ActivityBased

Budgeting

16-1

Objectives
Objectives
1. Describe theAfter
shortcomings
of
studying
After
studying this
thisthe traditional
master budgeting
process.
chapter,
you
chapter,
you should
should
be
2. Define flexible budgeting,
be able
able to:
to:and discuss its role
in planning, control, and decision making.
3. Define activity-based budgeting, and discuss
its role in planning, control, and decision
making.
Continue
Continue
16-2

Objectives
Objectives
4. Identify and discuss the key features that a
budgetary system should have to encourage
managers to engage in goal-congruent
behavior.
5. Describe budgets for merchandising and
service firms and zero-base budgeting.

16-3

Shortcomings
Shortcomings of
of the
the Traditional
Traditional
Master
Master Budgeting
Budgeting Process
Process
The traditional master budget is:
department oriented and does not
recognize the interdependencies among
departments.
static, not dynamic.
results, not process, oriented.

16-4

Static Budgets versus Flexible Budgets

A static budget is a budget for a particular level of

activity.
A flexible budget is a budget that provides a firm

with the capability to compute expected costs for a

range of activity.

16-5

Budgeted Information on ABT, Inc.

(in thousands)
For the Year Ended December 31, 2004
Quarter
1
2
3
4
Unit sales
2,000
Units to be produced 2,400
Budgeted fixed OH:
Supervision
100
Depreciation
200
Rent
20

Year

6,000
6,000

6,000
5,600

2,000
2,000

16,000
16,000

100
200
20

100
200
20

100
200
29

400
800
80

Continued
Continued
16-6

Budgeted Information on ABT, Inc.

(in thousands)
For the Year Ended December 31, 2004
Quarter
1
2
3
4
Budgeted unit costs:
Direct materials
Direct labor
Variable overhead:
Supplies
Indirect labor
Power

Year

$0.26
0.12
0.03
0.07
0.02
16-7

Performance Report: Quarterly Production Costs

(in thousands)
Actual

Budgeted

Variance

Units produced
3,000
Direct materials cost $ 927.3
Direct labor cost
360.0
Overhead:
Variable:
Supplies
80.0
Indirect labor
220.0
Power
40.0
Fixed:
Supervision
90.0
Depreciation
200.0
Rent
30.0
Total
$1,947.3

2,400
$ 624.0
288.0

600 F
$303.3 U
72.0 U

2,400,000
2,400,000xx$0.26
$0.26
2,400,000
xx$0.12
2,400,000
72.0 $0.12 8.0 U
168.0
52.0 U
48.0
-8.0 F
100.0
200.0
20.0
$1,520.0

-10.0 F
0.0 10.0 U
$427.3 U

16-8

Flexible Production Budget (in thousands)

Variable Cost Per Range of Production (units)
Unit
2,400
3,000
3,600

Production costs:
Variable:
Direct materials
Direct labor
Variable overhead:
Supplies
Indirect labor
Power
Total variable costs

$0.26
0.12

$ 624
288

$ 780
360

$ 936
432

0.03
0.07
0.02
$0.50

72
168
48
$1,200

90
210
60
$1,500

108
252
72
$1,800

Continued
Continued
16-9

Flexible Production Budget (in thousands)

Variable Cost Per Range of Production (units)
Unit
2,400
3,000
3,600

Production costs:
Fixed overhead:
Supervision
Depreciation
Rent
Total fixed costs
Total production costs

$ 100
200
20
$ 320
$1,520

$ 100
200
20
$ 320
$1,820

$ 100
200
20
$ 320
$2,120

16-10

Actual versus Flexible Performance Report:

Quarterly Production Costs (in thousands)
Actual

Units produced
Production costs:
Direct materials
Direct labor
Variable overhead:
Supplies
Indirect labor
Power
Total variable costs

Budgeted

Variance

3,000

3,000

----

$ 927.3
360.0

$ 780.0
360.0

$147.3 U
0.0

80.0
220.0
40.0
$1,627.3

90.0
210.0
60.0
$1,500.0

-10.0
10.0
-20.0
$127.3

F
U
F
U

Continued
Continued
16-11

Actual versus Flexible Performance Report:

Quarterly Production Costs (in thousands)
Actual

Units produced
Fixed overhead:
Supervision
Direct labor
Rent
Total fixed costs
Total production costs

Budgeted

3,000

3,000

90.0
200.0
30.0
$ 320.0
$1,947.3

$ 100.0
200.0
20.0
$ 320.0
$1,820.0

Variance

---$ -10.0 F
0.0
10.0 U
$ 0.0
$127.3 U

16-12

Budgets
Budgets can
can be
be used
used to
to
examine
examine the
the efficiency
efficiency
and
and effectiveness
effectiveness of
of aa
company.
company.

16-13

Efficiency
Efficiency isis achieved
achieved
when
when the
the business
business
process
process isis performed
performed in
in
the
the best
best possible
possible way,
way,
with
with little
little or
or no
no waste.
waste.

16-14

Managerial Performance Report:

Quarterly Production (in thousands)
Actual
Results
(1)

Flexible
Budget
(2)

Flexible
Budget
Variance
(3)

Static
Budget
(4)

Volume
Variance
(5)

Units produced
3,000
3,000
--2,400
600 F
Production costs:
Direct materials $ 927.3 $ 780.0 $147.3 U $ 624.0 $156.0 U
Direct labor
360.0
360.0
0.0
288.0 72.0 U
Supplies
80.0
90.0 -10.0 F
72.0 18.0 U
Indirect labor
220.0
210.0
10.0 U 168.0 42.0 U
Power
40.0
60.0 -20.0 F
48.0 12.0 U
Supervision
90.0
100.0 -10.0 F
100.0
0.0
Depreciation
200.0
200.0
0.0
200.0
0.0
Rent
30.0
20.0
10.0 U
20.0
0.0
Total costs
$1,947.3 $1,820.0 $127.3 U$1,520.0 $300.0 16-15
U

Activity Flexible Budget

Driver: Machine Hours
Formula
Level of Activity
Fixed
Variable
8,000
16,000

Maintenance
Machining
Subtotal

$ 20,000
15,000
$ 35,000
Fixed

Inspection
Setups
Subtotal

$ 80,000
0
$ 80,000
Fixed

Purchasing

$211,000

$5.50
2.00
$7.50

$ 64,000
31,000
$ 95,000

Drivers: Number of Batches

Variable
25

$2,100
1,800
$3,900

$132,500
45,000
$177,500

Drivers: Number of Orders

Variable
1,5000

$1

$226,000

$108,000
47,000
$155,000
30

$143,000
54,000
$197,000
25,000

$236,000
16-16

Activity-Based Performance Budget

Actual
Costs

Maintenance
Machining
Inspection
Setups
Purchases
Total

$ 55,000
29,000
125,500
46,500
220,000
$476,000

Budgeted
Costs

Budget
Variance

$ 64,000 $ 9,000 F
31,000
2,000 F
132,500
7,000 F
45,000
1,500 U
226,000
6,000 F
$498,500 $22,500 F

16-17

Traditional Budget for the Secure-Care Department

Expense
Category

Salaries and benefits:

Brad
Administrative assistants
Receptionist
Rent
Supplies
PCs and Internet
Travel
Investigative services
Telephone
Total

Budgeted
Amount

$110,000
70,000
30,000

$210,000
36,000
10,000
4,000
3,000
6,000
4,800
$273,800
16-18

Flexible Budget for the Secure-Care Department

Expense
Category

Variable expenses:
Supplies
Telephone
Total variable expenses
Fixed expenses:
Salaries and benefits
Rent
PC and Internet
Travel
Investigative services
Telephone
Total fixed expenses
Total expenses

Budgeted Amounts
for 60 Clients

$ 10,000
3,600
$ 13,600
$210,000
36,000
4,000
3,000
6,000
1,200
260,200
$273,800
16-19

Activity-Based Budget for

the Secure-Care Department
Activity
Description

Processing mail
Paying bills
Reconciling
accounts
Advertising/
interviewing
Investigating
Visiting homes
Writing reports
Managing dept.
Total

Activity
Driver

Cost per Unit Amount of Activity

of Driver
Driver
Cost

No. of clients
No. of bills

$125.00
1.75

60 $ 7,500
12,000
21,000

No. of accounts

114.00

350

39,900

No. of new hires

No. of new hires
No. of clients
No. of clients

120.00
100.00
650.00
175.00

60
60
60
60

7,200
6,000
39,000
10,500
142,700
$273,800
16-20

The
The Behavioral
Behavioral Dimension
Dimension
of
of Budgeting
Budgeting
Positive behavior occurs when the goals of
individual managers are aligned with the
goals of the organization and the manager has
the drive to achieve them.
If the budget is improperly administered, the reaction
of subordinate managers may be negative.

16-21

Characteristics
Characteristics of
of aa Good
Good
Budgetary
Budgetary System
System
An ideal budgetary system
is one that achieves
complete goal congruence
and simultaneously creates
a drive in managers to
achieve the organizations
goals in an ethical manner.

16-22

Monetary
Monetary and
and
Nonmonetary
Nonmonetary Incentives
Incentives
Incentives
Incentives are
are the
the
means
means that
that are
are used
used to
to
encourage
encouragemanagers
managers
to
to work
work toward
toward
achieving
achieving the
the
organizations
organizationsgoals.
goals.

16-23

Participative
Participative Budgeting
Budgeting
Participating budgeting has three potential
problems:
1. Setting standards that are either too high or too
low
2. Building slack into the budget (padding the
budget)
Only superficial
3. Pseudoparticipation

Only superficial
participation
participationisissought
sought
from
fromlower-level
lower-level
managers
managers
16-24

Zero-Base
Zero-Base Budgeting
Budgeting
The prior years budgeted level is not taken for
granted
Existing operations are subject to in-depth
analysis
Continuance of the activity must be justified on
the basis of need
Each submit company starts from ground zero
Time-consuming and costly
16-25

Zero-Base
Zero-Base Budgeting
Budgeting
A
Areasonable
reasonable compromise
compromise to
to cost
cost
isis to
to use
use zero-base
zero-base budgeting
budgeting
every
every three
three to
to five
five years
years in
in order
order
to
to weed
weed out
out waste
waste and
and
inefficiency.
inefficiency.

16-26

End of

Chapte
r
16-27

16-28