward to higher levels. o Permits management by exception at each level of responsibility. o Each higher level can obtain the detailed report for each lower level. - Types of Responsibility Centers: o Three basic types: ▯ Cost center • Incurs costs but does not directly generate revenues. • Managers have authority to incur costs. • Managers evaluated on ability to control costs. • Usually a production department or a service department. ▯ Profit center • Incurs costs and generates revenues. • Managers judged on profitability of center. • Examples include individual departments of a retail store or branch bank offices. ▯ Investment center • Incurs costs, generates revenues, and has investment funds available for use. • Manager evaluated on profitability of the center and rate of return earned on funds. • Often a subsidiary company or a product line. • Manager able to control or significantly influence investment decisions such as plant expansion. o Question: Under responsibility accounting, the evaluation of a manager’s performance is based on matters that the manager: a. Directly controls. b. Directly and indirectly controls. c. Indirectly controls. d. Has shared responsibility for with another manager. o RESPONSIBILITY ACCOUNTING FOR COST CENTERS: ▯ Based on a manager’s ability to meet budgeted goals for controllable costs. ▯ Results in responsibility reports which compare actual controllable costs with flexible budget data. • Include only controllable costs in reports. • No distinction between variable and fixed costs. o RESPONSIBILITY ACCOUNTING FOR PROFIT CENTERS ▯ Based on detailed information about both controllable revenues and controllable costs. ▯ Manager controls operating revenues earned, such as sales. ▯ Manager controls all variable costs incurred by the center because they vary with sales. - Responsibility Accounting for Profit Centers: o Direct fixed costs: ▯ Relate specifically to one responsibility center. ▯ Incurred for the sole benefit of the center. ▯ Called traceable costs since they can be traced directly to one center. ▯ Most direct fixed costs are controllable by the profit center manager. o Indirect fixed costs: ▯ Pertain to a company's overall operating activities. ▯ Incurred for the benefit of more than one profit center. ▯ Called common costs since they apply to more than one center. ▯ Most are not controllable by the profit center manager. o Responsibility Report: ▯ Budgeted and actual controllable revenues and costs. ▯ Uses cost-volume-profit income statement format: • Deduct controllable fixed costs from the contribution margin. • Controllable Margin - excess of contribution margin over controllable fixed costs. • Noncontrollable fixed costs are not reported. o DO IT! Midwest Division operates as a profit center. It reports the following for the year: - Evaluate Performance in the Investment Centers: o Return on Investment (ROI) is the primary basis for evaluating the performance of a manager of an investment center. o Shows the effectiveness of the manager in using the assets at his/her disposal. o Factors in ROI formula are controllable by manager. - Return on Investment (ROI) o Operating assets include current assets and plant assets used in operations by the center and controlled by the manager. o Base average operating assets on the beginning and ending cost or book values of the assets. - Responsibility Report: o Scope of manager’s responsibility affects content. o Investment center is an independent entity for operating purposes. o All fixed costs are controllable by center manager. o Shows budgeted and actual ROI below controllable margin. - Judgmental Factors in ROI o Valuation of operating assets. ▯ Acquisition cost, book value, appraised value, or fair value. ▯ Each provides a reliable basis for evaluating performance. o Margin (income) measure. ▯ Controllable margin, income from operations, or net income. ▯ Only controllable margin is a valid basis for evaluating performance of investment center manager. o Improve ROI by increasing controllable margin, and/or reducing average operating assets. - Increasing Controllable Margin: o Increase ROI by increasing sales or by reducing variable and controllable fixed costs. o 1.Increase sales by 10%. ▯ Sales increase $200,000 and contribution margin increases $90,000 ($200,000 X .45). ▯ Thus, controllable margin increases to $690,000 ($600,000 + $90,000). ▯ New ROI is 13.8%. o Increase ROI by increasing sales or by reducing variable and controllable fixed costs. o 2.Decrease variable and fixed costs 10%. ▯ Total costs decrease $140,000 [($1,100,000 + $300,000) X 10%]. ▯ Controllable margin becomes $740,000. ▯ New ROI becomes 14.8%. - Reducing Average Operating Assets: o Assume that average operating assets are reduced 10% or $500,000 ($5,000,000 x .10). o Average operating assets become $4,500,000. o Controllable margin remains unchanged at $600,000. o New ROI is 13.3%. o DO IT! Sales $400,000 Variable costs 320,000 Controllable fixed costs 40,800 Average operating assets 280,000 o Management is considering the following independent courses of action in 2015 in order to maximize the return on investment. 1.Reduce average operating assets by $80,000, with no change in controllable margin. 2.Increase sales $80,000, with no change in the contribution margin percentage. A. Compute controllable margin and the return on investment for 2017. B. Compute controllable margin and the expected return on investment.
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