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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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Management Accounting 2009

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.
Management Accounting 2009
Some of the above points can be illustrated by an example:
Monthly departmenta flexi
b
e budget

RM RM RM RM RM
Sales 10
0
12
0
14
0
160 180
Direct costs 40 48 56 64 72
Variable overhead 10 12 14 16 18
Semi-variable overhead 15 16 17 18 19
Fixed overhead 20 20 20 24 24

85 96 10
7
122 133
Profit 15 24 33 38 47
Table 1 Flexible Budget

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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.
Fixed Budget Comparative Statement
Depar For The Month Be
tment X
ginning 1st July, 19-8

Actual Budget Variance
s
Units Produced
Material cost Labour cost
Manufacturing 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)
Flexible Budget Comparative Statement
Department X For The Month Beginning 1st July, 19-8

Actual Budget Variances
Units Produced 1100 1000

Variable 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

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Management Accounting 2009
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.
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 RM18000
Fitting and installation of new oven RM2300
Estimated length of life of new oven 8 years
Residual value of oven after 8 years' RM1500
Management Accounting 2009
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.

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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.
Management Accounting 2009
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

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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.
Management Accounting 2009

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,
Bendigo Manufacturing Ltd Flexible Budget for the year ended 30 July 20x1

per Levels of activity

unit 20000 25000 30000
Variable costs: RM RM RM RM
Direct materials 5 100000 125000 150000
Direct labour 12 240000 300000 360000
Indirect material 0.5 10000 12500 15000
Indirect labour 0.75 15000 18750 22500
Light and power 1.25 25000 31250 37500
Total variable costs 19.5 390000 487500 585000
Fixed costs:

Supervision

60500 60500 60500
Rates

8700 8700 8700
Insurance

5200 5200 5200
Maintenance

4700 4700 4700
Depreciation

15300 15300 15300
Total fixed costs

94400 94400 94400
Total manufacturing costs

484400 581900 679400
Table 3 Flexible Budget

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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.
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.
Management Accounting 2009

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

Budget Actual Variance
Production units 20000 20000

Variable costs: RM RM RM
Direct materials 100000 110000 10000 A
Direct labour 240000 260000 20000 A
Indirect material 10000 11400 1400 A
Indirect labour 15000 16200 1200 A
Light and power 25000 24600 400 F
Total variable costs 390000 422200 32200 A
Fixed costs:

Supervision 60500 61400 900 A
Rates 8700 8700 0
Insurance 5200 5300 100 A
Maintenance 4700 4450 250 F
Depreciation 15300 15300 0
Total fixed costs 94400 95150 750 A
Total manufacturing costs 484400 517350 32950 A
A indicated an adverse variance
F indicated a favourable variance
Table 4 Flexible Budget Performance Report

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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.
Management Accounting 2009
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 RM
Variable overhead cost (B) 14000 16000 18000 20000
Fixed overhead cost (C) 45000 45000 45000 45000
Total overhead cost (13) 59000 61000 63000 65000
Variable overhead rate per

hour (B-A) 2 2 2 2
Fixed overhead rate per hour (C-A) 6.43 5.63 5.00 4.50
Total overhead rate per hour (D-A) 8.43 7.63 7.00 6.50
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Management Accounting 2009

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
Management Accounting 2009
(8000
X
RM2). 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.
Parramatta Manufacturing Co. Ltd Factory Overhead Flexible Budget for the month of January
20x2

Normal capacity

Percentage of capacity

70 80 90 100
Units of production

3500 4000 4500 5000
Standard direct labour hours

7000 8000 9000 10000
Budgeted factory overhead Per hour

Variable costs: RM RM RM RM RM
Indirect matarials 0.2 1400 1600 1800 2000
Maintenance 1.1 7700 8800 9900 11000
Light and power 0.7 4900 5600 6300 7000
Total variable costs 2 14000 16000 18000 20000
Fixed costs:

Salaries

9500 9500 9500 9500
Insurance

3000 3000 3000 3000
Rates

9300 9300 9300 9300
Supplies

2200 2200 2200 2200
Rent

6000 6000 6000 6000
Depreciation

15000 15000 15000 15000
Total fixed costs

45000 45000 45000 45000
Total factory overhead

59000 61000 63000 65000
Predetermined overhead rate per standard direct labour hour
(RM63000-9000 hours)

RM7

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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; and
6. Uncertainties regarding the global economy may affect customer demand.
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Management Accounting 2009
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 Costs
A 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.
1. Practical Example
Output (units) A Total Variable Costs (RM) B Variable Cost per unit (RM)
C=B/A
0 0 10
1 10 10
10 100 10
100 1000 10
1000 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 i
1200
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)


\



^^ \
f \
/
1000
1200
0
1000
0
8000
6000
4000
2000
0
Total
Costs
(RM)

0
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Management Accounting 2009
Fixed Costs
Total 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 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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Management Accounting 2009
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

2. Graphical Representation
Total Fixed Costs

1200
Output (units)
Cost
(RM
)
Output (units) Total Fixed Costs (RM) Fixed Cost per unit
A B (RM) C=B/A
0 1000 1000
1 1000 1000
10 1000 100
100 1000 10
1000 1000 1

/
V /
\


Fixed cost

\ ' \ /
120
0
100
0
SO
O
600
400
200
0
200 400 S
O
O
SO
O
1000
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Management Accounting 2009
Fixed Costs per unit
100 ,
90 ----- V
80 ----- V
60 \
40 \
N. Fixed Costs per unit
30 X.
10 ~~ ______________________________________________________________
0 ,
0 20 40 60 80 100 120
Output (luiit)

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
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 Unit
Variable 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.
Cost
(RM
)
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Management Accounting 2009
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 Example
Sales representatives are often paid a salary plus a commission and sales.

2. Graphical Representation
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 1.25
80000 40000 30000 70000 0.88
120000 60000 30000 90000 0.75
160000 80000 30000 110000 0.69
200000 100000 30000 130000 0.65
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Management Accounting 2009
Mixed Costs

-Variable Cost
Cost
(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 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

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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.
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Management Accounting 2009
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