chapter 6 · pdf filechapter 6 master budget and ... strategy analysis long-run planning...

Cost Accounting Horngreen, Datar, Foster

Chapter 6

Master Budget andResponsibility Accounting


Learning Objectives

� Understand what a master budget is and explain its benefits� Describe the advantages of budgets� Prepare the operating budget and its supporting schedules� Explain kaizen budgeting and how it is used for cost

management� Prepare an activity-based budget� Describe responsibility centers and responsibility

accounting.� Explain how controllability relates to responsibility

accounting.


Budgeting Cycle

� Performance planning� Providing a frame of reference� Investigating variations� Corrective action� Planning again


The Master Budget

Master BudgetMaster Budget

OperatingDecisionsOperatingDecisions

Financial DecisionsFinancial Decisions

based on one expected scenario


Why Budgets?

� Conveys strategy to employees and managers

� Provides a framework for judging performance

� Motivates employees and managers

� Promotes coordination and communication


Strategy, Planning, and Budgets

StrategyAnalysis

Long-runPlanning

Short-runPlanning

Long-runBudgets

Short-runBudgets


Time Coverage of Budgets

� Budgets typically have a set time period (month, quarter, year).

� This time period can itself be broken into sub-periods.

� The most frequently used budget period is one year.

� Businesses are increasingly using rolling budgets.


Operating Budget

Sales BudgetSales Budget Production Production B.B.

Finished GoodsFinished GoodsInventoryInventory B.B.

Production CostProduction Cost B.B.--directdirect-- overheadoverhead

RevenueRevenue B.B.

RequirementsRequirementsBudget:Budget:-- MaterialsMaterials-- LaborLabor-- CapacitiesCapacities

MaterialsMaterialsInventory Inventory B.B. ProcurementProcurement B.B.

NonNon--ProductionProductionCostCost B.B.


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.� 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?

� 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� 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 2,160Target ending inventory 480Total material to provide for 2,640Less beginning inventory 330Units to be purchased 2,310Unit purchase price $ 2.00Total purchase cost $4,620


Direct Manufacturing Labor 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: 1,080Direct labor-hours/unit 3Total direct labor-hours: 3,240Total budget at $7.00/hour: $22,680


Manufacturing Overhead Budget

� Variable overhead is budgeted at $8.00 per direct labor-hour.

� Fixed overhead is budgeted at $5,400 per month.� Hawaii Diving Manufacturing Overhead Budget for the

Month of August 2004:

Variable Overhead: (3,240 × $8.00) $25,920Fixed Overhead 5,400Total $31,320


Ending Inventory Budget

� Cost per finished unit:• Materials $ 4• Labor 21• Variable manufacturing overhead 24• Fixed manufacturing overhead 5*• Total $54

» *$5,400 ÷ 1,080 = $5

� 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• Total overhead 31,320• Cost of goods manufactured $58,320

� Assume that the beginning finished goods inventory is $5,400.

� Ending finished goods inventory is $4,320.� What is the cost of goods sold?



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) $36,960Fixed expenses 7,800Total $44,760



� 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?� Hawaii Diving Budgeted Income Statement for the Month

ending August 31, 2004Sales $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%


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.


Example: Cash Budget

� Depends on 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� Total overhead $31,320� Other expenses $9,760*� Total $68,380

*Other expenses exclude depreciation


Cash Budget

Cash Budgetfor the Month Ending August 31, 2004

Budgeted receipts $239,500Budgeted disbursements 68,380Net increase in cash $171,120


Exercise: Prepare a purchases budget in pounds for July, August, and September, and give total purchases in both pounds and dollars for each month.

Lubriderm Corporation has the following budgeted sales for the next six-month period:

There were 30,000 units of finished goods in inventory at the beginning of June. Plans are to have an inventory of finished products that equal 20% of the unit sales for the next month.Five pounds of materials are required for each unit produced. Each pound of material costs $8. Inventory levels for materials are equal to 30% of the needs for the next month. Materials inventory on June 1 was 15,000 pounds

Month Unit Sales June 90,000 July 120,000 August 210,000 September 150,000 October 180,000 November 120,000


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

Budgeted Hours/ItemJanuary – March 2004 3.00April – June 2004 2.95July – September 2004 2.90October – December 2004 2.85

A kaizen budgeting approach wouldincorporate future improvements.


Activity-Based Budgeting

Activity-based costing reports and analyzes past and current costs.

Activity-based budgeting (ABB) focuseson the budgeted cost of activities necessaryto produce and sell products and services.



Product A Product 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.

� 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



� Total cost allocated to each product line:� Product A: $8.00 × 2,640 = $21,120� Product B: $8.00 × 600 = $ 4,800

� 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?



Product A Product B$12,960 $12,960 $2,592 × 5 $2,592 × 5

Setup-related cost per unit:Product A: $12,960 ÷ 880 $14.73Product B: $12,960 ÷ 200 $64.80


What is a Responsibility Center?

It is any part, segment, or subunitof a business that needs control.

– production– service


Types of Responsibility Centers

� Cost Center� Profit Center� Investment Center


What is Controllability?

It is the degree of influence that a specificmanager has over costs, revenues,

or other items in question.

A controllable cost is any cost that isprimarily subject to the influence of agiven responsibility center manager

for a given time period.


Controllability

Responsibility accounting focuses oninformation and knowledge, not control.

A responsibility accounting system couldexclude all uncontrollable costs from

a manager’s performance report.

In practice, controllability is difficult to pinpoint.


Human aspects of Budgeting

� Budgeting should not be considered as a „mechanical tool“� Quality of the budget depends on the information that is fed

into the process � There are incentives for dishonest reports

• Budgetary slack• Empire building

� Management aims to ensure honest reporting by lower level management• Via appropriate performance measures• Monitoring


True or False ???

� A budget that covers the financial aspects is a qualitative expression of a proposed plan of action by management for a specified period.

� The master budget reflects the impact of only operating decisions.

� Feedback in the budgeting process may cause a firm to alter its strategies and plans.

� Statistical analysis should be the only input used to forecast sales.

� Sensitivity analysis allows managers to see how results will change if predicted data are not achieved or an underlying assumption changes.


Pick your Choice I:

� When a budget is administered wisely, it will • discourage strategic planning.• provide a framework for performance evaluation.• discourage managers and employees.• eliminate coordination and communication between subunits.

� If a firm is using activity-based budgeting, the firm would use this in place of which of the following budgets? • Direct materials budget• Revenue budget• Direct labor budget• Manufacturing overhead budget


Pick your Choice II:

� BDH Corporation, which makes only one product, Kisty, has the following information available for the coming year. BDH expects sales to be 30,000 units at $50 per unit. The current inventory of Kisty is 3,000 units. BDH wants an ending inventory of 3,500 units. Each unit of Kistytakes two units of component L. Component L is budgeted to cost $12 per unit. Current inventory of L is 4,000 units. BDH wants 6,000 units of L on hand at the end of the next year. How much will the direct materials budget show as the cost of materials to be purchased?

• $330,000• $390,000• $684,000• $756,000


Who Gets the Money? New York Post, April 29, 2001

In the above-cited article, ABC and its parent company, Walt Disney Company, say that the show "Who Wants to be a Millionaire," is the most profitable television show ever - generating almost $1 billion in revenue in a little less than two years on the air.Each individual show costs about $700,000 to produce, including prize money and host Regis Philbin's salary. Each show earns $2 million in advertising revenue. The rights to air Millionaire are also sold to Canada for $250,000 per episode.The Millionaire show also sells a CD-ROM game for $20. About 4 million of these games have been sold.There is also an on-line version of the game that Millionaire fans can play. Users of the game don't pay, but each "hit" is noted when advertising space is sold for the site.The article also points out that Disney also sells hats and t-shirts of the game, and markets a special version of "Millionaire" to corporations that can be played at conventions by employees and clients.


“Who Gets the Money?“ - Questions

1. The Millionaire show itself generates about $1.3 million per episode in net income ($2 million in revenue, $700,000 in expenses.) Give areason why this should be considered a profit center for evaluating a manager's performance.

2. Do you think that one manager has responsibility for the Millionaireshow, as a profit center, or is it divided as a cost center and as a revenue center?

3. Should the ancillaries of the show (the t-shirts, CD-ROM, etc.) be evaluated as a profit center, cost center or revenue center? Why?

chapter 6 · pdf filechapter 6 master budget and ... strategy analysis long-run planning...

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