7 9 Flexible Budgets

A flexible budget is made with the objective of reference with the actual results for the calculation of variances between the actual and budgeted results. This helps in a transparent and accurate calculation of variances. The original budget for selling expenses included variable and fixed expenses. To determine the flexible budget amount, the two variable costs need to be updated. The new budget for sales commissions is $10,500 ($262,500 sales times 4%), and the new budget for delivery expense is $1,750 (17,500 units times 10%). These are added to the fixed costs of $12,500 to get the flexible budget amount of $24,750. A budget report is prepared to show how actual results compare to the budgeted numbers.

It consists of two parts – first is the fixed cost and fixed cost portion of the semi-variable cost. And the second is the variable cost and variable cost portion of the semi-variable cost. A flexible budget provides cost estimates at a different level of activity. Also, a vivid classification of the expenses to different categories of a fixed cost, semi-variable cost, and variable cost is necessary before preparing a budget. In brief, a flexible budget is a budget that distinguishes the behavior of fixed and variable cost that changes. And changes that happen with the level of activity attained, or change in the revenue or other variable factors.

Flexible Budgets And Static Budgets

Flexible budget enable an organization to predict its performance and income levels at a given range of sales levels and activity levels. It can be seen the impact of changes in sales and production levels on revenue, expenses and ultimately income. A flexible budget is useful for manufacturing industries where costs change with a change in activity level. To make accurate budgets, companies must involve experts so that there is less scope for error and variance analysis is improved. In flexible budgeting, a budget has scenarios for different potential volume levels. During the year, a company compares its actual results to the budget scenario that’s most appropriate based on the actual volume of activity.

The result is that a flexible budget yields a budgeted cost of goods sold of $3.7 million at a $9 million revenue level, rather than the $4 million that would be listed in a static budget. It is also a useful planning tool for managers, who can use it to model the likely financial results at a variety of different activity levels. A budget is a financial plan for a defined period, often one year. It may also include planned sales volumes and revenues, resource quantities, costs and expenses, assets, liabilities and cash flows. Companies, governments, families, and other organizations use it to express strategic plans of activities or events in measurable terms.

The Purpose Of A Flexible Budget Is To

In this case, you create a personal budget based on your finances, income, needs and expenses. Then you adjust it based on how your spending shifts over the course of the year. It’s generally best to manage your budget on a monthly basis because this is how most billing cycles work. With flexible budgets, managers are constantly updating their projections and cost controls with current information.

• Leed Company’s manufacturing overhead cost budget at 70% capacity is shown below.
• The flexible budget for income before income taxes is $20,625, and 40% of that balance is $8,250.
• The management can also work with operational management to reduce the idol labor hours and machine wastes to increase the production capacity.
• If a budget is prepared assuming 100 customers will be served, how will the managers be evaluated if 300 customers are served?
• When using a static budget, a company or organization can track where the money is being spent, how much revenue is coming in, and help stay on track with its financial goals.
• Cost ascertainment at different levels of activity is possible because a flexible budget is prepared for various levels of activity.

In this method, the budget takes a tablet form, where horizontal columns represent the different levels of activity or capacity. And, the vertical rows represent the budgeted estimates against the different levels of activity or output. The expenses categorized into fixed, variable, and semi-variable costs. It helps the management to decide the level of output to be produced in order to generate profits for the business based on budgeted cost at different activity levels and budgeted sales. Variances can be calculated based on the revised budget and the actual performance. There are several accounting tools that businesses can use to plan for and track their monetary activity.

Managerial Accounting

As variables change over time, for example, raw material prices may change over time. The flexible budgets consider these changes, adjust the budgets and compare with actual results. The revised budgets may still have variances with actual results. A flexible budgeting approach narrows the gap between actuals and standards due to changes in activity levels. Flexible budgets act as a benchmark by setting expenditure at various levels of activity. And the estimates of expenses developed via a flexible budget helps in comparing the actual cost incurred for that level of activity.

Using the cost data from the budgeted income statement, the expected total cost to produce one truck was $11.25. The flexible budget cost of goods sold of $196,875 is $11.25 per pick up truck times the 17,500 trucks sold. The lack of a variance indicates that costs in total were the same as planned. It is the calculated difference between the planned or forecast budget against the actual results. In our working example, the company sets out a target of 85% production capacity. The budgeted or planned sales volume of 255,000 units would yield profits of $667,250.

Static Budgets Vs Flexible Budgets

This budget is defined as a budget which is prepared for period less than a year and is very useful to lower levels of management for control purposes. Such budgets are prepared for those activities, the trend in which is difficult to foresee over longer periods. Cash budget and material budget are examples of short-term budgets.

A master budget tailored to a single output level of 20,000 units of sales is a typical example of a fixed budget. The original budget assumed 17,000 Pickup Trucks would be sold at $15 each. To prepare the flexible budget, the units will change to 17,500 trucks, and the actual sales level and the selling price will remain the same. Given that the variance is unfavorable, management knows the trucks were sold at a price below the $15 budgeted selling price. It is pertinent to note that actual results will always differ with the planned targets. Budgeting helps management to analyze the causes or factors behind the variances.

Flexible Budget

Although flexed budgets tend to maintain fixed costs at the same level whatever the level of output/sales, very often fixed costs are actually fixed only over a relevant output range. Suppose material costs for a product suddenly increase during the year, making this item unprofitable. A flexible budget would spot this variance, and management could take corrective actions. It might be a price increase or an effort to find cost savings in manufacturing expenses. With static budgets, costs of operations and product profit margins are set at the start of the year, based on historical data. Unfortunately, real life doesn’t let everything stay the same.

Keep your eyes here for details on our upcoming release of a suite of tools we’re so excited about we can barely sit still long enough to type. An effective budget tells you where your money actually goes so you can make more informed decisions. It doesn’t tell you what should be important to you; it tells you what is actually important to you, at least in terms of your spending, so you can decide whether or not you’re OK with that.

Typical household fixed expenses are mortgage or rent payments, car payments, real estate taxes and insurance premiums. While you could theoretically change your monthly mortgage payment by refinancing your loan or by appealing your property tax assessment, this is not an easy switch. Flexible budget facilitates performance measurement and evaluation. It helps the management to evaluate the actual performance and efficiency with predetermined estimates. A flexible budget adjusts to changes in revenue so you can more effectively determine what’s going right, what’s going wrong, and why the changes are happening. In reality, like everything else about running your own business, it’s more complicated than that. In the example above, materials and supplies are budgeted at $1,700 / month, but for two consecutive months shoot well above that.

• If the actual level of activity is 85%, then the budget allowance for 85% activity should be computed.
• The company has determined that $400,000 of the $1 million of the cost of goods sold is fixed and $600,000 of the cost of goods sold will vary based on its revenue.
• Although flexed budgets tend to maintain fixed costs at the same level whatever the level of output/sales, very often fixed costs are actually fixed only over a relevant output range.
• A budget report is prepared to show how actual results compare to the budgeted numbers.
• The method of determining the fixed and variable elements of costs is often arbitrary and hence the flexed cost bear little relation to the correct budgeted cost for the flexed level of activity.
• The activity level here may refer to different cost drivers affecting the variable costs such as labor hours, direct materials, or sales commission, etc.

Variable costs$7,000Fixed costs$10,000Prepare a flexible budget for capacity level of 80% and 90%. Determine the fixed costs that are expected to be incurred during the period under consideration. The first step is to prepare a budget at your most likely sales level. Let’s say you anticipate selling 50 of your large aquariums next year. They sell for $1,000 each and cost you $550 each to produce.

For example, the jute industry, handloom industries, etc., where a worker performs a significant portion of work. Here, a flexible budget helps management in determining the productivity of the labor. The method of determining the fixed and variable elements of costs is often arbitrary and hence the flexed cost bear little relation to the correct budgeted cost for the flexed level of activity. The most significant advantage of this budget is that it helps the management of the company to determine the production level in different market and business conditions. Where the actual level of activity is different from that expected, comparisons of actual results against a fixed budget can give misleading results. A flexible budget allows a company to see when changes to certain costs should be made.

This type of budgeting often includes variable rates per unit rather than a fixed amount, which allows a company to anticipate potential increases or decreases in monetary needs. Z Ltd. had a profit plan approved for selling 5,000 units per month at an average selling price of Rs. 10 per unit.

I want to know if the profits were a fluke based on his unexpected departure or if we really did that well. Whatever you end up doing, the only reason you’re even able to make an informed decision is that you’re using a fairly detailed budget. This one is a static budget, however, meaning it works best if all the numbers stay the same, or at least stay within a relatively predictable range.

It helps to overcome the constraints of fixed budget which is prepared for a single expected level of activity. If, however, the cost was identified as a fixed cost, no changes are made in the budgeted amount when the flexible budget is prepared. Differences may occur in fixed expenses, but they are not related to changes in activity within the relevant range.

Let’s assume a company determines that its cost of electricity and supplies will vary by approximately $10 for each machine hour used. It also knows that other costs are fixed costs of approximately definition of flexible budget $40,000 per month. Typically, the machine hours are between 4,000 and 7,000 hours per month. Based on this information, the flexible budget for each month would be $40,000 + $10 per MH.

The budget, which remains constant, regardless of the actual output levels is known as Fixed Budget. The flexible budget is a budget which can be easily adjusted according to the output levels. Unfavorable variance is an accounting term that describes instances where actual costs are greater than the standard or expected costs. Static budgeting is constrained by the ability of an organization to accurately forecast its needed expenses, how much to allocate to those costs and its operating revenue for the upcoming period. When using a static budget, a company or organization can track where the money is being spent, how much revenue is coming in, and help stay on track with its financial goals. It sets the standard to measure the variances of the budget estimates and the actual performance of the company for control purposes.