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22

Budgetary Control and Responsibility Accounting

 CHAPTER PREVIEW 

In Chapter 21, we discussed the use of budgets for planning. We now consider how budgets are used by management to control operations. In the Feature Story on the Tribeca Grand Hotel, we see that management uses the budget to adapt to the business environment. This chapter focuses on two aspects of management control: (1) budgetary control and (2) responsibility accounting.

Pumpkin Madeleines and a Movie

Perhaps no place in the world has a wider variety of distinctive, high‐end accommodations than New York City. It's tough to set yourself apart in the Big Apple, but unique is what the Tribeca Grand Hotel is all about.

When you walk through the doors of this triangular‐shaped building, nestled in one of Manhattan's most affluent neighborhoods, you immediately encounter a striking eight‐story atrium. Although the hotel was completely renovated, it still maintains its funky mid‐century charm. Just consider the always hip Church Bar. Besides serving up cocktails until 2 A.M., Church's also provides food. These are not the run‐of‐the‐mill, chain hotel, borderline edibles. Church's chef is famous for tantalizing delectables such as duck rillettes, sea salt baked branzino, housemade pappardelle, and pumpkin madeleines.

Another thing that really sets the Tribeca Grand apart is its private screening room. As a guest, you can enjoy plush leather seating, state‐of‐the‐art projection, and digital surround sound, all while viewing a cult classic from the hotel's film series. In fact, on Sundays, free screenings are available to guests and non‐guests alike on a first‐come‐first‐served basis.

To attract and satisfy a discerning clientele, the Tribeca Grand's management incurs higher and more unpredictable costs than those of your standard hotel. As fun as it might be to run a high‐end hotel, management can't be cavalier about spending money. To maintain profitability, management closely monitors costs and revenues to make sure that they track with budgeted amounts. Further, because of unexpected fluctuations (think Hurricane Sandy or a bitterly cold stretch of winter weather), management must sometimes revise forecasts and budgets and adapt quickly. To evaluate performance when things happen that are beyond management's control, the budget needs to be flexible.

LEARNING OBJECTIVE 1

Describe budgetary control and static budget reports.

BUDGETARY CONTROL

One of management's functions is to control company operations. Control consists of the steps taken by management to see that planned objectives are met. We now ask: How do budgets contribute to control of operations?

The use of budgets in controlling operations is known as budgetary control . Such control takes place by means of budget reports that compare actual results with planned objectives. The use of budget reports is based on the belief that planned objectives lose much of their potential value without some monitoring of progress along the way. Just as your professors give midterm exams to evaluate your progress, top management requires periodic reports on the progress of department managers toward their planned objectives.

Budget reports provide management with feedback on operations. The feedback for a crucial objective, such as having enough cash on hand to pay bills, may be made daily. For other objectives, such as meeting budgeted annual sales and operating expenses, monthly budget reports may suffice. Budget reports are prepared as frequently as needed. From these reports, management analyzes any differences between actual and planned results and determines their causes. Management then takes corrective action, or it decides to modify future plans. Budgetary control involves the activities shown in Illustration 22-1.

ILLUSTRATION 22-1 Budgetary control activities

Budgetary control works best when a company has a formalized reporting system. The system does the following:

1. Identifies the name of the budget report, such as the sales budget or the manufacturing overhead budget.

2. States the frequency of the report, such as weekly or monthly.

3. Specifies the purpose of the report.

4. Indicates the primary recipient(s) of the report.

Illustration 22-2 provides a partial budgetary control system for a manufacturing company. Note the frequency of the reports and their emphasis on control. For example, there is a daily report on scrap and a weekly report on labor.

Name of Report

Frequency

Purpose

Primary Recipient(s)

Sales

Weekly

Determine whether sales goals are met

Top management and sales manager

Labor

Weekly

Control direct and indirect labor costs

Vice president of production and production department managers

Scrap

Daily

Determine efficient use of materials

Production manager

Departmental overhead costs

Monthly

Control overhead costs

Department manager

Selling expenses

Monthly

Control selling expenses

Sales manager

Income statement

Monthly and quarterly

Determine whether income goals are met

Top management

ILLUSTRATION 22-2 Budgetary control reporting system

STATIC BUDGET REPORTS

You learned in Chapter 21 that the master budget formalizes management's planned objectives for the coming year. When used in budgetary control, each budget included in the master budget is considered to be static. A static budget is a projection of budget data at one level of activity. These budgets do not consider data for different levels of activity. As a result, companies always compare actual results with budget data at the activity level that was used in developing the master budget.

Examples

To illustrate the role of a static budget in budgetary control, we will use selected data prepared for Hayes Company in Chapter 21. Budget and actual sales data for the Rightride product in the first and second quarters of 2017 are as follows.

Sales

First Quarter

Second Quarter

Total

Budgeted

$180,000

$210,000

$390,000

Actual

 179,000

 199,500

 378,500

Difference

$  1,000

$ 10,500

$ 11,500

ILLUSTRATION 22-3 Budget and actual sales data

The sales budget report for Hayes' first quarter is shown below. The right‐most column reports the difference between the budgeted and actual amounts.

ILLUSTRATION 22-4 Sales budget report—first quarter

The report shows that sales are $1,000 under budget—an unfavorable result. This difference is less than 1% of budgeted sales ($1,000÷$180,000=.0056)($1,000÷$180,000=.0056). Top management's reaction to unfavorable differences is often influenced by the materiality (significance) of the difference. Since the difference of $1,000 is immaterial in this case, we assume that Hayes management takes no specific corrective action.

Illustration 22-5 shows the budget report for the second quarter. It contains one new feature: cumulative year‐to‐date information. This report indicates that sales for the second quarter are $10,500 below budget. This is 5% of budgeted sales ($10,500÷$210,000)($10,500÷$210,000). Top management may now conclude that the difference between budgeted and actual sales requires investigation.