## **Learning Outcomes**

After reading this article, you will be able to distinguish between fixed and variable cost elements in budgeting, prepare and interpret flexed budgets, and explain the importance of cost behaviour in budgetary control. You will understand how flexible budgets support performance evaluation, learn the principles of the high-low method for estimating cost behaviour, and recognise the practical limitations of these techniques in the context of ACCA exam requirements.

## **ACCA Management Accounting (MA) Syllabus**

For ACCA Management Accounting (MA), you are required to understand how flexible budgets are constructed and used in business control, and to accurately separate fixed and variable cost elements. In your revision, focus on:

- The purpose and limitations of fixed and flexible budgets in performance management
- The role of flexible budgeting in budgetary control
- Identifying and separating fixed and variable elements in costs
- Applying the high-low method to divide semi-variable costs into fixed and variable components
- Preparing flexed budgets for scenarios with different levels of activity
- Explaining how flexible budgets improve variance analysis
- Recognising situations where flexible or fixed budgetary control is appropriate

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. What is the primary difference between a fixed budget and a flexible budget in terms of cost control?
2. When using the high-low method, what assumption is made about the relationship between cost and activity?
3. Which costs should be flexed when preparing a budget for a different level of activity: fixed costs, variable costs, or both?
4. List two limitations of the high-low method for separating cost behaviour.

## **Introduction**

Accurate budgetary control relies on understanding how costs change with activity levels. Flexible budgeting recognises that costs do not all change in the same way. By separating costs into their fixed and variable elements, managers can construct flexed budgets—budgets that reflect actual activity—so that fair comparisons between budget and actual performance can be made. This is essential for identifying realistic variances and supporting better decision making.

> **Key Term: flexible budget**
> A budget that adjusts costs and revenues in line with the actual level of activity, enabling direct comparison with real performance.
>
> **Key Term: flexed budget**
> A version of the original budget modified ("flexed") to correspond to the actual activity level achieved.
>
> **Key Term: cost behaviour**
> The way in which a cost changes as activity levels change, typically classified as fixed, variable, stepped, or semi-variable.
>
> **Key Term: high-low method**
> A statistical technique for estimating the variable and fixed elements of a semi-variable cost by using only the highest and lowest activity data points.

## FIXED VERSUS FLEXIBLE BUDGETS

A fixed budget is set at one expected level of activity. If the actual output differs, most budgeted costs will no longer provide a meaningful comparison. Inflexible budgets create misleading variances, especially when production or sales deviate from plan.

Flexible budgets, by contrast, show expected costs and revenues at different activity levels. Rather than a single figure, costs that vary with volume are recalculated for actual output. This makes variance analysis more reliable.

### When is each approach used?

- _Fixed budgets_ are suitable for environments with predictable, stable activity.
- _Flexible budgets_ are essential where output, sales, or volume are variable and where performance measurement must be fair and robust.

### **Worked Example 1.1**

A business sets a fixed budget for 10,000 units with variable costs at \$3 per unit and fixed costs at \$20,000. Actual production is 12,000 units, and total costs are \$57,000.

**Question:** Should the manager be judged against the original fixed budget or a flexed budget?

> **Answer:** The manager should be assessed against a flexed budget of \$36,000 variable (\$3 × 12,000) plus \$20,000 fixed = \$56,000. The variance of \$1,000 is adverse, but much less than the \$7,000 "overspend" shown if comparing to the fixed 10,000-unit budget.

### **Revision Tip**

Always flex budgets to the actual output to avoid unfairly penalising or rewarding managers for changes in activity.

## SEPARATING FIXED AND VARIABLE ELEMENTS

Before preparing a flexed budget, you need to split semi-variable costs into fixed and variable parts. Many indirect costs, such as utility bills or maintenance, contain both fixed and variable components.

The most common method in practice is the high-low analysis.

### The high-low method process

1. Identify the periods of highest and lowest activity and their associated total costs.
2. Calculate the variable cost per unit:

   Variable cost per unit =  
   (Cost at highest activity – Cost at lowest activity) ÷  
   (Highest activity – Lowest activity)

3. Calculate fixed cost using either the high or low data point:

   Fixed cost =  
   Total cost at chosen activity – (Variable cost per unit × Output at that activity)

4. Build the cost equation:  
   Total cost = Fixed cost + (Variable cost per unit × Number of units)

### **Worked Example 1.2**

A company records these costs:

| Output (units) | Total Cost (\$) |
| -------------- | --------------- |
| 4,000          | 10,000          |
| 6,000          | 13,000          |

**Question:** Determine fixed and variable cost components.

> **Answer:**
>
> Variable cost per unit = (\$13,000 – \$10,000) ÷ (6,000 – 4,000) = \$3,000 ÷ 2,000 = \$1.50 per unit.
>
> Fixed cost (using high point) = \$13,000 – (6,000 × \$1.50) = \$13,000 – \$9,000 = \$4,000.
>
> Cost equation: Total cost = \$4,000 + \$1.50 × units.

### Interpreting cost equations

Once you know the variable cost per unit and the fixed cost, you can flex the budget for any realistic activity level.

> **Exam Warning**
> The high-low method relies on just two observations and assumes costs change only with production volume. Results may be distorted by unusual costs or outliers—use with caution.

## APPLICATION: PREPARING A FLEXED BUDGET

When the budget period ends and actual results are known, follow these steps:

1. Start with the original budget.
2. Identify actual activity (output, sales, etc.).
3. Use cost behaviour to adjust (flex) costs:
   - **Variable costs:** Multiply variable rate by actual activity.
   - **Fixed costs:** Remain constant within the relevant range.
4. Compare flexed budget with actual results to identify controllable variances.

### **Worked Example 1.3**

Budgeted for 10,000 units:

- Variable cost: \$4/unit
- Fixed cost: \$15,000

Actual production: 8,000 units  
Actual total cost: \$48,000

**Question:** What is the flexed budget for costs at 8,000 units, and what is the variance?

> **Answer:**
>
> Flexed budget variable cost: 8,000 × \$4 = \$32,000  
> Flexed budget fixed cost: \$15,000  
> Total flexed budget: \$47,000  
> Actual total cost: \$48,000  
> Variance: \$1,000 adverse.

## LIMITATIONS OF THE HIGH-LOW METHOD AND FLEXIBLE BUDGETING

While useful, these techniques have drawbacks:

- The high-low method only uses two data points—random fluctuations or errors can bias estimates.
- It assumes all costs change linearly with activity and are affected only by output, overlooking factors such as inflation, step changes, or discounts.
- Semi-variable and stepped fixed costs complicate the analysis.
- Flexed budgets rely on correct cost behaviour analysis; errors lead to misleading variances.

> **Exam Warning**
> Avoid using high-low analysis where cost patterns are non-linear or the data contains abnormal transactions.

## THE IMPORTANCE OF FLEXIBLE BUDGETING IN CONTROL

A major benefit of flexible budgeting is the fair appraisal of managers’ performance. Fixed budgets can give misleading results—especially if activity differs from planned output. Flexed budgets align expectations with what managers could control, supporting robust performance management and variance analysis.

### Which costs should be flexed?

Only costs that change with the level of activity are flexed. Fixed costs do not change within the relevant range and are not adjusted in the flexed budget.

### **Worked Example 1.4**

A business sets these costs for a budgeted output of 5,000 units:

- Direct material: \$10,000 (variable)
- Indirect materials: \$1,500 (semi-variable)
- Rent: \$3,000 (fixed)

After high-low analysis, indirect materials are \$1,000 fixed plus \$0.10 per unit.

Actual output: 6,500 units

**Question:** Prepare the flexed budget for 6,500 units.

> **Answer:**
>
> Direct material: \$2 per unit × 6,500 = \$13,000  
> Indirect materials: \$1,000 + (6,500 × \$0.10) = \$1,650  
> Rent: \$3,000  
> Total flexed budget: \$13,000 + \$1,650 + \$3,000 = \$17,650

## WHEN TO USE FIXED OR FLEXIBLE BUDGETARY CONTROL

- Fixed budgetary control is appropriate if activity is always predictable, or for short-term forecasting.
- Flexible budgetary control is essential when activity levels vary and when performance measurement needs to be realistic and fair.

> **Revision Tip**
> In the exam, always flex the budget to the actual output before comparing with actual costs—this is essential for fair performance evaluation.

## **Summary**

A flexible budget adjusts costs for changes in activity, improving control by ensuring valid performance comparisons. Separating fixed and variable elements—often using the high-low method—enables accurate flexed budgeting. However, the reliability of conclusions depends on correctly classifying cost behaviour and recognising the high-low method’s limitations. For ACCA Management Accounting (MA), understand not only how to prepare a flexed budget, but also when and why it should be used for effective control and variance analysis.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Explain the need for separating fixed and variable costs in budgeting
- Describe the differences between fixed and flexible budgets
- Apply the high-low method to estimate variable and fixed cost elements
- Prepare a flexed budget based on actual activity levels
- Identify the benefits of flexible budgeting for control and performance appraisal
- Recognise the limitations of the high-low method and flexible budgeting
- Understand when to apply fixed versus flexible budgetary control

## **Key Terms and Concepts**

- flexible budget
- flexed budget
- cost behaviour
- high-low method

Flexible budgets and control - Separating fixed and variable elements