F5 Preparation materials
Fixed and variable costs
Based on above cost classifications, we can further classify cost into fixed, variable, stepped
and semi-variable cost. We look at whether or not a cost changes with the levels of activities
Fixed costs(FC)
Cost which is incurred for a particular period of time
Within certain activity levels, is unaffected by changes in the level of activity
Fixed in total, reduce on a per unit basis as the activity rises
Such as depreciation ,salary of accountants，rent…
A fixed cost can be represented in a graph as
Cost/unit
Cost
Level of activity
Level of activity
For example, if the company has $1000 fixed cost and produce and sell 100 units, products,
then the fixed cost per unit is $1000/100 = $10/unit
If the company increases its activity level to 200 units then the fixed cost per unit would be
$1000 /200 = $5/unit
Variable costs (VC)
Vary directly with the volume of output. For example, if making 1 unit product cost $20,
when the cost of making 100 unit products will cost $2000
Per unit cost stays the same
VC= v × Q
Total cost very with level of activity
Such as material cost, direct labour cost, sales commission, bonus payment
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A variable cost can be represented in a graph as
Cost/unit
Cost
Level of activity
Level of activity
Semi-variable cost(mixed cost)
Cost contains both fixed and variable components
Is partly affected by changes in the level of activities
Such as electricity and gas bills, salesman’s salary and costs of running a car
A semi-variable cost can be represented in a graph as
Cost
Level of activity
For the purpose of our studies, we will assume that costs react to each other in a linear
(straight line) relationship
Total cost
 Assumption
◦ With relevant range of output, costs are either fixed, variable, semi-variable
◦ Department cost assumed to be mixed costs TC= FC+VC
◦ Costs are set to be linear
TC=VC + FC =v Q + FC
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Are the following likely to be fixed, variable or mixed costs?
a) Telephone bill
b) Annual salary of the chief accountant
c) The management account’s annual membership fee paid to ACCA
d) Cost of materials used to pack 20 units of product X into a box
e) Wages of warehousemen
Budget
The budget we come across by far always assumes production is fixed, ie no variation in budgeted
levels of activity.
So here flexible budgets are introduced to take account of variations in activity levels.
The followings are some comparisons of flexible budgets and fixed budgets
Flexible budgets
◦
Set at the planning stage and used retrospectively
◦
Are designed to flex with the level of activity
◦
Used to show what cost and revenues should have been for the actual level of
activity
◦
Flexible budgets are prepared using marginal costing (fixed cost + variable cost )
(high-low method)
Fixed budgets
◦
Set prior to the start of an accounting period
◦
Remain unchanged regardless of the level of activity
◦
Based on estimated volume of production and sales
◦
Won’t change if actual level of production and sales are not same with estimated
volume of production and sales
◦
Are useful for controlling fixed cost, particularly non-production fixed cost
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Question 1
ABC company need to product 10,000 units next year, based on historical record.
The historical data about production and total cost is as follows：
Production (units)
Total cost $
8,800
45,200
9,500
48,600
10,500
50,300
What is the total cost if the selling price is $6
Also calculate the cost that should be expected when output expected is 12,ooo units
and 8,000 units
Solution
Step 1 use high-low method to find variable cost and fixed cost
Step 2 construct flex budgets based on the activity levels given
Flex budget
Fixed budget
Flexible budget
8,000 units
10,000
12,000 units
sales
Variable cost
Contribution
Fixed cost
Profit
Behavioral Aspects of Budgets
Budget can motivate employees but it can also produce undesirable negative reactions (build
slack). Therefore, we need to analyze how budget can affect employee behaviour.
The two major impacts of budget on employee behaviors are
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
Motivation
Ensure employees have positive attitudes towards budgets (goal congruence)

Participation
Two ways to set budget:
 Top down (imposed budget)
No input from operating personnel
Good points: save time, coordination,
Bad points: demotivate lower staff, less acceptance
 Bottom up ( participatory budget)
Lower level manger submit budget to their superiors
Based on the different budget effect, it is useful to have an expectation budget and
aspirations budgets
Ideal standard, low standard– demotivating
Achieved past level- too low, encourage budgetary slack
Variances
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Answers
Question 1
Flex budget
Fixed budget
Flexible budget
8,000 units
10,000
12,000 units
sales
48,000
60,000
72,000
Variable cost
24,000
30,000
36,000
Contribution
24,000
30,000
36,000
Fixed cost
18,800
18,800
18,800
Profit
5,200
11,200
17,200
Question 2
Material price variance
Material usage variance
Labour rate variance
Labour efficiency variance
Idle time variance
Variable overhead expenditure variance
Variable overhead efficiency variance
Fixed overhead expenditure variance
Fixed overhead volume variance
Selling price variance
Sales volume variance
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600A
500F
200F
3,400F
1000A
200A
510F
4,560A
1,850A
1,400A
1,500A
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