RESPONSIBILITY ACCOUNTING - Technical University of …multiedu.tul.cz/~olga.malikova/multiedu/MAU_E/MAU_E_L72.pdf · MANAGERIAL ACCOUNTING Topic7 3E‘s IN COST (MANAGERIAL) ACCOUNTING;

MANAGERIAL ACCOUNTING

Topic 7

3E‘s IN COST (MANAGERIAL) 3E‘s IN COST (MANAGERIAL)

ACCOUNTING;

RESPONSIBILITY ACCOUNTING

7.1 Definitions of 3E‘s

7.2 Why responsibility accounting?

7.3 Basic concepts of responsibility accounting

7.4 Responsibility accounting system

Structure of the lecture 7


7.5 Factors influencing responsible cost control

7.6 Responsibility for overhead costs

7.7 Responsibility for other factors

7.8 Variance analysis for responsibility accounting

7.1 Definitions of 3E‘s→ 3E‘s = effectiveness – efficiency - economy

7.1 Definitions of 3E‘s→ effectiveness• to achieve the goals

• the quality of working successfully or producing results

• the extent to which objectives are met ('doing the right things')

• the degree to which a predetermined objective or target is met

• Cost-effectiveness - Relationship between monetary inputs and the desired outcome, such as between the expenditure on an advertisingcampaign and increase in sales revenue.campaign and increase in sales revenue.

• Cost-effective = giving good value when compared with the original cost.

Effectiveness should be understood on deliverable basis and the achievement of goals. Its concept works around the fact if an objective was accomplished or not. Doing a good performance in terms of effectiveness is to deliver on time what was expected. Most directors and senior executives have in charge the responsibility to meet such criteria. If its division, business unit or company is working hard but not delivering the internal requests or the ones of the market then they are not effective. The best way to asses effectiveness is to set the objectives before the kick-off of a project or activities and see if they were achieved or not under the standards set at the beginning.

7.1 Definitions of 3E‘s→ efficiency• the ability to work well or to produce the right result or the right work

quickly

• performing tasks with reasonable effort ('doing things the right way')

• the right effort allocation

• the relative amount of inputs used to achieve a given level of output

Efficiency states the right use of resources to accomplish a task. It means the wise consumption of inputs on which the work is completed. Once that the wise consumption of inputs on which the work is completed. Once that the goals are attained it is fundamental to see how they can be met with the least effort. Improving efficiency means that the company is in a trend of reducing wastes and consuming less to deliver the same amount of value.

A proper way to measure efficiency is by acknowledging the process to complete a task and allocating the right amount of resources.

7.1 Definitions of 3E‘s→ Economy• an action which is intended to stop money or material from being wasted,

or the quality of being careful not to waste money or materials. To introduce economies or economy measures into the system = to start using methods to save money or materials.

• minimising the cost of resources ('doing things at a low price')

• reducing costs of inputs

• Economy depends on two factors: savings (= reducing the cost) and, utilization (increase of produced and sold volume for unchanged volume

• Economy depends on two factors: savings (= reducing the cost) and, utilization (increase of produced and sold volume for unchanged volume of costs).

Economy covers the financial side on which an activity is achieved. It is fundamental to balance the use of resources to achieve the right goals at the reasonable cost. There is a difference between Efficiency and Economy, the former states the volume of resources and its way of using them while the latter looks more in the terms the cost of them. Money is a type of resource that needs to be allocated wisely in today’s competitive exposure. Under the current free trade scheme of doing business, the offer is wider in terms of labour and commodities so big corporations have access to such advantages. Then competition is fiercely fought locally and internationally so the right cost becomes a critical factor to improve value delivery.

Exercise 7.1Economy. The budgeted direct material costs per unit

are CZK 10. Budgeted quantity of the production is 1,000 units. Actual total direct material costs are CZK 8,000.

Required:

• Consider economy of the company.

• Determine amount of units which the company is able to produce from saved direct material if you sustain the same economy.

Exercise 7.1

Recap.: Budgeted Actual

(in CZK) per unit total per unit total

variable costs 10 10,000 8 8,000

Budgeted quantity: 1,000 units

1) Economy: copany achieved material savings CZK 2 per unit.

2) 2,000 / 8 = 250 units as economy sustains on the same level.

7.2 Why responsibility accounting?→ Control of factory overhead

Well-designed information system should:

- Provide a control mechanism encompassing responsibility accounting.

- Make meaningful cost data available for setting policies and making decisions.

- Use predetermined or budgeted revenue and expense

policies and making decisions.

- Use predetermined or budgeted revenue and expense items for comparison with actual results, then for variance analysis or the management by exception principle.

The greatest profit results from:

• product costs must be fairly accurate, include all relevant costs,

• recognize cost differentials between products.

7.2 Why responsibility accounting?

→ „responsible = liable to be called upon to answer“

→ „responsibility = the obligation prudently to exercise

assigned or imputed authority attaching to the

assigned or imputed role of an individual or group

participating in organizational activities or decisions“participating in organizational activities or decisions“

→ „responsibility = an organizational unit having a single

head accountable for activities of the unit“

→ „controllability = degree of influence that a specific

manager has over costs, revenues, or other items in

question“

7.2 Why responsibility accounting?Management must provide a complete clarification

of the objectives and responsibilities of all levels of

the organization.

The successful achievement of effective

management control depends upon the lines of management control depends upon the lines of

communication between the accounting

department, the responsible supervisors, and their

superiors.

Responsibility accounting requires teamwork.


1.• RA is based on a classification of managerial

responsibilities (= departments) at every level in the organization for the purpose of establishing a budget for each.

• Individual in charge of each responsibility classification • Individual in charge of each responsibility classification should be responsible and accountable for the expenses of his / her activity.

• Costs are classified into controllable and not controllable by the department head.

• Cost charged directly to a department (with exception of fixed costs) are controllable by the department´s manager.

(e.g. depreciation expenses of dpt. equipment are directcost but are not under control of dpt. manager)


2.• RA information system depends on the organization chart

(structure) in which the spheres of jurisdiction have been determined.

• Authority leads to the responsibility for certain costs and expenses which, with the knowledge and cooperation of the supervisor, department head, or manager, are presented in supervisor, department head, or manager, are presented in the budget.

3.• Each individual budget should clearly identify the costs

controllable by that person.

• The chart of accounts should be adapted to permit recording of controllable or accountable expenses within the jurisdictional framework.

7.4 Responsibility accounting systemUses the concept of controllable costs to assign

managers the responsibility for costs and expenses under their control.

Responsibility center = part, segment, or subunit of an organization whose manager is accountable for a set of activities. of activities.

Four major types: cost center, revenue center, profitcenter, investment center.

Responsibility accounting budgets = plans that identify costs and expenses under each manager´s control; managers should be involved in preparing their budgets.


Board of directors

Executive Vice President

MARKETING

Executive Vice PresidentExecutive Vice President

FINANCEExecutive Vice President

Organizational responsibility chart (consulting firm)

President

MARKETING FINANCE

Managerbenchmarking

department

OPERATIONS

Vice president Vice president OPERATIONAL

consulting

Vice president Vice president STRATEGIC

consulting

Manager costmanagement department

Manageroutsourcing department

Manager

servicedepartment


Responsibility accounting performance report = accumulates

and reports costs and expenses that a manager is

responsible for and their budgeted amounts.

Management´s analysis of differences between budgeted Management´s analysis of differences between budgeted

amounts and actual costs and expenses often results in

corrective or strategic managerial actions.

Control over costs and expenses belongs to several levels of

management; managerial positions reflect channels of authority

(at lower levels , managers have limited responsibility and

relatively little control over costs and expenses).

VP operational

consulting

Budegeted amount Actual amount Over (under) budget

Salaries, dpt.managers

Depreciation

Insurance

Benchmarking dpt 79600 79900 300

Cost mngm dpt.

Outsourcing dpt.

Service dpt.

Totals

Manager, benchmarking

dpt.

Budegeted amount Actual amount Over (under) budget

Salaries 51600 52500 900

Supplies 8000 7800 - 200

Other cotrollable costs 20000 19600 -400

Totals 79600 79900 300


Organizational structure may be organized primarily

• by business function

(e.g. Exploration, refining, and marketing), or (e.g. Exploration, refining, and marketing), or

• by product or brand line

(e.g. Toothpaste, soap, shower gels,…).

7.5 Factors influencing responsible cost control• Productivity

• Cost behaviour

• Supportive relations

• Worker utilization

• Work group cohesion

• Reliability

Internal factors

Performance model

• Reliability

• Cooperation

• flexibillity

• Planning ability

• Share of market

• Dealer opinions

• Environmental stability

• Environmental diversity

Environmental

factors

Interdependencywith other

departments

Departmental

effectiveness

7.6 Responsibility for overhead costs• Many overhead items are directly chargeable to a

given department and become the direct responsibility of the departmental supervisor.

• Other overhead item must be allocated or distributed in order to calculate a departmental factory overhead rate (which charge all costs to a job, product, or the rate (which charge all costs to a job, product, or the work performed) – this is not useful (necessary) for cost control.

• The distribution between departments can be looked upon as a „purchase“ by the recipient department and a „sale“ by the providing service department – it is based on what is termed a billing rate, sold-hour rate, charging rate, or a transfer rate.

7.6 Responsibility for overhead costs

Determination of the billing rate:

1. Estimate or budget costs of any service

department according to their nature (e.g.

Supervision, supplies, electricity, …)

2. Classify costs as fixed or variable. 2. Classify costs as fixed or variable.

3. Determine a rate by dividing total estimated

departmental cost by the number of hours the

service is expected to be needed.

4. Compare actual service department costs with

estimated or budgeted costs.

7.7 Responsibility for other factors• In the direct materials and direct labour areas, many

individuals may be assigned the responsibility for costs incurred, which becomes nearly impossible to identify.

Variances or deviations from a predetermined norm or standard will result in:

• Direct material • Direct material

– Material price variances,

– Material quantity, or mix and yield variances

– Excessive defective work, rejects, or scrap costs.

• Direct labour

- pay rate variations

- efficiency variations

- overtime costs.

7.8 Variance analysis for responsibility accountingThe cost and/or budget department should issue monthly

reports that compare actual results with predetermined amounts or budget allowances.

In general, variable expenses are controllable at the departmental level, while fixed expenses are not.

Certain variable expenses may be controlled at a higher level in the organization (e.g. Employee benefits as a result of negotiations between executive management and labour negotiations between executive management and labour union).

Certain fixed cost may be controlled by department manager – so-called committed fixed expenses (e.g. Equipment depreciation, lease expense) or programmed fixed expenses (e.g. Number of supervisors in the department).

Generally, department managers should be well enough informed to explain cost variances, even thought the control or certain aspects of the control do not fall within their scope of authority and responsibility.


Spending variance

= difference between the actual and expected (or budgeted) amount of an expense.

Use in the producing departments:

Variable cost rates = variable departmental overhead Variable cost rates = variable departmental overhead divided by the predetermined or estimated direct labour hours, direct labour cost, or machine hours.

actual hours or actual costs for the month are multiplied by the variable cost rate to arrive at the budgeted or estimated variable costs.


Spending variance

In the service department:

Estimated allowance = actual monthly consumption

multiplied by the corresponding variable rates.

- Pinpointing responsibility is more complicated then in

the producing departments


Idle capacity variance

= measure of utilization of plant facilities. The variance

results when a plant is underutilized (idle), and actual

production falls below the expected, budgeted, or

normal activity

(e.g., activity in machine-hours was 5000 and the fixed

overhead applied rate is $6. The actual hours used

were 4200. The idle capacity variance is (5000 – 4200) x

$6 = $4800, an unfavorable variance because the

company’s plant was underutilized)

7.8 Variance analysis for responsibility accounting• Sold-hour rate = monthly budget / service-hours available

• Variable rate per hour = budgeted variable cost / capacity available (e.g. service-hour)

• Charged variable cost = actual services used (hours) x variable rate

• (a) Spending variance = actual cost - budgeted cost = actual cost - budgeted fixed cost - budgeted variable cost

• (b) Spending variance = actual variable cost - charged • (b) Spending variance = actual variable cost - charged variable cost

• actual variable cost = actual total cost - fixed cost

• fixed rate = total fixed cost /normal capacity (maintenance hours, number of employees)

• (a) Idle capacity variance = budgeted allowance - applied (charged out) cost

• (b) Idle capacity variance = ( normal capacity - actual capacity) * fixed cost rate

Exercise 7.2Sold-hour rates, variance analysis. A company has two service departments that

show the following budgeted and actual cost and service-hours data:

Service Center Monthly budget

(€)

Service-Hours Available Actual monthly

expenses (€)

Carpenter Shop 20,000 2,000 19,300

Electricians 30,000 2,500 28,400

The two service departments serve three producing departments that show the following

budgeted and actual cost and service-hours data:

Estimated service required Actual Services UsedEstimated service required Actual Services Used

Carpenter Shop Electricians Carpenter Shop Electricians

1 st department 600 hrs 900 hrs 400 hrs 1,000 hrs

2nd department 750 hrs 1,000 hrs 800 hrs 850 hrs

3rd department 650 hrs 600 hrs 450 hrs 550 hrsRequired:

1. Compute the sold-hour rates for the two service departments.

2. Compute the amounts charged to the producing departments for services rendered.

3. Compute the spending variances for the two service departments, assuming that 70% of the

budgeted expense is fixed in Carpenter Shop and 80% in Electricians.

Exercise 7.2Required:

1. Compute the sold-hour rates for the two service departments.

Sold-hour rate = monthly budget / service-hours available

Carpenter Shop Electricians

monthly budget 20000 30000

service-hours available 2000 2500

Sold-hour ratesSold-hour rates

(€ per hour) 20000/2000 10 30000/2500 12


2. Compute the amounts charged to the producing departments for services rendered.

amount charged = actual services used (hours) x sold-hour rate

Carpenter Shop Electricians Total

1st dpt 400x10 4000 1000x12 12000 160001st dpt 400x10 4000 1000x12 12000 16000

2nd dpt 800x10 8000 850x12 10200 18200

3rd dpt 450x10 4500 550x12 6600 11100

Total 16500 28800 45300


3. Compute the spending variances for the two service departments, assuming that

70% of the budgeted expense is fixed in Carpenter Shop and 80% in Electricians.

1variable rate per hour = budgeted variable cost /service-hour available

2charged variable cost = actual services used (hours) x variable rate

3Spending variance = actual cost - budgeted cost

= actual cost - budgeted fixed cost - budgeted variable cost= actual cost - budgeted fixed cost - budgeted variable cost




Carpenter Shop Electricians

monthly budget (€) 20000 30000

service-hours available 2000 2500

actual service used (total hours) 1650 2400

fixed cost(%) 70% 80%fixed cost(%) 70% 80%

actual cost 19300 28400

fixed cost (€) 14000 24000

budgeted variable cost (€) 6000 6000

variable rate per hour1 (€ per hour) 3 2,4

charged variable cost2 4950 5760

spending variance3 350 -1360




ALSO POSSIBLE TO COMUPUTE:4Spending variance = actual variable cost - charged variable cost

5actual variable cost = actual total cost - fixed cost

Carpenter Shop ElectriciansCarpenter Shop Electricians

actual variable cost5 5300 4400

charged variable cost2 4950 5760

spending variance4 350 -1360

Documents

RESPONSIBILITY ACCOUNTING - Technical University of …multiedu.tul.cz/~olga.malikova/multiedu/MAU_E/MAU_E_L72.pdf · MANAGERIAL ACCOUNTING Topic7 3E‘s IN COST (MANAGERIAL) ACCOUNTING;