Budget frameworks - Fixed, flexed, rolling, and activity-bas...

Learning Outcomes

After reading this article, you will be able to explain and distinguish between fixed, flexed, rolling, and activity-based budgets. You will know how each budgeting framework supports planning and control, identify their main uses and limitations, and apply them for performance management. You will also recognise when and how to construct each type and avoid common mistakes in exam scenarios.

ACCA Performance Management (PM) Syllabus

For ACCA Performance Management (PM), you are required to understand the design and application of various budgetary frameworks for managerial planning and control. This article addresses:

• The principles and uses of fixed, flexed, rolling, and activity-based budgets
• The limitations of fixed budgets and the need for flexing
• How to prepare and use rolling budgets in dynamic environments
• The basics of activity-based budgeting (ABB) and its benefits over traditional frameworks
• When to implement each framework for optimal performance management and examination requirements

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. When actual activity differs from the budgeted level, which framework allows a fair performance comparison?
   1. Fixed budget
   2. Flexed budget
   3. Zero-based budget
   4. Incremental budget
2. Which budgeting approach helps maintain relevant forecasts in rapidly changing environments?
   1. Fixed budgeting
   2. Flexed budgeting
   3. Rolling budgeting
   4. Activity-based budgeting
3. Select the correct statement:
   1. Activity-based budgeting allocates all overheads by volume
   2. Rolling budgets are recalculated only at year-end
   3. Flexible budgets adjust for actual output levels
   4. Fixed budgets should always be used for performance control

4. What is the main advantage of activity-based budgeting compared to traditional methods?

Introduction

Budgetary frameworks provide the structure for forecasting, planning, and controlling within an organisation. The ACCA exam requires not only knowledge of how to produce budgets but also the understanding of which framework to use for various scenarios. Selecting the wrong budget type can lead to unfair performance evaluations and lost marks.

Budgetary control involves comparing actual results with the budget to identify variances and take corrective actions. This comparison must be meaningful and fair. Different frameworks exist to meet different management needs.

Key Term: fixed budget
A budget prepared for a single, planned level of activity, without adjustment for actual output.

Key Term: flexed (flexible) budget
A budget that has been adjusted to reflect the actual output or activity level, enabling fair comparison with actual results.

Key Term: rolling budget
A continuously updated budget that adds a new period (e.g., month or quarter) as the latest period finishes, ensuring forecasts remain current.

Key Term: activity-based budgeting (ABB)
A budgeting method that determines resource requirements and costs based on the planned volume and complexity of activities rather than traditional cost centres.

Fixed Budgets: The Traditional Approach

A fixed budget is drawn up before the start of a period for an expected activity level (e.g., units produced or sales made). It remains unchanged irrespective of what actually happens.

Fixed budgets are useful for setting out original intentions and resource plans. However, they become less relevant when actual output differs significantly from what was planned.

• Fixed budgets should never be used for performance evaluation if actual activity varies from the original plan.
• Variances measured against a fixed budget in these cases can mislead managers and staff.

Worked Example 1.1

A company prepares a fixed budget for 20,000 units. In reality, it produces 25,000 units. Variable costs were budgeted at $12 per unit, fixed costs at $36,000. Actual variable costs are $320,000. Should the production manager be criticised for the $20,000 over-budget on variable costs?

Answer:
No. The original budget was for 20,000 units ($12 × 20,000 = $240,000 variable costs). But 25,000 units were made, so the relevant expected cost is 25,000 × $12 = $300,000. Comparing $320,000 actual with $300,000 flexed budget means only $20,000 is genuinely unexplained—not the $80,000 against the original (fixed) budget.

Exam Warning

Never compare actual results to a fixed budget if output levels differ. Use a flexed budget to earn easy marks and avoid this frequent exam error.

Flexed Budgets: Adapting for Actual Output

A flexed (or flexible) budget takes the original budgeted cost or revenue figures and adapts them for the actual level of activity achieved. This allows for a fair and accurate variance analysis, isolating operational performance.

• Variable costs are recalculated to match the actual output.
• Fixed costs remain unchanged, as they do not vary with output in the relevant range.

Worked Example 1.2

A business budgets for 12,000 units, variable costs $8/unit, fixed costs $24,000. Actual output is 10,000 units; variable costs incurred are $90,000.

Answer:
Flexed budget:
Variable costs: 10,000 × $8 = $80,000
Fixed costs: $24,000
Total flexed budget = $104,000
Actual total cost = ($90,000 variable + $24,000 fixed) = $114,000
Total variance = $10,000 adverse compared to flexed, not $26,000 adverse if compared to the fixed budget for 12,000 units.

Revision Tip Use the flexed budget as your reference whenever actual output deviates from plan—an essential step before variance calculations.

Rolling Budgets: Keeping Forecasts Up to Date

A rolling budget updates budget figures on a regular basis (usually monthly or quarterly). As the earliest period passes, a new forecast period is added, and all remaining budgets are revised using the latest information.

• Most useful in uncertain, fast-changing environments.
• Maintains a constant time horizon (e.g., always 12 months out).
• Helps address outdated assumptions and encourages frequent plan reviews.

Key Term: rolling budget
A continuously refreshed budget that extends the planning window by adding a new period as the oldest period concludes.

Worked Example 1.3

A firm prepares a rolling budget quarterly. In January, new information shows demand will be lower due to market changes. The original budget planned for $480,000 sales in Q2 but a rolling reforecast, based on actual Q1 results, predicts $410,000 sales and adjusts all subsequent quarters accordingly.

Answer:
This approach ensures that resource allocations, such as purchases and hiring, reflect the latest environment. Managers are better equipped to make accurate decisions, avoiding over-committing resources and reducing last-minute fire-fighting.

Exam Warning Do not confuse rolling budgets with fixed annual budgets. Rolling budgets adjust each period, whereas fixed budgets do not change until the next annual cycle.

Activity-Based Budgeting (ABB): Aligning Budgets with Activities

Traditional budgeting allocates costs according to cost centres and often uses volume-based allocations. Activity-based budgeting analyses the fundamental activities driving costs and budgets accordingly.

• More accurate, especially in businesses with significant overheads or complex processes.
• Helps identify non-value-adding activities or cost drivers needing attention.
• Can improve resource allocation and cost control by focusing on what causes costs.

Key Term: activity-based budgeting (ABB)
A budgeting method based on estimating planned activity volumes, assigning resource requirements and costs by activity drivers rather than by department.

Worked Example 1.4

An engineering firm expects to process 400 purchase orders and 120 production set-ups next year. Previous analysis shows purchase order costs run $150 per order, and set-ups cost $800 each. What budget should be set for these activities?

Answer:
Budget for purchase order activity: 400 × $150 = $60,000
Budget for set-up activity: 120 × $800 = $96,000
These amounts feed into the overall budget, giving a clearer view of which activities consume resources.

Revision Tip Use ABB when overheads are high, processes are complex, or management needs to focus on eliminating unnecessary activities.

Comparison and Suitability

Key Point Checklist

This article has covered the following key knowledge points:

• Define fixed, flexed, rolling, and activity-based budgets
• Explain when to use each budgeting framework for planning and control
• Identify the main strengths and weaknesses of each approach
• Prepare and use flexed and rolling budgets for fair performance management
• Recognise when ABB delivers better control than traditional frameworks
• Avoid the common exam errors relating to inappropriate use of fixed or flexed budgets

Key Terms and Concepts

• fixed budget
• flexed (flexible) budget
• rolling budget
• activity-based budgeting (ABB)