Management Accounting 2009

Management Accounting 2009

Question

a) Describe what a flexible budget is and under what circumstances is it used?b) Outline and explain the typrs of costs involved in a flexible budget. For each cost

type, describe and illustrate the cost behaviour characteristics by drawing graphs, providing definitions and explaining its usage with examples. All graphs should be properly labeled.

Answer

Flexible budget

The budget that enables a firm to compute expected costs for a range of activity level is called a flexible budget. The key to flexible budgeting is knowledge of fixed and variable costs. There are two types of flexible budgets:

1. This budget can help managers prepare the master budget for the expected level of activity. This type of flexible budget can help managers deal with uncertainly by allowing them to see the expected outcome for a range of activity levels. It can be used to generate financial results for a number of plausible scenarios.

2. The flexible budget is the budget for the actual level of activity. This type of budget is used after the fact to compute what costs should have been for the actual level of activity. Those expected costs are then compared with the actual costs in order to assess performance.

Flexible budgeting is the key to providing the frequent feedback that managers need to exercise control and effectively carry out the plans of an organization. The purpose of a flexible budget is to measure performance more accurately by comparing actual costs for a given volume level with the budgeted costs for the same volume level. The flexible budget is dynamic. It establishes a relationship between cost and volume that can be used to develop budgets at different levels of activity. By contrast, a static budget can be developed for only one level of activity.

A flexible budget separates costs into its variable and fixed components. It adjusts the budgeted costs by changing the total variable costs according to the actual activity level attained. Fixed costs by definition remain unchanged. The flexible budget eliminates the variances between actual costs and budgeted costs created by volume increases or decreases. These volume variances are a major weakness of the static budget.

Flexible budgets should not present you with any problems. All you have to do is work out a budget for the actual level of activity which has been attained. In doing so, it help to remember us earlier studies concerning cost behavior.


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Comparison of Flexible and Fixed Budgets

1. In a fixed budget the figures are for a single level of activity while a flexible budget is prepared for different levels of activity.

2. Under fixed budgets managers are held responsible for variances not under their control.

3. In a static or fixed budget figures for one level of activity are compared with actual results, that is, comparing actual performance at, say, 8500 hours with a plan for, say, 9000 hours. Such a comparison is, according to Horngren, 'non-sense from the control view point-from a viewpoint of judging how efficiently a manager has manufactured any given output'.

4. Where flexible budget is used comparison is more meaningful because the activity level underlying the comparison is the same. The flexible budget is flexed to the actual volume.

5. It is the variable cost which is flexed to the actual volume. The fixed cost remains the same. The variable costs are regarded as controllable and the fixed costs as uncontrollable. In practice, not all variable costs are controllable and not all fixed costs are uncontrollable. It is difficult to decide whether a cost item is controllable or uncontrollable. In the short run many costs are uncontrollable but in the long run all costs are generally controllable. Rent may be uncontrollable over the short term but is controllable in the long term.

6. Flexible budgets are not exactly flexible and are in fact part flexible and part fixed. The part showing the fixed cost is in fact a fixed budget. Only the variable part is flexible.


Some of the above points can be illustrated by an example:

Fixed Budget Comparative StatementDepar For The Month Be ■tment X

ginning 1st July, 19-8

Monthly departmenta flexib

e budget

RM RM RM RM RMSales 10

0120

140

160 180

Direct costs 40 48 56 64 72Variable overhead 10 12 14 16 18Semi-variable overhead 15 16 17 18 19Fixed overhead 20 20 20 24 24

85 96 107

122 133

Profit 15 24 33 38 47Table 1 Flexible Budget


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Actual Budget Variances

Units Produced

Material cost Labour costManufacturing overhead

1100 RM 1200 2100 3700

1000 RM 1000 2000 3000

100(F) RM

200(A) 100(A) 700(A)

Fixed cost 7000 1000

6000 1000

1000(A)

8000 7000 1000(A)

The fixed budget comparative statement shows all the variances as adverse. It does not tell us how much of the adverse variance the manager's responsibility. In the second statement the budget is flexed to the actual level of activity. It can be seen that in the case of material cost and manufacturing overhead there is an adverse variance of RM100 and RM400 respectively. In case of labour there is a favourable variance of RM100 (F). The actual and the budgeted volumes are the same. Therefore, the cost variances are due only to differences in spending. These are controllable variances and the manager can therefore be held responsible for these variances.

The activity level used for comparison is the same. The budget is flexed to the actual level of activity. This makes comparison meaningful as like is compared with like. In the first statement, comparison is made between 2 different levels of activity. These only the variable cost portion varies with the level of activity. The fixed cost remains the same.


Advantage of Flexible Budget

1. Ascertainment of costs: Costs can be ascertained with greater degree of accuracy. Under or over-recovery of overhead can be kept at a minimum level.

Flexible Budget Comparative StatementDepartment X For The Month Beginning 1st July, 19-8

Actual Budget VariancesUnits Produced 1100 1000Variable cost: RM RM RM

Material cost 1200 1100 100(A)Labour cost 2100 2200 100(F)Manufacturing overhead 3700 3300 400(A)

7000 6600 400(A)Fixed overhead 1000 1000

8000 7600 400(A)Table 2 Comparison of Flexible and Fixed Budgets


2. Control over costs: Flexible budget enables management to control costs as it predetermines what the costs should have been at various levels of activity.

3. Management by exception: As flexible budget shows the expenses at various levels of activity, management can compare actual with the figures as shown by the flexible budget. Any deviation from flexible budget should be brought to the notice of top management for taking remedial measures.

4. Determination of maximum return level: A carefully prepared flexible budget enables management to keep a watch on the production, sales and inventory levels and to make periodic adjustments to attain a level of activity which should give management the best result.

Methods of Preparing Flexible Budget

1. Where the budget is prepared before the budget period begins, determine the normal level of activity. The budget is flexed to the normal level;

2. Prepare budgets for all important levels of activity. When the actual level is known then the budget is prepared by interpolating between the budgets of the activity levels immediately below or above the actual level; and

3. Where the budget is prepared at the end of the budget period, determine the actual level of activity. The budget is flexed to the actual level.

Preparing a Flexible Budget

A flexible budget is one in which you develop different scenarios, based on different assumptions, in order to judge whether changes that you are able to make might be beneficial. In the case of the proposed cafe, we can experiment with different types of assumptions and examine other ways of doing things. For example, using the first draft budget for the cafe, we can show the effect of increasing the sales by 50 per cent and 100 per cent. If sales were increased by 100 per cent, the existing oven would not cope with the extra volume of food required. A new oven would have to be purchased to cope with a 100 per cent increase in sales. The additional capital expenditure would be:

Acquisition of new oven RM18000Fitting and installation of new oven RM2300 Estimated length of life of new oven 8 yearsResidual value of oven after 8 years' RM1500


If sales increase by 50 per cent, the staff costs for cooking and preparation would remain unchanged, but additional staff would be required for waiting on the tables. This would cost an extra RM250 per month. If sales increased by 100 per cent, then the increase in the monthly cost of staff would be RM350.

In order to calculate a flexible budget for a full year and forecast the annual profit or loss the following approach could be followed:

1. The period we are asked to look at is a full year, so we need to estimate both revenue (sales) and expenses (costs) for a 12 month period.

2. We are asked to forecast the annual profit or loss.


3. We are asked first to assume a 50 per cent increase in sales for the full year and, second, a 100 per cent increase in sales for a full year.

4. If we buy an extra oven to cope with extra demand that will involve capital expenditure and our budget estimates will have to include an increased allowance for 'depreciation'.

Activity Flexible Budgeting

Activity flexible budgeting is the prediction of what activity costs will be as activity output changes. Variance analysis within an activity framework makes it possible to improve traditional budgetary performance reporting. It also enhances the ability to manage activities.

In a functional-based approach, budgeted costs for the actual level of activity are obtained by assuming that a single unit-based driver (unit of product or direct labour hours) droves all costs. A cost formula is developed for each cost item as functions of units produced or direct labour hours. However, costs vary with respect to more than one driver and the drivers are not highly correlated with direct labour hours, then the predicted costs can be misleading.

The solution, of course, is to build flexible budget formulas for more than one driver. Cost estimation procedures can be used to estimate and validate the cost formulas for each activity. In principle, the variable cost component for each activity should correspond to resources acquired as needed, and the fixed cost component should correspond to resources acquired in advance of usage. This multiple formula approach allows managers to predict more accurately what costs ought to be for different levels of activity usage, as measured by the activity output measure. These costs can then be compared with the actual costs to help assess budgetary performance. The budgeted amounts for the other items differ significantly from the traditional amounts because the activity output measures differ.


Flexible Budgets and Performance Reports

A flexible budget is a tool that is extremely useful in cost control. In contrast to a static budget, the flexible budget is characterized as follows:

1. It is geared toward a range of activity rather than a single level of activity.2. It is dynamic in nature rather than static. By using the flexible budget formula, a

series of budgets can be easily developed for various levels of activity.

The static budget is geared for only one level of activity and is relatively ineffective in cost control. Flexible budgeting distinguishes between fixed and variable costs, thus allowing for a budget that can be automatically adjusted to the particular level of activity actually attained. Thus, variances between actual cost and budgeted costs are adjusted for volume ups and downs before differences due to price and quantity factors are computed.

The primary use of the flexible budget is to give accurate measurements of performance by comparing actual costs for a given output with the budgeted costs for the


same level of output.

Performance Evaluation with a Flexible Budget

The use of a flexible budget for cost performance reporting makes the budget estimates and actual results comparable since they both are based on the same level of activity. Table 3 presents a flexible budget performance report for the production department of Bendigo Manufacturing Ltd. Instead of achieving favourable financial results that might be reported with the fixed budget shown earlier, the department actually incurred an adverse variance of RM32950. Both the budget column and the actual column in the report are based on the same production level of 20000 units. The flexible budget performance report represents a much more realistic evaluation of the departmental cost performance than the fixed budget performance report.


The variances shown in table 4 have meaning since they relate to the cost performance only. Production differences have been eliminated by adjusting the flexible budget to the level of 20000 units. The performance report provides management with a realistic indication of the areas that should be investigated further in order to control the production cost. For example, direct materials cost and direct labour cost exceeded the budget estimates by RM10000 (10%) and RM20000 (8.3%) respectively. Corrective action will be required if future profitability goals are to be achieved.


Bendigo Manufacturing Ltd Flexible Budget for the year ended 30 July 20x1per Levels of activityunit 20000 25000 30000

Variable costs: RM RM RM RMDirect materials 5 100000 125000 150000Direct labour 12 240000 300000 360000Indirect material 0.5 10000 12500 15000Indirect labour 0.75 15000 18750 22500Light and power 1.25 25000 31250 37500

Total variable costs 19.5 390000 487500 585000Fixed costs:

Supervision 60500 60500 60500Rates 8700 8700 8700Insurance 5200 5200 5200Maintenance 4700 4700 4700Depreciation 15300 15300 15300

Total fixed costs 94400 94400 94400Total manufacturing costs 484400 581900 679400

Table 3 Flexible Budget

The dynamic nature of a flexible budget permits management to adjust it to any level as long as the same cost behavior patterns prevail. In the case of Bendigo Manufacturing Ltd, the actual level of activity was the same as one of the levels in the original flexible budget (20000 units). Even if the actual activity level is not found in the flexible budget, management easily can adjust the budget to that level. For example, if Bendigo Manufacturing Ltd had produced 22400 units, the budget would be adjusted to that level and the results would be compared with the associated actual costs. The variable cost rates (totaling RM19.50 per unit) would be multiplied by 22400 to determine the total variable costs, and the fixed costs would be the same as they were for the production of 25000 units (RM94400). The total budgeted manufacturing costs for 22400 units would be RM531200.



Bendigo Manufacturing Ltd Flexible Budget Performance Reportfor the year enc led 30 July 20x1

Budget Actual VarianceProduction units 20000 20000Variable costs: RM RM RM

Direct materials 100000 110000 10000 ADirect labour 240000 260000 20000 AIndirect material 10000 11400 1400 AIndirect labour 15000 16200 1200 ALight and power 25000 24600 400 F

Total variable costs 390000 422200 32200 AFixed costs:

Supervision 60500 61400 900 ARates 8700 8700 0Insurance 5200 5300 100 AMaintenance 4700 4450 250 FDepreciation 15300 15300 0

Total fixed costs 94400 95150 750 ATotal manufacturing costs 484400 517350 32950 A

A indicated an adverse varianceF indicated a favourable variance

Table 4 Flexible Budget Performance Report

Flexible Budget for Factory Overhead

A flexible budget can be prepared for factory overhead to avoid the limitations of a fixed budget. A distinction between variable and fixed costs is made and the budget is prepared for a range of production levels so that management can evaluate the impact of attaining an activity level different from the one planned. The production activity levels are based on the same measure of standard production used to apply the overhead. Whenever the standard production performance is different from that planned, management can easily adjust to the change by revising the original budget. The budgeted fixed overhead costs for the standard production level attained will be the same as those in the original budget, but the budgeted variable overhead cost will change.


A factory overhead flexible budget for the Parramatta Manufacturing Co. Ltd is shown in table 5. The budget represents the January portion of the annual flexible budget used by the firm to calculate a predetermined overhead rate and to provide a comparative basis for cost performance evaluation with variance analysis. Standard direct labour hours are used to measure the level of production and range from 7000 to 10000 for the budget period. Four production levels are budgeted as percentages of maximum capacity at 70%, 80%, 90%, and 100%. Maximum capacity is the measure of the highest production level a firm can achieve with its existing physical facilities and organizational structure. The variable overhead costs change at a rate of RM2 per standard direct labour hour within the budgeted range of activity. The fixed costs remain constant at RM45000. As a result, the total factory overhead at any level of activity can be calculated with the following formula:

Factory overhead = RM45000 + (RM2 x Standard direct labour hours)

Since a range of production activity is considered in the flexible budget, a single level of production must be selected for the calculation of the predetermined overhead rate. The choice of a specific production level is important because different overhead rates are calculated for different levels of production. These differences are caused by the fact that the fixed costs per standard direct labour hour decrease as the number of hour's increases. The following schedule illustrates the effect of cost behavior on the calculation of a predetermined overhead rate from the flexible budget of Parramatta Manufacturing Co. Ltd:

70% 80% 90% 100%Standard direct labour hours (A) 7000 8000 9000 10000

RM RM RM RMVariable overhead cost (B) 14000 16000 18000 20000Fixed overhead cost (C) 45000 45000 45000 45000Total overhead cost (13) 59000 61000 63000 65000Variable overhead rate per

hour (B-A) 2 2 2 2


Fixed overhead rate per hour (C-A) 6.43 5.63 5.00 4.50Total overhead rate per hour (D-A) 8.43 7.63 7.00 6.50




Parramatta Manufacturing Co. Ltd Factory Overhead Flexible Budget for the month of January 20x2

Normal capacityPercentage of capacity 70 80 90 100Units of production 3500 4000 4500 5000Standard direct labour hours 7000 8000 9000 10000

Budgeted factory overhead Per hour

Variable costs: RM RM RM RM RMIndirect matarials 0.2 1400 1600 1800 2000Maintenance 1.1 7700 8800 9900 11000Light and power 0.7 4900 5600 6300 7000

Total variable costs 2 14000 16000 18000 20000Fixed costs:

Salaries 9500 9500 9500 9500Insurance 3000 3000 3000 3000Rates 9300 9300 9300 9300Supplies 2200 2200 2200 2200Rent 6000 6000 6000 6000Depreciation 15000 15000 15000 15000

Total fixed costs 45000 45000 45000 45000Total factory overhead 59000 61000 63000 65000

Predetermined overhead rate per standard direct labour hour (RM63000-9000 hours)

RM7

Table 5 Factory overhead flexible budget

As a result, the total overhead rate decreases from RM8.43 per hour to RM6.50 per hour as the capacity increases from 70% to 100%. If the correct production level is not selected at the beginning of the period, the wrong amount of overhead will be applied to work in process even if the actual cost performance is equal to its related budget estimates. For example, if Parramatta Manufacturing Co. Ltd selects its predetermined overhead rate from the maximum capacity level, the fixed portion of the rate will be RM4.50. If the firm works only 8000 standard direct labour hours, the fixed overhead applied will be RM36000 (8000* RM4.50) despite the fact that the budgeted fixed costs were RM45000. The variable costs do not cause the same problem since they automatically adjust to the level of 8000 standard direct labour hours, with the applied amount and budgeted amount being equal at RM16000


(8000XRM2). The following four concepts of capacity can be considered for the choice of a production level within a flexible budget:

1. Maximum capacity: The highest level of production activity possible if optimal operating conditions exist with no delays, materials shortages or maintenance problems.

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2. Practical capacity: Maximum capacity less reasonable allowances for departures from an optimal performance.

3. Expected capacity: Level of production activity expected for a specific year, given the firm's operating conditions and market demand for its products.

4. Normal capacity: The average annual production activity that will satisfy the market demand over a relatively long time, such as a three to five year period.

Why do Companies need Flexible Budget?

1. The supply and cost of raw materials, electricity, and natural gas may change unexpectedly;

2. Competitive pressures from imports and substitute materials may intensify;3. The market demand for steel products may change;4. Change to foreign trade policy may alter current importing and exporting practices;5. New government regulations could significantly increase environmental compliance

costs; and6. Uncertainties regarding the global economy may affect customer demand.

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Question b

Classification of Costs by behavior

Costs may or may not vary with the level of activity. The level of activity usually refers to the volume of production or number or value of items sold. A manager must have knowledge about a company's cost behavior so that may predict the impact of their decision on profit and in controlling costs. The preparation of a flexible budget requires an understanding of basic cost-behavior patterns. They are:

Variable CostsA variable cost is one that changes in response changes in the level of activity. Variable

costs vary in direct proportion to the volume of activity, that is, doubling the level of activity wills double the total variable cost. Total variable costs are linear and a unit variable cost is constant i.e. total variable costs decrease as the production decreases and vice versa, variable cost per unit remains fixed. For examples: Direct Material Costs, Direct Labour Cost, Direct Expenses, and Variable Overheads.

Variable costs remain the same per unit as activity levels rise or fall. The total expenditure on variable costs of course rises or falls. Variable costs have two types, they are as follows:

a. Linear variable cost or engineered cost: When the relationship between variable cost and output can be shown as a straight line oh the graph, they are termed as linear variable cost. A variable cost is called as engineered cost because an optimum relationship can be carefUlly determined by work measurement technique between input and output. Direct material cost and direct labour cost are good examples of engineered cost.

b. Non-linear or curvilinear variable cost: When the relationship between variable cost and output can be shown as a curved line on a graph, it is said to be curvilinear. The non-linear variable cost may be of two types. They are convex-linear variable cost and concave-linear variable cost. The convex- linear variable cost it is a cost where each extra unit of output causes a less than proportionate increase in cost. The concave-linear variable cost it is a cost where each extra unit of output causes a more than proportionate increase in cost. Differential piece rate system of wage payment is a good example for this type of cost.

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1. Practical ExampleOutput (units) A Total Variable Costs (RM) B Variable Cost per unit (RM)

C=B/A0 0 101 10 1010 100 10100 1000 101000 10000 10

Thus, variable cost per unit remains fixed and does not change with the changes in the volume of output.

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___________________Management Accounting 12009

2. Graphical Representation

Total Variable Costs

200 400 (500 S00

Output (units i1200

Variable costs per unit

1 2 -

10 -------------------------------------------------------------------- Variable Cost

Costs 6 (RM)4 — Variable costs per unit

0 200 400 600 800 1000 1200 Output (milts)

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\

^^ \ f \ /

1000

1200

0

1000

0

800

0

6000

4000

200

0 0

Total Costs (RM)

0



Fixed CostsTotal fixed costs are those costs which do not vary with the change in the volume of production

up to a given range. Fixed costs per unit vary with the change in the volume of production. Thus, fixed cost per unit goes on decreasing as the total number of output produced increases i.e. fixed cost per unit decreases as the production increases and vice versa. For examples: Rent and Insurance of Building, Plant & Machinery & Furniture, Salary of manager etc.

Fixed costs remain the same regardless of activity levels. The salary of the chief executive is a fixed cost. Fixed costs, on the other hand, rise per unit if the activity level falls, because the number of units that must bear them has fallen. Similarly, if the activity levels rise fixed cost per unit will be fall.

Fixed costs have two types, they are as follow:a. Committed cost: These costs are related to the provision of a capacity to do business. The

amount of committed cost is fixed by decisions which were made in the past and is not subject to management control in the present on a short run basis. Since there is no direct relationship between committed costs and either the planned or actual utilization of existing facilities, the amount will remain constant over the whole range of operating activity.

b. Programmed or managed cost: These costs are related to the utilization of the capacity provided.

There have five categories of fixed costs:a. The time period classification: Those types of cost which are not likely to change

significantly in the short term, usually a year. In the long term all costs may change or become avoidable.

b. The volume classification: Costs which are fixed for small, but not large changes in output or capacity.

c. The joint classification: Where a cost is incurred jointly with another cost and is only capable of being altered jointly. For example, if an organization leases a showroom which has a warehouse attached then the fixed cost element applies to both parts of the asset acquired whether or not they are both wanted.

d. The policy classification: These are costs which are fixed by management policy and bear no causal relationship to volume or time. They are usually items which are dealt with by appropriation budgets, e.g. expenditure on advertising, research and development. These

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types of costs are sometimes known as programmed fixed costs and typically are reviewed annually.

e. The avoidable classification: These are costs which are fixed in the normal sense i.e. they do not vary with activity, but they are avoidable if particular

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decisions or events occur. For example, the rent and rates for a branch office would normally be classed as fixed yet they are avoidable if the branch was shut down. 1. Practical Example

Output (units) Total Fixed Costs (RM) Fixed Cost per unitA B (RM) C=B/A0 1000 10001 1000 100010 1000 100100 1000 101000 1000 1


Total Fixed Costs

/ V / \

Fixed cost

\ ' \ /

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Cost (RM)


1200

Output (units)

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120

0

10

00

SO

O

60

0

400

20

0 0

200

400 SOO

SOO

1000



Fixed Costs per unit100 ,

90 - - - -V—80 ------V—

60 \

40 \N. Fixed Costs per unit

30 X.

10 ~~ ___________________________________________________

0 ■,0 20 40 60 80 100 120

Output (luiit)

A summary of both variable and fixed cost behavior is present in below table.Cost Behavior of the Cost (within the relevant range)

In Total Per UnitVariable cost Total variable cost increases and

decreases in proportion to change in the activity level.

Variable cost per unit remains constant.

Fixed cost Total fixed cost is not affected by changes in the activity level within the relevant range.

Fixed cost per unit decreases as the activity level rises and increases as

the activity level falls.

Mixed (Semi-Variable) Cost

Semi-variable costs are those costs of which one part remains fixed up to a given range and the other part varies with the change in the volume of production but not in the same proportion. Semi-variable costs are costs that vary but do not vary in direct proportion to the level of activity because some of these costs are a mixture of fixed and variable costs. Semi-variable costs are also known as semi-fixed costs. For example, the delivery costs, which include the petrol or diesel of a delivery fleet, will vary the number of kilometers driven. Other related costs, however, such as road tax, insurance and maintenance are generally fixed over a given period.

When managers have identified a semi-var5iable cost they will need to know how much of it is fixed and how much is variable. Only when they have determined this they will be able to estimate the cost to be incurred at relevant activity levels. Past

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Cost (RM)



record of costs and their associated activity levels are usually used to carry out the analysis. The three most common methods used to separate the fixed and variable elements are as follows:

a. The high-low method: This method picks out the highest and lowest activity levels from the available data and investigates the change in cost which has occurred between them. The highest and lowest points are selected to try to use the greatest possible range of data. This improves the accuracy of the result.

b. The scatter graph method: This method takes account of all available historical data and it is very simple to use. However, it is prone to inaccuracies that arise due to subjectivity and the likelihood of human error.

c. The least squares method of regression analysis

1. Practical ExampleSales representatives are often paid a salary plus a commission and sales.

Output (units) A

Variable Cost (RM) B

Fixed Cost (RM) C

Total Semi-variable Costs (RM) D=A+B

Semi-variable Cost per unit (RM)E=D/A

40000 20000 30000 50000 1.2580000 40000 30000 70000 0.88120000 60000 30000 90000 0.75160000 80000 30000 110000 0.69200000 100000 30000 130000 0.65


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Mixed Costs

-Variable CostCost(RM) ®000

Fixed Cost

0 40000 SOOOO 120000 160000 200000

Summary

This coursework look at flexible budget and the types of costs involved in a flexible budget. A flexible budget can be developed by expressing revenues and variable costs on a budgeted per output unit basic and then multiplying these amounts by the appropriate output level. Alternatively, the flexible budget can be developed, first by computing standard

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costs for its inputs, then summing those amounts to obtain the standard cost per output unit, and finally by multiplying these standard costs per output unit by the appropriate output level.

In contrast, flexible budgets are prepared for different levels of activity. Comparison is more meaningful because the flexible budget is flexed to actual level of activity.

The master budget is typically static; that is, it is developed in detail for one level of activity. A flexible budget recognizes that variable costs and revenues are


expected to differ from the budget if the actual activity differs from what was budgeted. A flexible budget can be thought of as the costs and revenues that would have been budgeted if the activity level had been correctly estimated in the master budget. The general relationship between the actual results, the flexible budget, and the master budget follows: a) Actual- Actual costs and revenues based on actual activity. b) Flexible budget- Cost and revenues that would have been budgeted if actual activity had been budgeted. c) Master budget- Budgeted costs and revenues based on budgeted activity.

In flexible budgeting, costs must be separated into fixed, variable and semi- variable (fixed) cost. The measurement of activity may be expressed in units produced or labour hours or machine hours or number of units sold. We have seen that the distinction between fixed and variable costs is only valid within a relevant range of activity. Whatever measure is chosen there must be a high correlation with cost, especially variable cost under consideration.

A variable cost is a cost that changes in total in proportion to changes of a cost driver. Unit variable cost is expected to stay the same regardless of the change in level of activity within the relevant range. A fixed cost is a cost that does not change in total despite changes of a cost driver. Unit fixed cost will vary with any change in level of activity. Semi-variable (fixed) has both a variable and a fixed cost component.

References

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3. The Cost Management Toolbox, By Lianabel Oliver, Amacom, 1999 Published by AMACOM Div American Mgmt Assn

4. Managing Public Services—implementing Changes, By Tony L. Doherty, Terry Horne, 2002, Published by Routledge

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Published by Academic Publishers

7. Cost Accounting, By P. C. Tulsian, 2006, Published by McGraw -Hill

8. Managing Financial Resources (Edition 3), By Michael Broadbent, John Cullen, 2003, Published by Butterworth-Heinemann

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Management Accounting 2009