CH 6

CHAPTER 6
Master Budgeting
and
Responsibility Accounting
Learning Objective 1
Understand what a master budget

is and explain its benefits.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright 2006 by Pearson Education. All rights reserved.
6-2
Budget Defined
The quantitative expression of a proposed
plan of action by management for a specified

period, and
An aid to coordinating what needs to be done
to implement that plan
May include both financial and nonfinancial
data
6-3
Objectives of budgeting
Establishing specific goals
Executing plans to achieve the goals
Periodically comparing actual results to the
goals
6-4
Budget Cycle
Managers and accountants plan the
performance of the company, taking into
account past performance and anticipated
future changes
2. Senior managers distribute a set of goals
against which actual results will be
compared
1.
6-5
Budget Cycle
Accountants help managers investigate
deviations from budget. Corrective action
occurs at this point
4. Managers and accountants assess market
feedback, changed conditions, and their
own experiences as plans are laid for the
next budget period
3.
6-6
Budgeting Cycle
Performance planning
Providing a frame of reference
Investigating variations
Corrective action
Planning again
6-7
Describe the advantages

of budgets.
6-8
Advantages of Budgets
Promotes coordination and communication
among subunits within the company

Provides a framework for judging
performance
Motivates managers and other employees
6-9
Challenges in Budgets
It is a time consuming process that involves
all levels of management. Management at all
levels should understand and support the
budget.
Budgets should not be administered rigidly.
Changing conditions may call for changes in
plans.
6-10
Time Coverage of Budgets

Budgets typically cover a set time period
including a full business cycle. Normally an
annual budget would be prepared, but broken
down into sub-periods such as a month or
quarter.
Rolling budgets (continuous budgeting):
Created by continually adding a month or
quarter to the existing budget, so that the
company always has a 12-month budget in
place.
6-11
Continuous
Continuous Budgeting
Budgeting
One-Year Budget
Feb.
2006
Mar. Apr.
2006 2006
May
2006
June
2006
July
2998
Aug.
2006
Sep.
2006
Oct.
2006
Nov.
2006
Dec.
2006
Jan.
2007
Delete on
February 28
6-12
Continuous
Continuous Budgeting
Budgeting
One-Year Budget
Mar. Apr.
2006 2006
May
2006
June
2006
July
2998
Aug.
2006
Sep.
2006
Oct.
2006
Nov.
2006
Dec.
2006
Jan.
2007
Feb.
2007
Add February 2007

6-13
Prepare the operating budget

and its supporting schedules.
6-14
Master Budgets
The master budget expresses
managements operating and financial plans

for a specified period (usually a year). The
master budget is actually a series of budgets
including a set of budgeted financial
statements (sometimes called pro forma
statements).
6-15
Components of Master Budgets

Operating Budget include budgets reflecting
the planned operational aspects of the

business, including revenues, production,
manufacturing costs, and other expenses for
the period. It culminates in a budgeted
income statement.
Financial Budget consist of a capital
expenditures budget, a cash budget, a
budgeted balance sheet, and a budgeted
statement of cash flows.
6-16
Basic Operating Budget Steps

Final objective: Budgeted income statement
1. Prepare the Revenues Budget
2. Prepare the Production Budget (in Units)
3. Prepare the Direct Materials Usage Budget
and Direct Materials Purchases Budget
4. Prepare the Direct Manufacturing Labor
Budget
6-17
Basic Operating Budget Steps

5.
6.
7.
8.
9.
Prepare the Manufacturing Overhead Costs

Budget
Prepare the Ending Inventories Budget
Prepare the Cost of Goods Sold Budget
Prepare the Operating Expense (Period
Cost) Budget
Prepare the Budgeted Income Statement
6-18
Input cost / unit
Inputs consumed
by each unit
Beginning and
Target ending balances
6-19
Step 1: Revenues Budget

Starting point for operating budget production level,
inventory level, MFG costs, non-MFG costs depend on
the forecasted level of units sales.
6-20
Step 2: Production Budget (in units)

Revenues
Revenues
Budget
Budget
Production Budget
Budgeted units of sales

+ Target units in ending Finished Goods
Units in beginning Finished Goods
=Budgeted production units
6-21
Step 2: Production Budget (in units)
6-22
Step 3:Direct Materials Usage Budget

Based on materials used in each unit as well
as the production units

Both units and cost are needed.
6-23
Step 3:Direct Materials Usage Budget
6-24
Step 3: Direct Materials Purchase

Budget
Sales
Sales
Budget
Budget
Production Budget
Direct
DirectMaterials
Materials
Purchases
PurchasesBudget
Budget
Materials needed for production

+ Target ending materials inventory
Beginning materials inventory
=Direct materials to be purchased
6-25
Step 3: Direct Materials Purchase Budget
6-26
Step 4: Direct Manufacturing Labor Budget

Labor standardsthe time allowed per unit of output
are used to calculate direct labor costs.
6-27
Step 5: Manufacturing Overhead Costs

Budget
From this budget, managers can determine a
predetermined overhead application rate.
6-28

Budget
It includes a budget for each item of manufacturing
overhead.
Variable operation OH: Direct labor hour (300,000)
Variable Setup OH: Setup hour (15,000)
6-29

Budget
Mfg OH costs are classified as variable and fixed costs
6-30

Budget
6-31
Step 6: Ending Inventories Budget

This is simply a listing of the budgeted ending inventories
in materials and finished goods. Units and dollar
amounts are included. Work-in-process inventory is not
budgeted.
6-32
Step 6: Ending Inventories Budget
6-33
Step 7: Cost of Goods Sold Budget

It is simply a matter of pulling the numbers already
available into a cost of goods sold format for this
budget.
6-34
Step 8: Non-manufacturing Cost Budget

It includes the budgeted amount for all nonmanufacturing costs the company expects to incur for
the period.
6-35
Step 9: Budgeted Income Statement

It simply follows the format of an income statement.
6-36
Budgeting Overview Flowchart
6-37
Basic Financial Budget Steps

Based on the Operating Budgets:
1. Prepare the Capital Expenditures Budget
2. Prepare the Cash Budget
3. Prepare the Budgeted Balance Sheet
4. Prepare the Budgeted Statement of Cash
Flows
6-38
Use computer-based financial

planning models in
sensitivity analysis.
6-39
Sensitivity Analysis
1. What the operating income would be if there
is a 3% decrease in the selling price?
2. What the operating income would be if there
is a 5% increase in the purchase price of direct
materials?
6-40
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.
6-41
Software
Software packages ( like ERP) are now
readily available to reduce the
computational burden and time required to
prepare budgets.
These packages assist managers
to do sensitivity analysis (what if technique).
6-42
Explain kaizen budgeting

and how it is used for
cost management.
6-43
What is Kaizen?
The Japanese use the term kaizen
for continuous improvement.
Kaizen budgeting is an approach that
explicitly incorporates continuous
improvement factors in the budgeting
process.
6-44
Kaizen Budgeting
It was previously estimated that it should
take 3 labor-hours for manufacture its
product.
A kaizen budgeting approach would
incorporate future improvements.
6-45
Kaizen Budgeting
Budgeted Hours/Item
January March 2004
April June 2004
July September 2004
October December 2004
3.00
2.95
2.90
2.85
6-46
Describe responsibility centers

and responsibility accounting.
6-47
What is a Responsibility Center?

Responsibility Center a part, segment, or
subunit of an organization whose manager is
accountable for a specified set of activities
production
service
6-48
Types of Responsibility Centers

Cost accountable for costs only
2. Revenue accountable for revenues only
3. Profit accountable for revenues and costs
4. Investment accountable for investments,
revenues, and costs
1.
6-49
Budgeting and the Organization:

Responsibility Accounting
Responsibility Accounting a system that
measures the plans, budgets, actions, and

actual results of each Responsibility Center
6-50
Budgets and Feedback

Budgets offer feedback in the form of
variances: actual results deviate from

budgeted targets
Variances provide managers with
Early warning of problems
A basis for performance evaluation
A basis for strategy evaluation
6-51
Explain how controllability

relates to responsibility
accounting.
6-52
What is Controllability?
Controllability is the degree of influence that
a manager has over costs, revenues, or related
items for which he is being held responsible.
A controllable cost is any cost that is
primarily subject to the influence of a given
responsibility center manager for a given
period.
6-53
Controllability
A responsibility accounting system could
exclude all uncontrollable costs from a
managers performance report.
In practice, controllability is difficult to pinpoint.
Responsibility Accounting focuses on
information sharing, not in laying blame on a
particular manager.
6-54
Human Aspects of Budgeting
6-55
Budgeting and Human Behavior

The budgeting process may be abused both
by superiors and subordinates, leading to

negative outcomes
Superiors may dominate the budget process
or hold subordinates accountable for events
they have no control over.
Subordinates may build budgetary slack into
their budgets
6-56
Budgetary Slack
The practice of underestimating budgeted
revenues, or overestimating budgeted

expenses, in an effort to make the resulting
budgeted goals (profits) more easily
attainable
To avoid budgetary slack:
1: Use budgets primarily for planning
2: Managers involvement
6-57

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CH 6

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CHAPTER 6

Understand what a master budget

plan of action by management for a specified

Describe the advantages

among subunits within the company

Time Coverage of Budgets

Add February 2007

Prepare the operating budget

managements operating and financial plans

Components of Master Budgets

the planned operational aspects of the

Basic Operating Budget Steps

Basic Operating Budget Steps

Prepare the Manufacturing Overhead Costs

Input cost / unit

Step 1: Revenues Budget

Step 2: Production Budget (in units)

Budgeted units of sales

Step 2: Production Budget (in units)

Step 3:Direct Materials Usage Budget

as the production units

Step 3:Direct Materials Usage Budget

Step 3: Direct Materials Purchase

Materials needed for production

Step 3: Direct Materials Purchase Budget

Step 4: Direct Manufacturing Labor Budget

Step 5: Manufacturing Overhead Costs

Step 5: Manufacturing Overhead Costs

Step 5: Manufacturing Overhead Costs

Mfg OH costs are classified as variable and fixed costs

Step 5: Manufacturing Overhead Costs

Step 6: Ending Inventories Budget

Step 6: Ending Inventories Budget

Step 7: Cost of Goods Sold Budget

Step 8: Non-manufacturing Cost Budget

Step 9: Budgeted Income Statement

Budgeting Overview Flowchart

Basic Financial Budget Steps

Use computer-based financial

Financial Planning Models

Explain kaizen budgeting

Describe responsibility centers

What is a Responsibility Center?

Types of Responsibility Centers

Budgeting and the Organization:

measures the plans, budgets, actions, and

Budgets and Feedback

variances: actual results deviate from

Explain how controllability

Human Aspects of Budgeting

Budgeting and Human Behavior

by superiors and subordinates, leading to

revenues, or overestimating budgeted

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