1. Budgetary
Control
Static Budgets Budgeting and Budgetary
Control
Flexible Budgets
Responsibility
Accounting
Responsibility
Reports/Cost
Responsibility
Reports -Profit
Investment
Centers
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S
EL
End
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7-1
2. Budgetary Control and
Budgetary
Control
Responsibility Accounting
Static Budgets
Flexible Budgets
Responsibility
Accounting
Responsibility
Reports/Cost
Responsibility
Reports -Profit
Investment
Centers
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Slide Slide
End
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7-2
3. Budgetary
Management Functions
Control
Static Budgets • Planning
Flexible Budgets
Responsibility
Accounting • Directing and Motivating
Responsibility
Reports/Cost
Responsibility
• Controlling
Reports -Profit
Investment
Centers
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Slide Slide
End
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7-3
4. Budgetary Control
Budgetary
Control
• One of the three main
Static Budgets
Flexible Budgets functions of management
Responsibility
Accounting is to control.
Responsibility
Reports/Cost • Budgets are useful in
Responsibility
Reports -Profit
Investment
controlling operations.
Centers
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Slide Slide
End
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7-4
5. Budgetary Control
Budgetary
Control
Static Budgets
The use of budgets to
Flexible Budgets control operations.
Responsibility
Accounting Compare actual results
Responsibility
Reports/Cost with planned objectives.
Responsibility
TS
Reports -Profit
EN L
EMCIA
BU
AT N
ST INA
DG
Investment
F
TE
Centers
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7-5
6. Illustration 7-1
Budgetary Control
Budgetary
Control
Static Budgets
Flexible Budgets
Responsibility
Accounting
Responsibility
Reports/Cost
Responsibility
Reports -Profit
Investment
Centers
Previous Next
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End
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7-6
7. Illustration
7-2
Budgetary Control Reporting System
8. Illustration 7-6
Static Budget
Budgetary
Control
Static Budgets
A projection of budget data
Flexible Budgets at one level of activity.
Responsibility
Accounting Barton Steel (Forging Department)
Manufacturing Overhead Budget (Static)
Responsibility For the Year Ended December 31, 2002
Reports/Cost
Responsibility Budgeted Production in units (steel ingots)
Budgeted Production in units (steel ingots) 10,000
10,000
Reports -Profit Budgeted Costs
Budgeted Costs
Indirect materials
Indirect materials $$250,000
250,000
Investment Indirect labor 260,000
Indirect labor 260,000
Centers Utilities 190,000
Utilities 190,000
Depreciation
Depreciation 280,000
280,000
Property taxes
Property taxes 70,000
70,000
Supervision
Supervision 50,000
50,000
Previous Next $1,100,000
$1,100,000
Slide Slide
End
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7-8
10. Flexible Budget
Budgetary
Control
Static Budgets
A projection
Flexible Budgets of budget
Responsibility
Accounting data for
Responsibility
Reports/Cost
various
Responsibility
Reports -Profit
levels of
Investment activity.
Centers
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End
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7 - 10
13. Management by Exception
Budgetary
Control
Static Budgets
The review of budget reports
Flexible Budgets by management focused
Responsibility
Accounting entirely or primarily on
Responsibility
Reports/Cost differences between actual
Responsibility
Reports -Profit results and planned
Investment
Centers objectives.
Previous Next
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End
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7 - 13
14. Illustration 7-17
Responsibility Reporting System
Budgetary
Control The preparation of reports
Static Budgets for each level of
Flexible Budgets
Responsibility
responsibility in the
Accounting company’s organization
Responsibility
Reports/Cost chart.
Responsibility
Reports -Profit
Investment
Centers
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End
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7 - 14
15. Controllable Costs
Budgetary
Control
Static Budgets
Costs that a manager has the
Flexible Budgets authority to incur within a
Responsibility
Accounting given period of time.
Responsibility
Reports/Cost
Responsibility
Reports -Profit
Investment
Centers
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End
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7 - 15
16. Illustration 7-17
Responsibility for Controlling Costs
Budgetary
Control
Static Budgets
Flexible Budgets
Responsibility
Accounting
Responsibility
Reports/Cost
Responsibility
Reports -Profit
Investment
Centers
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End
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7 - 16
17. Decentralization
Budgetary
Control
Static Budgets
Control of operations is
Flexible Budgets delegated to many managers
Responsibility
Accounting throughout the organization.
Responsibility
Reports/Cost
Responsibility
Reports -Profit
Investment
Centers
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End
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18. Segment
Budgetary
Control
Static Budgets
An area of responsibility in
Flexible Budgets decentralized operations.
Responsibility
Accounting
Responsibility
Reports/Cost
Responsibility
Reports -Profit
Investment
Centers
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End
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7 - 18
19. Responsibility Accounting
Budgetary
Control
Static Budgets
A part of management
Flexible Budgets accounting that involves
Responsibility
Accounting accumulating and reporting
Responsibility
Reports/Cost revenues and costs on the
Responsibility
Reports -Profit basis of the manager who
Investment
Centers has the authority to make
the day-to-day decisions
Previous
Slide
Next
Slide about the items.
End
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7 - 19
21. Direct Fixed Costs
Budgetary
Control
Static Budgets
Costs that relate specifically
Flexible Budgets to a responsibility center
Responsibility
Accounting and are incurred for the
Responsibility
Reports/Cost sole benefit of the center.
Responsibility
Reports -Profit
Investment
Centers
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End
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7 - 21
22. Indirect Fixed Costs
Budgetary
Control
Static Budgets
Costs that are incurred for
Flexible Budgets the benefit of more than one
Responsibility
Accounting profit center.
Responsibility
Reports/Cost
Responsibility
Reports -Profit
Investment
Centers
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End
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7 - 22
23. Cost Center
Budgetary
Control
Static Budgets
A responsibility center that
Flexible Budgets incurs costs but does not
Responsibility
Accounting directly generate revenues.
Responsibility
Reports/Cost
Responsibility
Reports -Profit
Investment
Centers
Previous Next
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End
Show Warranty Dept
7 - 23
24. Profit Center
Budgetary
Control
Static Budgets
A responsibility center that
Flexible Budgets incurs costs but also
Responsibility
Accounting generates revenue.
Responsibility
Reports/Cost
Responsibility
Reports -Profit
Investment
Centers
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End
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7 - 24
25. Investment Center
Budgetary
Control
Static Budgets
A responsibility center that
Flexible Budgets incurs costs, generates
Responsibility
Accounting revenues, and has control
Responsibility
Reports/Cost over the investment funds
Responsibility
Reports -Profit available for use.
Investment
Centers
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End
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7 - 25
27. Illustration 7-22
Responsibility Report
Budgetary
Control Contribution margin less controllable
Static Budgets fixed costs=Controllable Margin.
Flexible Budgets
Responsibility Mantel Manufacturing Company (Marine Division)
Accounting Responsibility Report
Responsibility For the Year Ended December 31, 2002
Reports/Cost
Difference
Difference
Responsibility Favorable F
Favorable F
Reports -Profit Budget Actual Unfavorable U
Budget Actual Unfavorable U
Investment Sales
Sales $1,200,000 $1,150,000
$1,200,000 $1,150,000 $50,000 U
$50,000 U
Centers Variable Costs
Variable Costs
Cost of goods sold
Cost of goods sold 500,000
500,000 490,000
490,000 10,000 F
10,000 F
Selling & administrative
Selling & administrative 160,000
160,000 156,000
156,000 4,000 F
4,000 F
Total
Total 660,000
660,000 646,000
646,000 14,000 F
14,000 F
Contribution margin
Contribution margin 540,000
540,000 504,000
504,000 36,000 U
36,000 U
Previous Next Controllable fixed costs
Slide Slide Controllable fixed costs
Cost of goods sold
Cost of goods sold 100,000
100,000 100,000
100,000 -0-
-0-
End Selling & administrative
Selling & administrative 80,000
80,000 80,000
80,000 -0-
-0-
Show Total
Total 180,000
180,000 180,000
180,000 -0-
-0-
7 - 27 Controllable margin
Controllable margin $$360,000 $$324,000
360,000 324,000 $36,000 U
$36,000 U
28. Residual Income
Budgetary
Control The income that remains after
Static Budgets
Flexible Budgets
subtracting from the
Responsibility controllable margin the
Accounting
Responsibility
minimum rate of return on a
Reports/Cost company’s operating assets.
Responsibility
Reports -Profit
Investment
Centers
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End
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7 - 28
29. Return on Investment (ROI)
Budgetary
Control
A measure of management’s
Static Budgets
effectiveness in utilizing assets
Flexible Budgets at its disposal in an investment
Responsibility
Accounting
center.
Responsibility
Reports/Cost
Responsibility
Reports -Profit
Investment
Centers
Previous Next
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End
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7 - 29
30. Principles of Performance Evaluation
Budgetary • Managers of responsibility centers
Control
should have direct input into the
Static Budgets
process of establishing budget goals of
Flexible Budgets
their area of responsibility.
Responsibility
Accounting • The evaluation of performance should
Responsibility be based entirely on matters that are
Reports/Cost controllable by the manager being
Responsibility evaluated.
Reports -Profit
• Top management should support the
Investment
Centers
evaluation process.
• The evaluation process must allow
managers to respond to their
Previous Next evaluations.
Slide Slide
• The evaluation should identify both
End
Show good and poor performance.
7 - 30
32. • Outline
Budgetary
Control
Static Budgets
Flexible Budgets
Responsibility • Traditional Capital Budgeting Techniques
Accounting
Responsibility
Reports/Cost
– Payback Period Approach
Responsibility – Discounted Payback Period Approach
Reports -Profit – Discounted Cash Flow Techniques
Investment • Net Present Value
Centers
• Internal Rate of Return
• Profitability Index
• Net Present Value versus Internal Rate of Return
Previous Next
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End
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7 - 32
33. • Meaning of Capital Budgeting
Budgetary
Control
Static Budgets
• Capital budgeting addresses the issue of
Flexible Budgets
Responsibility
strategic long-term investment decisions.
Accounting • Capital budgeting can be defined as the
Responsibility
Reports/Cost
process of analyzing, evaluating, and
Responsibility
deciding whether resources should be
Reports -Profit allocated to a project or not.
Investment • Process of capital budgeting ensure
Centers
optimal allocation of resources and helps
management work towards the goal of
Previous Next
shareholder wealth maximization.
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End
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7 - 33
34. • Significance of Capital Budgeting
Budgetary
Control
Static Budgets
Flexible Budgets
• Considered to be the most important
Responsibility decision that a corporate treasurer
Accounting
Responsibility
has to make.
Reports/Cost
Responsibility
• So much is the significance of capital
Reports -Profit
budgeting that many business
Investment
Centers schools offer a separate course on
capital budgeting
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End
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7 - 34
35. • Why Capital Budgeting is so
Budgetary Important?
Control
Static Budgets
Flexible Budgets
• Involve massive investment of
Responsibility
Accounting
resources
Responsibility • Are not easily reversible
Reports/Cost
Responsibility • Have long-term implications for
Reports -Profit
Investment
the firm
Centers
• Involve uncertainty and risk for
the firm
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End
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7 - 35
36. Why Capital Budgeting is so Important?
Budgetary
Control
• Due to the above factors, capital budgeting
decisions become critical and must be evaluated
Static Budgets very carefully.
Flexible Budgets
Responsibility • Any firm that does not follow the capital
Accounting budgeting process will not be maximizing
Responsibility shareholder wealth and
Reports/Cost
Responsibility • Management will not be acting in the best
Reports -Profit interests of shareholders.
Investment
Centers
• RJR Nabisco’s smokeless cigarette project
example
– Project initiated in 1989
Previous Next – More than $300 million was invested
Slide Slide – Had 2 flaws- required special lighter & was tasteless
for smoker
End
Show
– Within 2 years the project failed to deliver
7 - 36
37. Why Capital Budgeting is so Important?
Budgetary
• Similarly:
Control • Euro-Disney,
– Failed miserably because of following factors :
Static Budgets – Cultural gap’s – French felt that their children might loose
Flexible Budgets french culture as it had more of English culture
– Europeans love travelling and not interested in 1 day
Responsibility vaccation
Accounting – All Investments were Bad (Lost everything) . 1st year $900m
Responsibility
loss.
Reports/Cost • Concorde Plane,
– Too noisy
Responsibility – Too expensive
Reports -Profit
– Plane crash in 2000- killed 113 passengers
Investment • Saturn of GM
Centers – Best selling model to kill competition from Japan cars
– For 5 years GM did not make any other model
– After 5 years brought various models killing the Saturn
model
Previous Next
Slide Slide
All faced problems due to bad capital budgeting, while
End Intel became global leader due to sound capital
Show budgeting decisions in 1990s.
7 - 37
38. • Techniques of Capital Budgeting
Budgetary Analysis
Control
Static Budgets • Payback Period Approach
Flexible Budgets
Responsibility • Discounted Payback Period
Accounting
Responsibility
Approach
Reports/Cost
• Net Present Value Approach
Responsibility
Reports -Profit
• Internal Rate of Return
Investment
Centers
• Profitability Index
Previous Next
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End
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7 - 38
39. • Which Technique should we follow?
Budgetary
Control
Static Budgets
Flexible Budgets
• A technique that helps us in selecting
Responsibility projects that are consistent with the
Accounting principle of shareholder wealth
Responsibility
Reports/Cost maximization.
Responsibility • A technique is considered consistent with
Reports -Profit
Investment
wealth maximization if
Centers – It is based on cash flows
– Considers all the cash flows
Previous
– Considers time value of money
Next
Slide Slide – Is unbiased in selecting projects
End
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7 - 39
40. • Payback Period Approach
Budgetary
Control
Static Budgets
Flexible Budgets • The amount of time needed to recover the
Responsibility initial investment
Accounting
• The number of years it takes including a
Responsibility
Reports/Cost
fraction of the year to recover initial
investment is called payback period
Responsibility
Reports -Profit • To compute payback period, keep adding the
Investment cash flows till the sum equals initial
Centers investment
• Simplicity is the main benefit, but suffers
from drawbacks
Previous Next • Technique is not consistent with wealth
Slide Slide
maximization—Why?
End
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7 - 40
41. • Discounted Payback Period
Budgetary
Control
Static Budgets
• Similar to payback period approach with
Flexible Budgets
Responsibility
one difference that it considers time value
Accounting of money
Responsibility
Reports/Cost
• The amount of time needed to recover
Responsibility
initial investment given the present value of
Reports -Profit cash inflows
Investment
Centers
• Keep adding the discounted cash flows till
the sum equals initial investment
• All other drawbacks of the payback period
Previous Next remains in this approach
Slide Slide
End
• Not consistent with wealth maximization
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7 - 41
42. • Net Present Value Approach
Budgetary
Control
Static Budgets
Flexible Budgets
• Based on the Rupees amount of cash flows
Responsibility • The Rupee amount of value added by a
Accounting
project
Responsibility
Reports/Cost • NPV equals the present value of cash
Responsibility
Reports -Profit
inflows minus initial investment
Investment • Technique is consistent with the principle
Centers
of wealth maximization—Why?
• Accept a project if NPV ≥ 0
Previous Next
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End
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43. • Internal Rate of Return
Budgetary
Control
Static Budgets
Flexible Budgets
• The rate at which the net present
Responsibility value of cash flows of a project is
Accounting
zero, I.e., the rate at which the
Responsibility
Reports/Cost present value of cash inflows equals
Responsibility initial investment
Reports -Profit
Investment • Project’s promised rate of return
Centers
given initial investment and cash
flows
Previous Next • Consistent with wealth maximization
Slide Slide
End • Accept a project if IRR ≥ Cost of
Show
7 - 43
Capital
44. • NPV versus IRR
Budgetary
Control
Static Budgets
• Usually, NPV and IRR are consistent with
Flexible Budgets
Responsibility
each other. If IRR says accept the project,
Accounting NPV will also say accept the project
Responsibility • IRR can be in conflict with NPV if
Reports/Cost
Responsibility
– Investing or Financing Decisions
Reports -Profit – Projects are mutually exclusive
Investment • Projects differ in scale of investment
Centers • Cash flow patterns of projects is different
– If cash flows alternate in sign—problem of
multiple IRR
Previous Next
Slide Slide • If IRR and NPV conflict, use NPV
End approach
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7 - 44
45. • Profitability Index (PI)
Budgetary
Control
Static Budgets
• A part of discounted cash flow family
Flexible Budgets
Responsibility
• PI = PV of Cash Inflows/initial investment
Accounting
• Accept a project if PI ≥ 1.0, which means
Responsibility
Reports/Cost positive NPV
Responsibility • Usually, PI consistent with NPV
Reports -Profit
Investment
• PI may be in conflict with NPV if
Centers – Projects are mutually exclusive
• Scale of projects differ
• Pattern of cash flows of projects is different
Previous
Slide
Next
Slide
• When in conflict with NPV, use NPV
End
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7 - 45
46. • Evaluating Projects with Unequal
Budgetary Lives
Control
Static Budgets
Flexible Budgets
• Replacement Chain Analysis
Responsibility
Accounting
• Equivalent Annual Cost Method
Responsibility
Reports/Cost
• If two machines are unequal in life,
Responsibility we need to make adjustment before
Reports -Profit
Investment
computing NPV.
Centers
Previous Next
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End
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7 - 46
47. • Which technique is superior?
Budgetary
Control
Static Budgets • Although our decision should be based on
Flexible Budgets NPV, but each technique contributes in
Responsibility
its own way.
Accounting • Payback period is a rough measure of
Responsibility riskiness. The longer the payback period,
Reports/Cost
more risky a project is
Responsibility
Reports -Profit • IRR is a measure of safety margin in a
Investment project. Higher IRR means more safety
Centers margin in the project’s estimated cash
flows
• PI is a measure of cost-benefit analysis.
Previous
Slide
Next How much NPV for every dollar of initial
Slide
investment
End
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7 - 47
