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Master Budget and

Responsibility
Accounting
Chapter 6

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6-1
Learning Objective 1

Understand what a master budget


is and explain its benefits.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6-2
Budgeting Cycle

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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6-3
The Master Budget

Master
Master Budget
Budget

Operating
Operating Financial
Financial
Decisions
Decisions Decisions
Decisions

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6-4
Learning Objective 2

Describe the advantages


of budgets.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6-5
What are the Advantages
of Budgets?

#1 Compels strategic planning

Provides a framework
#2 for judging performance

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6-6
What are the Advantages
of Budgets?

Motivates employees
#3 and managers

Promotes coordination
#4 and communication

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6-7
Strategy, Planning, and Budgets

Long-run Long-run
Planning Budgets
Strategy
Analysis
Short-run Short-run
Planning Budgets

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6-8
Time Coverage of Budgets
Budgets typically have a set time
period (month, quarter, year).
This time period can itself be broken
into subperiods.
The most frequently used budget
period is one year.
Businesses are increasingly using
rolling budgets.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6-9
Learning Objective 3

Prepare the operating budget


and its supporting schedules.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 10


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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 11


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.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 12
Operating Budget Example

Variable nonmanufacturing costs are


expected to be $0.14 per revenue dollar.
Fixed nonmanufacturing costs are
$7,800 per month.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 13


Production Budget Example

Budgeted sales (units)


+ Target ending finished goods inventory (units)
– Beginning finished goods inventory (units)
= Budgeted production (units)

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 14


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?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 15


Production Budget Example

Hawaii Diving Production Budget


for the Month of August 2004
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
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 16
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
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 17
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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 18


Direct Materials Usage Budget

How many pounds are needed to produce


1,080 units in August?
1,080 × 2 = 2,160 pounds

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 19


Material Purchases Budget
Hawaii Diving Direct Material Purchases
Budget for the Month of August 2004
Units needed for production 2,160
Target ending inventory 480
Total material to provide for
2,640
Less beginning inventory 330
Units to be purchased 2,310
Unit purchase price $ 2.00
Total
©2003 Prentice purchase
Hall Business cost
Publishing, Cost $4,620
Accounting 11/e, Horngren/Datar/Foster 6 - 20
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: 1,080
Direct labor-hours/unit 3
Total direct labor-hours: 3,240
Total budget @ $7.00/hour: $22,680
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 21
Manufacturing Overhead Budget

Variable overhead is budgeted at $8.00


per direct labor-hour.
Fixed overhead is budgeted at $5,400 per month.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 22


Manufacturing Overhead Budget

Hawaii Diving Manufacturing Overhead


Budget for the Month of August 2004
Variable Overhead:
(3,240 × $8.00) $25,920
Fixed Overhead 5,400
Total $31,320

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 23


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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 24


Ending Inventory Budget

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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 25


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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 26


Cost of Goods Sold Budget

Assume that the beginning finished


goods inventory is $5,400.
Ending finished goods inventory is $4,320.
What is the cost of goods sold?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 27


Cost of Goods Sold Budget

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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 28


Nonmanufacturing Costs Budget

Hawaii Diving Other Expenses Budget


for the Month of August 2004
Variable Expenses:
($0.14 × $264,000) $36,960
Fixed expenses 7,800
Total $44,760

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 29


Cost of Goods Sold Budget

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?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 30


Budgeted Statement of Income

Hawaii Diving Budgeted Income


Statement
for the Month ending$264,000
Sales August 31, 2004
100%
Less cost of sales 59,400 22%
Gross margin $204,600 78%
Other expenses 44,760 17%
Operating income $159,840 61%
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 31
Learning Objective 4

Use computer-based financial


planning models in
sensitivity analysis.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 32


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.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 33


Software

Software packages are now readily


available to reduce the computational
burden and time required to prepare
budgets.
These packages assist managers
to do sensitivity analysis.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 34


Sensitivity Analysis
Consider Hawaii Diving.
What if some parameters in the budget model
were to change?
For example, what if the selling price is
expected to be $230 instead of $240?
What are expected revenues?
1,100 × $230 = $253,000 instead of $264,000
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 35
Sensitivity Analysis
What if the materials cost is expected to increase
to $2.50 per pound instead of $2.00.
What is the cost of goods sold?
1,100 × $55 = $60,500 instead of $59,400
Why the increase?
Because materials cost per unit become
$5.00 instead of $4.00.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 36
Cash Budget

Hawaii Diving has the following


collection pattern:
In the month of sale: 50%
In the month following sale: 27%
In the second month following sale: 20%
Uncollectible: 3%
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 37
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?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 38


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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 39


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
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 40
Cash Budget
Cash Budget
for the Month Ending August 31, 2004
Budgeted receipts $239,500
Budgeted disbursements 68,380
Net increase in cash $171,120

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 41


Learning Objective 5

Explain kaizen budgeting


and how it is used for
cost management.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 42


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.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 43


Kaizen Budgeting

It was previously estimated that it should


take 3 labor-hours for Hawaii Diving to
manufacture its product.
A kaizen budgeting approach would
incorporate future improvements.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 44


Kaizen Budgeting

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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 45


Learning Objective 6

Prepare an activity-based
budget.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 46


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.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 47


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
$25,920 per month.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 48


Activity-Based Budgeting

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

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 49


Activity-Based Budgeting

Total cost allocated to each product line:


Product A: $8.00 × 2,640 = $21,120
Product B: $8.00 × 600 = $ 4,800

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 50


Activity-Based Budgeting

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?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 51


Activity-Based Budgeting

Product A Product B
$2,592 × 5 $12,960
$2,592 × 5 $12,960
Setup-related cost per unit:
Product A: $12,960 ÷ 880 $14.73
Product B: $12,960 ÷ 200 $64.80

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 52


Learning Objective 7

Describe responsibility centers


and responsibility accounting.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 53


What is a Responsibility Center?

It is any part, segment, or subunit


of a business that needs control.

– production
– service

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 54


Types of Responsibility Centers

Cost
Cost center
center

Investment
Investment center
center

Profit
Profit center
center

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 55


Learning Objective 8

Explain how controllability


relates to responsibility
accounting.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 56


What is Controllability?

It is the degree of influence that a specific


manager has over costs, revenues,
or other items in question.
A controllable cost is any cost that is
primarily subject to the influence of a
given responsibility center manager
for a given time period.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 57
Controllability

Responsibility accounting focuses on


information and knowledge, not control.
A responsibility accounting system could
exclude all uncontrollable costs from
a manager’s performance report.
In practice, controllability is difficult to pinpoint.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 58


End of Chapter 6

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 6 - 59

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