CIMA - C1 Fundamentals of Management Accounting
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10: Flexible budgeting ⏐ Part C Financial planning and control
(a) In this example, the variances are meaningless for purposes of control. Costs were higher than budget because
the volume of output was also higher; variable costs would be expected to increase above the budgeted costs in
the fixed budget. There is no information to show whether control action is needed for any aspect of costs or
revenue.
(b) For control purposes, it is necessary to know the answers to questions such as the following.
(i) Were actual costs higher than they should have been to produce and sell 3,000 CLs?
(ii) Was actual revenue satisfactory from the sale of 3,000 CLs?
2.1.1 The correct approach to control
The correct approach to control is as follows.
•
Identify fixed and variable costs.
•
Produce a flexible budget based on the actual activity level.
In the previous example of W Co, let us suppose that we have the following estimates of cost behaviour.
(a) Direct materials, direct labour and maintenance costs are variable.
(b) Rent and rates and depreciation are fixed costs.
(c) Other costs consist of fixed costs of $1,600 plus a variable cost of $1 per unit made and sold.
The control analysis should therefore be based on a flexible budget as follows.
Fixed Flexible Actual Budget
budget budget results variance
(a) (b) (c) (c)–(b)
Production and sales (units) 2,000 3,000 3,000
$ $ $ $
Sales revenue
20,000
30,000
30,000
0
Variable costs
Direct materials 6,000 9,000 8,500 500 (F)
Direct labour 4,000 6,000 4,500 1,500 (F)
Maintenance 1,000 1,500 1,400 100 (F)
Semi-variable costs
Other costs 3,600 4,600 5,000 400 (A)
Fixed costs
Depreciation 2,000 2,000 2,200 200 (A)
Rent and rates
1,500
1,500
1,600
100
(A)
Total costs
18,100
24,600
23,200
1,400
(F)
Profit
1,900
5,400
6,800
1,400
(F)
$3,500 (F)
Volume variance
$1,400 (F)
Expenditure variance
$4,900 (F)
Total variance
Notice that the total variance has not altered. It is still $4,900 (F) as in Section 2.1. The flexible budget comparison
merely analyses the total variance into two separate components.
Variances are calculated by comparing actual results and the flexible budget, not actual results and the original budget.
Important!
Important!
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Part C Financial planning and control ⏐ 10: Flexible budgeting
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2.1.2 Interpretation of the control statement
We can analyse the above as follows.
(a) In selling 3,000 units the expected profit should have been, not the fixed budget profit of $1,900, but the
flexible budget profit of $5,400. Instead, actual profit was $6,800 ie $1,400 more than we should have
expected. This is the $1,400 favourable expenditure variance. The reason for this $1,400 improvement is
that, given output and sales of 3,000 units, overall costs were lower than expected (and sales revenue was
exactly as expected). For example the direct material cost was $500 lower than expected.
(b) Another reason for the improvement in profit above the fixed budget profit is the sales volume. W Co sold
3,000 units of CL instead of 2,000, with the following result.
$
$
Budgeted sales revenue increased by
10,000
Budgeted variable costs increased by:
direct materials
3,000
direct labour
2,000
maintenance
500
variable element of other costs
1,000
Budgeted fixed costs are unchanged
6,500
Budgeted profit increased by
3,500
Budgeted profit was therefore increased by $3,500 because sales volume increased. This is the $3,500
favourable volume variance.
(c) A full variance analysis statement would be as follows.
$
$
Fixed budget profit
1,900
Variances
Sales volume
3,500 (F)
Direct materials cost
500 (F)
Direct labour cost
1,500 (F)
Maintenance cost
100 (F)
Other costs
400 (A)
Depreciation
200 (A)
Rent and rates
100
(A)
Total expenditure variance
1,400
(F)
Actual profit
6,800
If management believes that any of these variances are large enough to justify it, they will investigate the reasons for
them to see whether any corrective action is necessary.
Important!
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10: Flexible budgeting ⏐ Part C Financial planning and control
Question
Budget cost allowances
WL Co manufactures and sells a single product, R. Since the R is highly perishable, no inventories are held at any time.
WL Co's management uses a flexible budgeting system to control costs. Extracts from the flexible budget are as follows.
Output and sales (units)
4,000
5,500
Budget cost allowances
$
$
Direct material
16,000
22,000
Direct labour
20,000
24,500
Variable production overhead
8,000
11,000
Fixed production overhead
11,000
11,000
Selling and distribution overhead
8,000
9,500
Administration overhead
7,000
7,000
Total expenditure
70,000
85,000
Production and sales of product R amounted to 5,100 units during period 5.
The total budget cost allowances in the flexible budget for period 5 will be:
(a) Direct material $
(b) Direct labour $
(c) Variable production overhead $
(d) Fixed production overhead $
(e) Selling and distribution overhead $
(f) Administration overhead $
(g) Production and sales of product R in period 6 amounted to 5,500 units. Budgeted output for the period was 4,000
units. Actual total expenditure was $82,400.
(i) The total expenditure variance for period 6 was $
favourable/adverse (delete as necessary)
(ii) The volume variance for period 6 was $
favourable/adverse (delete as necessary)
Answer
(a) Direct material $
20,400
(b) Direct labour $
23,300
(c) Variable production overhead $
10,200
(d) Fixed production overhead $
11,000
(e) Selling and distribution overhead $
9,100
(f) Administration overhead $
700
(g) (i) The total expenditure variance for period 6 was $
2,600
favourable/adverse
(ii) The volume variance for period 6 was $
15,000
favourable/adverse
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Part C Financial planning and control ⏐ 10: Flexible budgeting
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Workings
(a) Direct material is a variable cost of $16,000/4,000 = $4 per unit
Budget cost allowance for 5,100 units = 5,100 × $4 = $20,400
(b) Direct labour is a semi-variable cost which can be analysed using the high-low method.
Output
Units
$
High
5,500
24,500
Low
4,000
20,000
Change
1,500
4,500
Variable cost per unit = $4,500/1,500 = $3
Substituting in high output, fixed cost = $24,500 – (5,500 × $3)
= $8,000
Budget cost allowance for 5,100 units:
$
Variable cost = 5,100 × $3
15,300
Fixed cost
8,000
23,300
(c) Variable production overhead per unit = $8,000/4,000 = $2 per unit
Budget cost allowance for 5,100 units = 5,100 × $2 = $10,200
(d) Fixed production overhead cost allowance is fixed at $11,000.
(e) Selling and distribution is a semi-variable cost which can be analysed using the high-low method.
Output
Units
$
High
5,500
9,500
Low
4,000
8,000
Change
1,500
1,500
Variable cost per unit = $1,500/1,500 = $1
Substituting in high output, fixed cost = $9,500 – (5,500 × $1)
= $4,000
Budget cost allowance for 5,100 units:
$
Variable cost = 5,100 × $1
5,100
Fixed cost
4,000
9,100
(f) Administration overhead cost allowance is fixed at $7,000.
(g) The budgeted and actual output volumes correspond to the two activity levels provided in the question data. The
total budget cost allowance for each activity level can be used as the basis for the variance calculations.
(i) Expenditure variance = budget cost allowance for 5,500 units – actual expenditure for 5,500 units
= $85,000 – $82,400
= $2,600 favourable
(ii) Volume variance = budget cost allowance for original budget of 4,000 units – budget cost allowance for
actual volume of 5,500 units
= $70,000 – $85,000 = $15,000 adverse
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10: Flexible budgeting ⏐ Part C Financial planning and control
Question
Zebra Co
The following extract is taken from the production cost budget of Zebra Co:
Production units 4,000 6,000
Production cost $35,529 $41,280
The budget cost allowance for an activity level of 8,000 units is $
Answer
Change
Production units 4,000 6,000 2,000
Production cost $35,520 $41,280 $5,760
Variable cost per unit =
$5,760
2,000
= $2.88
Fixed costs = $35,520 – (4,000 × $2.88) = $24,000
Therefore, budget cost allowance for activity level of 8,000 units = $24,000 + (8,000 × $2.88)
= $47,040
You may come across the term 'flexed budget'. This is similar to a flexible budget. A flexible budget is designed at the
planning stage to vary with activity levels. A flexed budget is a revised budget that reflects the actual activity levels
achieved in the budget period.
3 Budgets and management reward
Budgets can be used in a system of reward strategies for managers. They act as targets or benchmarks for managerial
performance.
We mentioned at the start of Chapter 9 that one of the reasons for using budgets is to provide a means of evaluating the
performance of managers.
Research has shown that if an organisation’s reward system (promotions, salary increases, bonuses, ‘perks’) is
connected to a control system, management motivation will increase and management will perceive the control
system as important, which should improve its effectiveness.
For performance evaluation purposes, a system of control using budgets as targets or benchmarks for managerial
performance, against which actual performance is compared, can be adopted.
This provides a way of evaluating the performance of the manager and good results can be rewarded with a financial
bonus or promotion.
The process needs to be carried out so as to motivate managers, however, rather than create resentment and adverse
reactions. The process should not make managers feel under pressure to achieve but should encourage:
• Participation
• Initiative
• Responsibility
FA
S
T F
O
RWAR
D
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It is therefore important that budget targets are:
• Under the control of managers (ie they can control the costs and revenues in question)
• Clearly defined
• Attainable (but not too easy to achieve as this will be demotivating)
• Understood and accepted as a target
• Focused on the short, medium and long term
Keeping managers informed of their performance also helps to encourage motivation. Feedback on performance
therefore needs to be:
• Frequent
• Up to date
• Accurate
• Relevant (ie relates to items over which the manager has control)
Chapter Roundup
• A fixed budget is a budget which is set for a single activity level.
• A flexible budget is a budget which recognises different cost behaviour patterns and is designed to change as volume of
activity changes.
• Control involves comparing a flexible budget (based on the actual activity level) with actual results. The differences
between the flexible budget figures and the actual results are budget variances.
• Budgets can be used in a system of reward strategies for managers. They act as targets or benchmarks for managerial
performance.
Quick Quiz
1 Fill in the blanks with the word 'fixed' or the word 'flexible'.
(a) At the planning stage, a ……………………. budget can show what the effects would be if the actual outcome
differs from the prediction.
(b) At the end of each period, actual results may be compared with the relevant activity level in the
……………………. budget as a control procedure.
(c) Master budgets are ……………………. budgets.
2 Flexible budgets are normally prepared on a marginal costing basis.
True
False
3 Fill in the gaps.
Budget cost allowance = ……………………. + (……………………. × …………………….)
4 What is the wrong approach to budgetary control?
5 What is the correct approach to budgetary control?
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10: Flexible budgeting ⏐ Part C Financial planning and control
Answers to Quick Quiz
1 (a) At the planning stage, a flexible budget can show what the effects would be if the actual outcome differs from the
prediction.
(b) At the end of each period, actual results may be compared with the relevant activity level in the flexible budget as
a control procedure.
(c) Master budgets are fixed budgets.
2 True
3 Budget cost allowance = budgeted fixed cost + (number of units × variable cost per unit)
4 To compare actual results against a fixed budget.
5 • To identify fixed and variable costs
• To produce a flexible budget using marginal costing techniques
Now try the questions below from the Question Bank
Question numbers Page
52–56 363
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Part D
Costing and accounting
systems
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Topic list
Learning outcomes
Syllabus references
Ability required
1 Accounting for costs D(i) D(2) Comprehension
2 Integrated systems D(i), (ii) D(1), (2) Comprehension, Application
3 Standard cost bookkeeping D(ii) D(3) Application
Cost bookkeeping
Introduction
In Part A of this Study Text you saw how to determine the major elements of the cost of a
unit of product - material, labour, overhead - and how to build up these elements into a total
cost. In Chapters 12 and 13 you will see how costs are recorded depending on the costing
method adopted by an organisation. But what you need to know first is how to account for
costs within a cost accounting system. This chapter will teach you. It will teach you cost
bookkeeping.
The overall bookkeeping routine will vary from organisation to organisation but either an
integrated or an interlocking system will be used. For the purposes of this Paper C1 syllabus
you only need to know about integrated systems, however.
In the last part of this chapter we will look at how a standard costing system is used in
conjunction with an integrated system of cost bookkeeping.
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