Session 15

Flexible Budgets, Budgetary

Control and Reporting

FOCUS
This session covers the following content from the ACCA Study Guide.

C. Budgeting
4. Flexible budgets
a) Explain the importance of flexible budgets in control.
b) Explain the disadvantages of fixed budgets in control.
c) Identify situations where fixed or flexible budgetary control would be
appropriate.
d) Flex a budget to a given level of volume.
6. Budgetary control and reporting
a) Calculate simple variances between flexed budget, fixed budget and actual
sales, costs and profits.
b) Discuss the relative significance of variances.
c) Explain potential action to eliminate variances.
d) Define the concept of responsibility accounting and its significance
in control.
e) Explain the concept of controllable and uncontrollable costs.
f) Prepare control reports suitable for presentation to management
(to include recommendation of appropriate control action).

Session 15 Guidance
Read carefully sections 1 and 2, which cover some theoretical issues behind budgeting. Knowledge of
these issues is vital to understand and appreciate other budgeting elements of the syllabus. Ensure
that you can distinguish between the types of budget which take account of changes in activity level
(all begin with "f").
Understand the concept of flexed budgeting and use the simple Example 1 to prepare a flexed budget.

(continued on next page)

F2 Management Accounting Becker Professional Education | ACCA Study System

Sadia sadia Afzal - gentledove004@gmail.com

VISUAL OVERVIEW
Objective: To describe alternative methods of budget preparation and their role in
budgetary control and to introduce variance analysis.

BUDGETARY SYSTEMS
• Categories
• Budgetary Control

ACTIVITY LEVEL BUDGETED PERIOD

• Fixed Budgets • Periodic Budgets
• Flexible Budgets • Rolling Budgets
• Flexed Budgets

VARIANCES
• Meaning
• Calculation
• Relative Significance
• Potential Action

RESPONSIBILITY ACCOUNTING
• The Concept
• Conditions for Use
• Controllable and
Uncontrollable Costs
• Responsibility Reports
• Control Reports

Session 15 Guidance
Understand the term "rolling budget" (s.3) and read section 4, which introduces the idea of a
variance and analyse thoroughly Illustration 4 to appreciate the potential use of variances.
Learn the concept of "responsibility accounting" (s.5), which is widely used in real life to assess
managers' performance. Appreciate the importance of controllable/uncontrollable costs and the
content of control reports. Attempt Examples 2 and 3.

© 2014 DeVry/Becker Educational Development Corp. All rights reserved. 15-1

Sadia sadia Afzal - gentledove004@gmail.com

Session 15 • Flexible Budgets, Budgetary Control and Reporting F2 Management Accounting

1 Budgetary Systems

1.1 Categories
Budgetary systems can be split into three categories, each of
which looks at a specific budgetary problem. The categories can
be defined by the following questions: *The third question is
particularly relevant
1. How should the budget respond to changes in activity level? to performance
2. How should the budget respond to changes that occur during management.
the budgeted period?
3. How much regard should be given to previous budgets in the
setting of the current budget?*

1.2 Budgetary Control

Budgetary control is effected by: Budgetary
control—the use
 Preparing budget reports (see s.5.4) which compare actual of budgets, relating
results with the budget; the responsibility
 Analysing differences and determining their causes of managers to the
(see Session 16); requirements of
 Taking corrective action, where necessary; and a policy, and the
continuous comparison
 Revision of future budgets, where necessary. of actual with
budgeted results to

2
control operations.
Activity Level

A fixed ("static") budget is prepared at the anticipated level of

activity.

2.1 Fixed Budgets

 For example—output 10,000 units and sales 5,000 units (i.e.
just one level of activity).
 The fixed budget will be compared to actual results with no *The main
adjustment made for any changes in activity level. disadvantage of fixed
budgets for control
 Fixed budget uses include: purposes is that they
 Planning and defining the broad objectives of a business. are based on just one
 Providing a starting point for the ongoing budgeting process. level of activity. It
is not meaningful
 Comparing actual results when the actual level of activity
to compare actual
approximates the level budgeted (e.g. where sales and production costs for
production volumes can be forecast with reasonable the level of activity
certainty).* achieved with budgeted
 Assessing fixed costs in a manufacturing business (e.g. production costs for
production, selling, distribution, administrative expenses). a level of activity that
was not achieved.
 Fixed budgets are used by many service industries in which
most costs are fixed (rather than manufacturing industries in
which many costs are variable).

15-2 © 2014 DeVry/Becker Educational Development Corp. All rights reserved.

Sadia sadia Afzal - gentledove004@gmail.com

F2 Management Accounting Session 15 • Flexible Budgets, Budgetary Control and Reporting

2.2 Flexible Budgets

A flexible budget is essentially a series of fixed budgets prepared
for different possible activity levels.
 To develop the flexible budget, it is necessary to determine the:
 possible (relevant) range of activity;
 variable cost per unit of activity (which may vary across the
range); and
 different levels of fixed costs that may arise across the range.

 Budgets are then prepared for selected increments of activity

within the relevant range to take account of:
 stepped fixed costs; and
 non-constant variable costs per unit due to economies of
scale, the "learning curve" effect, bulk discounts, etc.*

*The high-low
method or statistical
techniques (see
A flexible budget recognises different cost behaviour patterns and so Session 13) may be
changes with the volume of activity. used to analyse costs
into fixed and variable
elements.

Illustration 1 Flexible Budgets

At the start of the year, Fred prepares his budget based on the
assumptions that selling price per unit will be $50, variable costs per
unit will be $30 and total fixed costs will be $10,000. He prepares
three budgets based on annual production and sales volumes of:
1. 500 units
2. 700 units
3. 900 units
At the end of the year, his actual sales are 750 units. To compare his
actual sales against the budget, Fred will choose the budget that was
prepared based on output of 700 units, because this is closest to the
actual output.

 Flexible budgets are used because:

 They provide a better basis for evaluating performance
in the areas of production control (i.e. activity level) and
cost control than a fixed budget because they respond to
expected cost behaviour.
 Variance analysis provides more useful information as each
cost is analysed taking into account its behaviour.
 They are prepared in advance for different activity scenarios.
This can be particularly important for resource planning
and management in "seasonal" businesses. For example,
in delivering professional exam-based training, a training
college might expect to require freelance lecturers in each
month leading up to the examinations being sat. Additional,
temporary, administrative support staff might also be
required for administering courses and client services.

© 2014 DeVry/Becker Educational Development Corp. All rights reserved. 15-3

Sadia sadia Afzal - gentledove004@gmail.com

Session 15 • Flexible Budgets, Budgetary Control and Reporting F2 Management Accounting

 With computerisation (e.g. using spreadsheets) they can

facilitate more efficient operations. For example, if actual
demand is seen to be increasing, the effect on production
can be anticipated. This in turn will affect quantities
demanded from suppliers which can be ordered on a
timelier basis.
 They are useful in manufacturing industries which regularly
introduce new products or change product design (e.g. those
influenced by changes in fashion); and are engaged in
made-to-order activities (e.g. aircraft manufacture).

2.3 Flexed Budgets

• A flexed budget is not a budget for a future period of time but

prepared retrospectively.
• Previously budgeted costs and revenues are attributed to an actual
level of activity achieved.

For a flexed budget, the following occurs:

 Initially a budget is prepared at the anticipated level of activity
(i.e. original fixed budget) or different possible levels (i.e. a
flexible budget).
 The original budget's figures are prorated to actual activity
level before comparisons are made. Apart from the level of
activity, the original budget assumptions are unchanged.
Flexed budgets are used in variance analysis (see also Session 16):
 Actual costs are compared with the budgeted costs for the
actual activity level achieved.
 However, no account is taken of:
 stepped fixed costs or
 variable costs per unit, which are not constant.*

*Although a flexible budget should take account of such changes,

no further allowance is made for such changes in flexing the budget
which is selected as being closest to the actual level of activity.

Illustration 2 Flexed Budget

ABC budgeted to sell 50,000 units at $30 each.

Actual revenue for the year was $1,080,000 and 37,500 units
were sold.
The flexed revenue budget is 37,500 × $30 = $1,125,000
Actual revenue is $45,000 less than the flexed budget.

15-4 © 2014 DeVry/Becker Educational Development Corp. All rights reserved.

Sadia sadia Afzal - gentledove004@gmail.com

F2 Management Accounting Session 15 • Flexible Budgets, Budgetary Control and Reporting

Example 1 Flexed Budgets

KK has prepared an original budget as follows:

$000
Sales (50,000 items @ $100) 5,000
Production costs (55,000 units)
Materials (55,000 × $40) 2,200
Labour (55,000 × $3) 165
Variable overheads (55,000 × $9) 495
Fixed overheads (55,000 × $15) 825
Budgeted cost of production 3,685
Less: Closing inventory (5,000 @ $67) (335)
Standard cost of goods sold 3,350
Budgeted profit (50,000 @ $33) 1,650

Actual sales were 53,000 units and production was 56,000 units.
Required:
Prepare a flexed budget for the actual level of activity.
Solution:

$000
Sales

Production costs

Materials

Labour
Variable overheads

Fixed overheads

Actual cost of production

Less: Closing inventory

Cost of goods sold

Profit

© 2014 DeVry/Becker Educational Development Corp. All rights reserved. 15-5

Sadia sadia Afzal - gentledove004@gmail.com

Session 15 • Flexible Budgets, Budgetary Control and Reporting F2 Management Accounting

3 Budgeted Period

3.1 Periodic Budgets

A periodic budget is typically for one year at a time.
 No alterations are made once the budget has been set.
 It is suitable for stable businesses in which forecasting is easy
and tight control is not necessary.

3.2 Rolling Budgets*

A rolling budget is a budget that is kept continuously up to date
by adding another accounting period (e.g. month or quarter)
when the earliest accounting period has expired. *Also called a
"continuous" budget.
 The aim of a rolling budget is to keep tight control and always
have a budget for the next 12 months which is accurate.

Illustration 3 Rolling Budget

On 1 January 2012 prepare 12 months to 31 December 2012.

Then, on 1 February 2012:
• compare actual with budget for January 2012;
• if remaining budget is shown to be unrealistic, adjust the
remaining 11 months (not merely because targets are not
achieved); and
• prepare the next month to 31 January 2013.

 Rolling budgets are used:

 When accurate forecasts cannot be made (e.g. in service
industries).
 For any area or component which needs tight control
(probably too time consuming to do for the whole business).

4 Variances

4.1 Meaning For meaningful

analysis, a usage
A variance (or budget variance) is simply the difference between variance must be
an actual result and an expected result. For example, a: compared with the
 price variance is a difference between budgeted price and actual level of activity
actual price; (e.g. production
output) achieved.
 usage variance is the difference between budgeted usage and
actual usage.

15-6 © 2014 DeVry/Becker Educational Development Corp. All rights reserved.

Sadia sadia Afzal - gentledove004@gmail.com

F2 Management Accounting Session 15 • Flexible Budgets, Budgetary Control and Reporting

4.2 Calculation

Illustration 4 Variance

Following on from Example 1 calculate the sales, cost and profit variances if
actual results were as follows:

Actual Flexed
Variance
Results Budget
$000 $000 $000
Sales revenue 5,035 5,300 (265) A
Production costs
Materials 2,300 2,240 60 A

Labour 180 168 12 A

Variable overheads 502 504 (2) F
Fixed overheads 935 825 110 A
3,917 3,737 180 A

Less: Closing inventory (201) (201) —

Cost of goods sold 3,716 3,536 180 A

Profit 1,319 1,764 445 A

Analysis
Actual results must be compared with the flexed budget.
A favourable variance (F) increases profit and an unfavourable or adverse
variance (A) decreases profit.
Some immediate conclusions can be drawn:
• Some goods were sold for less than the budgeted selling price of $100 each.
• Fixed overheads incurred were $110,000 more than originally budgeted so
this is a direct "hit" on profit.
• In this illustration, no variance arises on the value of closing inventory
because it has been assumed to be valued at standard cost.
Although it can be seen that material and labour costs were more than they
should have been, there is insufficient information to know why that was the
case. Therefore, these items must be analysed in more detail (see Session 16).

4.3 Relative Significance

The main purpose of variance analysis is to identify the cause(s)
so that remedial action can be taken for control and decision-
making purposes. For example:
 to identify the need for new (cheaper) suppliers of raw materials;
 to assess whether the labour force is as productive as
expected; or
 to determine the cost to the organisation of machine
breakdowns.

© 2014 DeVry/Becker Educational Development Corp. All rights reserved. 15-7

Sadia sadia Afzal - gentledove004@gmail.com

Session 15 • Flexible Budgets, Budgetary Control and Reporting F2 Management Accounting

Not all variances will be significant and management will direct

its attention to those which are significant. Significance may be
assessed in many ways, considering, for example:
 whether adverse or favourable (as more importance is
generally placed on the adverse);
 absolute amount of a variance;
 relative amount of a variance (e.g. as compared with total
cost); and/or
 whether there is an emerging trend (e.g. of increasing
variances).
It also is important to consider the interrelationship between
variances (see Session 16).

4.4 Potential Action to Eliminate Variances

Significant variances will result either in:
 corrective action being taken to eliminate them in the future
(e.g. machine settings may be recalibrated to reduce the
amount of raw material wastage or production workers may
be retrained); or
 budget revisions to accommodate the variance (e.g. if a raw
material is no longer available at the budgeted cost).

5 Responsibility Accounting

5.1 The Concept

Responsibility accounting is concerned with providing financial
information about costs (and, where relevant, revenues) on the
basis of the manager who has the authority to make day-to-day
decisions about those costs and revenues.
A manager's financial performance can therefore be evaluated
(e.g. in terms of economy, efficiency and effectiveness) on
matters that are directly under that individual's control.

5.2 Conditions for Use

Responsibility accounting can be used at every level of
management under the following conditions:
 costs can be directly associated with the specific level of
management responsibility;
 costs are controllable at the level of responsibility with which
they are associated; and
 budget data is developed for evaluating effectiveness in
controlling the costs.

15-8 © 2014 DeVry/Becker Educational Development Corp. All rights reserved.

Sadia sadia Afzal - gentledove004@gmail.com

F2 Management Accounting Session 15 • Flexible Budgets, Budgetary Control and Reporting

5.3 Controllable and Uncontrollable Costs

Reporting of costs under responsibility accounting differs from
budgeting in two respects:
1. A distinction must be made between controllable and
non-controllable costs.
2. Performance reports either emphasize or include only
controllable items.
Controllability describes the degree of influence that a
departmental manager has over costs incurred, revenues
generated, investment decisions, etc.
 A controllable cost is any cost that is primarily subject to the
influence of a responsibility centre manager (see Session 3).
A cost which is not controllable by a manager in one department
may be controllable by a manager in another department.*
*All costs are
 Uncontrollable costs are incurred indirectly (e.g. increases controllable at some
in expenditure due to inflation). They may be allocated to a level of managerial
responsibility level. responsibility.

5.4 Responsibility Reports

The evaluation of a manager's performance is based on the
individual's ability to meet budgeted goals (e.g. for controllable
costs). A responsibility reporting system involves the preparation
of a report for each level of responsibility in the company's
organization chart.
Responsibility reports usually:
 compare actual costs with flexed budget data;
 identify the "controllable margin" (i.e. excess of contribution
over controllable fixed costs); and
 show only controllable costs (e.g. uncontrollable fixed costs
are not reported).

5.5 Control Reports

A budgetary control report:
 compares actual performance against a flexed budget (and/or
original fixed budget);
 highlights significant variances;
 presents key reasons for variances;
 draws management's attention to the possible implications
of variances;
 identifies possible action(s) to eliminate variances and their
relative advantages; and
 recommends appropriate control actions.

© 2014 DeVry/Becker Educational Development Corp. All rights reserved. 15-9

Sadia sadia Afzal - gentledove004@gmail.com

Session 15 • Flexible Budgets, Budgetary Control and Reporting F2 Management Accounting

Such reports may be prepared routinely (e.g. monthly or quarterly)

and are widely used in the public sector (e.g. in monitoring
activities of local councils, hospitals, state schools, etc).
They are usually part of a formalised reporting system. Each
report should:
 have a title (e.g. relating it to a function or department);
 state its frequency;
 specify its purpose; and
 identify the recipients.

Example 2 Control Reports

Suggest the likely frequency, purpose and primary recipient(s) of reports on each of the following:

Primary
Report Frequency Purpose
Recipient(s)

(a) Sales

(b) Wastage

(c) Factory
overheads

(d) Income
statement

15-10 © 2014 DeVry/Becker Educational Development Corp. All rights reserved.

Sadia sadia Afzal - gentledove004@gmail.com

F2 Management Accounting Session 15 • Flexible Budgets, Budgetary Control and Reporting

Example 3 Budgetary Control Report

Simple produces a single product. The budget for Period 3 was as follows:

Budgeted output 6,000 units

Standard costs per unit:
Direct material 8 kg @ $9 per kg
Direct labour 5 hours @ $8 per hour
Variable overheads $4 per labour hour
Fixed overheads $5 per labour hour

The following actual figures have been extracted for Period 3:

Actual output 6,500 units

Actual costs:
Material 51,000 kg @ $9.10 per kg
Labour 33,000 hours @ $8.20 per hour
Variable overheads $135,000
Fixed overheads $155,000
Required:
(a) Prepare a budgetary control report for Year 1 Period 3 showing, for each cost
element:
(i) The original budget
(ii) The flexed budget
(iii) The actual results
(iv) The total variance
(b) Comment on the significance of each variance.
Solution
(a) Period 3

Original Flexed Actual Favourable/

Variance
Budget Budget Results Adverse
Direct materials
Direct labour
Variable overheads
Fixed overheads
Total costs

(b) Significance

© 2014 DeVry/Becker Educational Development Corp. All rights reserved. 15-11

Sadia sadia Afzal - gentledove004@gmail.com

 Summary
 Budgetary control is the use of budgets, relating the responsibility of managers to the
requirements of a policy, and the continuous comparison of actual with budgeted results,
to control operations.
 A fixed budget is prepared at the anticipated level of activity and remains fixed.
 Flexible budgeting involves preparing several budgets for different activity levels.
Comparison of actual is made with the closest budget.
 To make comparisons with actual results more meaningful, a budget may be "flexed" to
reflect the actual level of activity. Original budget assumptions are otherwise unchanged.
 Periodic budgets are prepared for a particular period and remain unchanged until that
period is complete.
 Rolling budgets are continuously updated (e.g. monthly).
 A variance is the difference between an actual amount and corresponding flexed
budget amount.
 Responsibility accounting focuses on controllable costs (and revenues).

Session 15 Quiz
Estimated time: 15 minutes

1. Describe how management effects budgetary control. (1.2)

2. Name and describe THREE types of budgets classified according to activity level(s). (2.1, 2.3)

3. Give THREE uses of fixed budgets and THREE uses of flexible budgets. (2.1, 2.2)

4. State whether a rolling budget is "forwards" or "backwards" looking. (3.2)

5. True or false? Flexing of budgeted data is absolutely required to perform meaningful variance
analysis. (4.3)

6. Describe responsibility accounting. (5.1)

7. True or false? "Responsibility accounting" means that a person "responsible" for certain issues
within an organisation is required to "account" for issues under that individual's control. (5.2)

8. Define "controllable cost". (5.4)

Study Question Bank

Estimated time: 30 minutes

Priority Estimated Time Completed

Q64 Solo 30 minutes

Additional
Q61 XYZ
Q63 Flexible

15-12 © 2014 DeVry/Becker Educational Development Corp. All rights reserved.

Sadia sadia Afzal - gentledove004@gmail.com

 Session 15

EXAMPLE SOLUTIONS
Solution 1—Flexed Budgets
$000
Sales(1) (53,000 x $100) 5,300
Production costs (1)
Materials (56,000 × $40) 2,240
Labour (56,000 × $3) 168
Variable overheads (56,000 × $9) 504
Fixed overheads 825(2)
Actual cost of production 3,737
Less: Closing inventory (3,000 @ $67) (201)
Cost of goods sold 3,536
Profit 1,764

Notes:
1. Only the activity levels (for sales and production) are changed. Unit selling
prices and unit costs are unchanged and closing inventory is valued at
standard cost.
2. Fixed overheads may remain fixed (as shown here). Alternatively, since the
unit cost of $15 in the original budget is the amount to be absorbed per unit the
fixed overhead may be flexed to $840,000 (56,000 × 15). This is illustrated in
the next session. You should anticipate that in this case an adjustment will be
needed (1,000 units @ $15) in respect of the over-absorption that has arisen
(see Session 8).

Solution 2—Control Reports

Primary
Report Frequency Purpose
Recipient(s)

(a) Sales Weekly To show the extent Sales manager/

to which sales senior management
targets are met

(b) Wastage Daily To control efficient Production manager

use of materials

(c) Factory Monthly To control overhead Factory manager

overheads costs

(d) Income Monthly and To show whether Senior management

statement quarterly profit objective is
being met

© 2014 DeVry/Becker Educational Development Corp. All rights reserved. 15-13

Sadia sadia Afzal - gentledove004@gmail.com

Solution 3—Budgetary Control Report
(a) Period 3

Original Flexed Actual Favourable/

Variance
Budget Budget Results Adverse
Direct materials 432,000 468,000 464,100 3,900 Favourable
Direct labour 240,000 260,000 270,600 10,600 Adverse
Variable overheads 120,000 130,000 135,000 5,000 Adverse
Fixed overheads 150,000 162,500 155,000 7,500 Favourable
Total costs 942,000 1,020,500 1,024,700 4,200 Adverse

(b) Significance*

The total cost variance is only 0.5% of total costs budgeted (0.4% of total flexed costs)
and does not appear significant. However, considering the make-up of this net adverse
variance, the largest variance is for labour. This has arisen because labour hours were
budgeted at $8 but actually cost $8.20. Thus $6,600 of the adverse labour variance is
attributed to a higher hourly rate. The remainder of this variance is due to labour having
been inefficient as compared with the standard.
Because labour was inefficient there also is an adverse efficiency variance arising on
variable overheads.
Although the fixed overhead variance is favourable this is attributable to the fact that the
original budget has been flexed to the actual level of activity (i.e. $162,500 is the amount of
fixed overhead that is absorbed by the units produced). If there are no steps in fixed costs
then actual fixed overheads are $5,000 more than budgeted—an adverse expenditure variance.
The direct material variance is favourable overall even though the actual price per kg was
more than standard. So the adverse price variance $5,100 (51,000 kgs purchased at $9.10
instead of $9.00) is more than offset by a favourable variance of $9,000. This is because
6,500 units should have required 52,000 kgs but actually required only 51,000 kgs.

*Such analysis will be explained in considerably more detail in the

next session.

15-14 © 2014 DeVry/Becker Educational Development Corp. All rights reserved.

Sadia sadia Afzal - gentledove004@gmail.com

NOTES

© 2014 DeVry/Becker Educational Development Corp. All rights reserved. 15-15

Sadia sadia Afzal - gentledove004@gmail.com