Master Budget and Responsibility Accounting Chapter 6

Cost Accounting

Horngreen, Datar, Foster

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.
Cost Accounting Horngreen, Datar, Foster

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

Cost Accounting

Horngreen, Datar, Foster

The Master Budget

Master Budget Master Budget

based on one expected scenario

Operating Operating Decisions Decisions

Financial Financial Decisions Decisions

Cost Accounting

Horngreen, Datar, Foster

Foster . Datar.Why Budgets? Conveys strategy to employees and managers Provides a framework for judging performance Motivates employees and managers Promotes coordination and communication Cost Accounting Horngreen.

Planning. Datar.Strategy. Foster Long-run Budgets Short-run Budgets . and Budgets Long-run Planning Strategy Analysis Short-run Planning Cost Accounting Horngreen.

Businesses are increasingly using rolling budgets. Datar. The most frequently used budget period is one year. Cost Accounting Horngreen.Time Coverage of Budgets Budgets typically have a set time period (month. year). This time period can itself be broken into subperiods. Foster . quarter.

Materials . Foster . Non-Production Cost B. Production B. Sales Budget Finished Goods Inventory B.Labor . Cost Accounting Production Cost B. Datar.Operating Budget Materials Inventory B. Procurement B.overhead Horngreen.Capacities Revenue B. Requirements Budget: . -direct .

100 units to be sold during the month of August 2004. Datar. Selling price is expected to be $240 per unit.100 × $240 = $264.000 Cost Accounting Horngreen. How much are budgeted revenues for the month? 1.Operating Budget Example Hawaii Diving expects 1. Foster .

$24.00 per direct laborhour. Datar. Fixed overhead is budgeted at $5. Variable nonmanufacturing costs are expected to be $0. Fixed nonmanufacturing costs are $7. $4. $21.Operating Budget Example Two pounds of direct materials are budgeted per unit at a cost of $2. Cost Accounting Horngreen.800 per month. Three direct labor-hours are budgeted per unit at $7.00 per unit.400 per month.00 per pound.00 per unit.00 per unit. Variable overhead is budgeted at $8. Foster .14 per revenue dollar.00 per hour.

Datar. Foster .Production Budget Example Budgeted sales (units) + – = Target ending finished goods inventory (units) Beginning finished goods inventory (units) Budgeted production (units) Cost Accounting Horngreen.

100 80 1. Foster . of finished units Units to be produced 1. How many units need to be produced? Units required for sales Add ending inv. Beginning finished goods inventory is 100 units.180 100 1. inv. of finished units Total finished units required Less beg. Datar.080 Cost Accounting Horngreen.Production Budget Example Assume that target ending finished goods inventory is 80 units.

September sales are forecasted to be 1. Datar. Foster .00 per pound.Direct Materials Usage Budget Each finished unit requires 2 pounds of direct materials at a cost of $2.600 units. What is the ending inventory in August? 480 pounds Cost Accounting Horngreen. Desired ending inventory equals 15% of the materials required to produce next month’s sales.

100 units × 2 × 15% = 330 units How many pounds are needed to produce 1. Datar.080 units in August? 1.080 × 2 = 2.200 × 15% = 480 pounds (the desired ending inventory) What is the beginning inventory in August? 1.600 × 2 pounds per unit = 3.Direct Materials Usage Budget September sales: 1.200 pounds 3.160 pounds Cost Accounting Horngreen. Foster .

Datar.160 480 2.310 $ 2.620 .00 $4. Foster 2.640 330 2.Material Purchases Budget Hawaii Diving Direct Material Purchases Budget for the Month of August 2004 Units needed for production Target ending inventory Total material to provide for Less beginning inventory Units to be purchased Unit purchase price Total purchase cost Cost Accounting Horngreen.

680 Cost Accounting Horngreen.00 per hour.240 $22. Datar.00/hour: 1.Direct Manufacturing Labor Budget Each unit requires 3 direct labor-hours at $7.080 3 3. Foster . Hawaii Diving Direct Labor Budget for the Month of August 2004 Units produced: Direct labor-hours/unit Total direct labor-hours: Total budget at $7.

Hawaii Diving Manufacturing Overhead Budget for the Month of August 2004: Variable Overhead: (3.00) $25.240 × $8.320 Cost Accounting Horngreen. Foster .Manufacturing Overhead Budget Variable overhead is budgeted at $8.00 per direct laborhour.920 Fixed Overhead 5. Fixed overhead is budgeted at $5.400 per month.400 Total $31. Datar.

080 = $5 $ 4 21 24 5* $54 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. Foster .Ending Inventory Budget Cost per finished unit: • • • • • Materials Labor Variable manufacturing overhead Fixed manufacturing overhead Total » *$5.320 Cost Accounting Horngreen.400 ÷ 1. Datar.

320 22.Cost of Goods Sold Budget • • • • Direct materials used 2.320 Assume that the beginning finished goods inventory is $5.160 × $2. Datar. Foster .400.00 Direct labor Total overhead Cost of goods manufactured 4. What is the cost of goods sold? Cost Accounting Horngreen.320 $58. Ending finished goods inventory is $4.320.680 31.

320 $59.720 $ 4.320 $63.Cost of Goods Sold Budget Beginning finished goods inventory + Cost of goods manufactured = Goods available for sale – Ending finished goods inventory = Cost of goods sold $ 5.400 $58. Foster . Datar.400 Cost Accounting Horngreen.

Nonmanufacturing Costs Budget Hawaii Diving Other Expenses Budget for the Month of August 2004 Variable Expenses: Fixed expenses Total ($0.960 7.760 Cost Accounting Horngreen.800 $44. Foster .000) $36.14 × $264. Datar.

400 $204.000 59.Cost of Goods Sold Budget Hawaii Diving has budgeted sales of $264.000 for the month of August. 2004 Sales Less cost of sales Gross margin Other expenses Operating income Cost Accounting $264. Datar.760 $159.600 44. Foster 100% 22% 78% 17% 61% . Cost of goods sold are budgeted at $59.840 Horngreen. What is the budgeted gross margin? Hawaii Diving Budgeted Income Statement for the Month ending August 31.400.

Cost Accounting Horngreen. Foster . financial activities.Financial Planning Models Financial planning models are mathematical representations of the interrelationships among operating activities. Datar. and other factors that affect the master budget.

Example: Cash Budget Depends on collection pattern: In the month of sale: In the month following sale: In the second month following sale: Uncollectible: 50% 27% 20% 3% Cost Accounting Horngreen. Datar. Foster .

000 What are the expected cash collections in August? Cost Accounting Horngreen. Foster .000 $250.000 $260. Datar.Cash Budget Budgeted charge sales are as follows: • • • • June July August September $200.000 $264.

500 $40.500 Cost Accounting Horngreen.000 $67. 2004 August sales: July sales: June sales: Total $264.000 × 20% $132.000 × 50% $250. Datar.000 × 27% $200. Foster .000 $239.Cash Budget Budgeted Cash Receipts for the Month Ending August 31.

2004 August purchases Direct labor Total overhead Other expenses Total *Other expenses exclude depreciation $ 4.Cash Budget Budgeted Cash Disbursements for the Month Ending August 31.320 $9.620 $22. Foster .680 $31.380 Cost Accounting Horngreen.760* $68. Datar.

Datar.120 Cost Accounting Horngreen. Foster .380 $171. 2004 Budgeted receipts Budgeted disbursements Net increase in cash $239.Cash Budget Cash Budget for the Month Ending August 31.500 68.

Materials inventory on June 1 was 15. Foster .000 150.000 120.000 units of finished goods in inventory at the beginning of June.000 210. Five pounds of materials are required for each unit produced.Exercise: Prepare a purchases budget in pounds for July.000 180. Inventory levels for materials are equal to 30% of the needs for the next month.000 120. and September.000 There were 30.000 pounds Cost Accounting Horngreen. Each pound of material costs $8. Plans are to have an inventory of finished products that equal 20% of the unit sales for the next month. and give total purchases in both pounds and dollars for each month. Datar. Lubriderm Corporation has the following budgeted sales for the next six-month period: Month June July August September October November Unit Sales 90. August.

Datar. Kaizen budgeting is an approach that explicitly incorporates continuous improvement during the budget period into the budget numbers. Cost Accounting Horngreen. Foster .What is Kaizen? The Japanese use the term “kaizen” for continuous improvement.

85 . Datar.Kaizen Budgeting A kaizen budgeting approach would incorporate future improvements. Budgeted Hours/Item January – March 2004 April – June 2004 July – September 2004 October – December 2004 Cost Accounting Horngreen. Foster 3.90 2.00 2.95 2.

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. Cost Accounting Horngreen. Datar. Foster .

Total budgeted labor-hours are: Product A: 880 × 3 Product B: 200 × 3 Total What is the allocation rate per labor-hour? • $25.240 Cost Accounting Horngreen.00 2. Foster .920 per month.920 ÷ 3.Activity-Based Budgeting 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 $25.240 = $8. Datar.640 600 3.

00 × 600 = $ 4.920 budgeted machine setup cost ÷ 10 budgeted machine setup-hours = $2. Foster .800 Under ABB.120 Product B: $8. $25.640 = $21.Activity-Based Budgeting Total cost allocated to each product line: Product A: $8. How much machine setup related costs are allocated to each product line? Cost Accounting Horngreen.592 allocation rate per machine setup-hour. the number of setups is the cost driver.00 × 2. Datar.

960 $2.960 ÷ 880 $14.73 Product B: $12.960 $2. Foster .960 ÷ 200 $64.592 × 5 Setup-related cost per unit: Product A: $12.80 Cost Accounting Horngreen.592 × 5 Product B $12. Datar.Activity-Based Budgeting Product A $12.

or subunit of a business that needs control. segment. Datar. Foster .What is a Responsibility Center? It is any part. – production – service Cost Accounting Horngreen.

Foster . Datar.Types of Responsibility Centers Cost Center Profit Center Investment Center Cost Accounting Horngreen.

What is Controllability? It is the degree of influence that a specific manager has over costs. or other items in question. Datar. Cost Accounting Horngreen. revenues. A controllable cost is any cost that is primarily subject to the influence of a given responsibility center manager for a given time period. Foster .

Datar.Controllability Responsibility accounting focuses on information and knowledge. Cost Accounting Horngreen. not control. In practice. controllability is difficult to pinpoint. Foster . A responsibility accounting system could exclude all uncontrollable costs from a manager’s performance report.

Datar.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 Cost Accounting Horngreen. Foster .

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. Datar. 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. Cost Accounting Horngreen. The master budget reflects the impact of only operating decisions. Sensitivity analysis allows managers to see how results will change if predicted data are not achieved or an underlying assumption changes. Foster .

• eliminate coordination and communication between subunits. Foster .Pick your Choice I: When a budget is administered wisely. • provide a framework for performance evaluation. it will • discourage strategic planning. the firm would use this in place of which of the following budgets? • • • • Direct materials budget Revenue budget Direct labor budget Manufacturing overhead budget Cost Accounting Horngreen. • discourage managers and employees. Datar. If a firm is using activity-based budgeting.

Pick your Choice II: BDH Corporation. BDH wants 6.500 units.000 • $684.000 • $390. Each unit of Kisty takes two units of component L.000 units. BDH expects sales to be 30. Kisty.000 • $756. which makes only one product. The current inventory of Kisty is 3.000 units at $50 per unit.000 Cost Accounting Horngreen.000 units. Datar. How much will the direct materials budget show as the cost of materials to be purchased? • $330. Current inventory of L is 4. has the following information available for the coming year. Foster .000 units of L on hand at the end of the next year. BDH wants an ending inventory of 3. Component L is budgeted to cost $12 per unit.

generating almost $1 billion in revenue in a little less than two years on the air. including prize money and host Regis Philbin's salary. Datar.000 to produce. and markets a special version of "Millionaire" to corporations that can be played at conventions by employees and clients.000 per episode. ABC and its parent company. but each "hit" is noted when advertising space is sold for the site. There is also an on-line version of the game that Millionaire fans can play. The rights to air Millionaire are also sold to Canada for $250. Walt Disney Company.Who Gets the Money? New York Post. April 29. 2001 In the above-cited article. Each show earns $2 million in advertising revenue. Cost Accounting Horngreen. The Millionaire show also sells a CD-ROM game for $20. Each individual show costs about $700. Foster . About 4 million of these games have been sold. say that the show "Who Wants to be a Millionaire. The article also points out that Disney also sells hats and t-shirts of the game. Users of the game don't pay." is the most profitable television show ever .

) Give a reason why this should be considered a profit center for evaluating a manager's performance. etc.“Who Gets the Money?“ . $700.) be evaluated as a profit center. Foster . as a profit center. 2. The Millionaire show itself generates about $1. Datar.000 in expenses. cost center or revenue center? Why? Cost Accounting Horngreen. Do you think that one manager has responsibility for the Millionaire show. or is it divided as a cost center and as a revenue center? 3.Questions 1.3 million per episode in net income ($2 million in revenue. CD-ROM. Should the ancillaries of the show (the t-shirts.

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