What Is A Flexible Budget? Definition And Example
For example, suppose a proposed sale of items does not occur because the expected client opted to go with another supplier. In a static budget situation, this would result in large variances in many accounts due to the static budget being set based on sales that included the potential large client. The changes made in the flexible budget would then be compared to what actually occurs to result in more realistic and representative variance.
The extra expenditures might prove worthwhile, if they don’t exceed the profits, or if they were an investment. For instance, if you had to spend money unexpectedly on new equipment, the monthly budget might show a deficit. However, if the new machine made production became more efficient, leading to increased sales, you can estimate how long the machine will take to pay itself off. Comparing the two budgets lets you make these calculations. Flexible budget is a budget which, by recognizing the difference in behaviour between fixed and variable costs in relation to fluctuations in output, turnover, or other variable factors, etc. It is designed to change in relation to the level of activity actually attained. A flexible budget is one that takes account of a range of possible volumes.
Marginal Revenue And Marginal Cost Of Production
Then you’ll have a better idea of how strong an investment the advertising campaign would be, and how much to invest. To create the budgets, you must make educated guesses about how much you’ll need to spend in each scenario on supplies like packaging, employee wages and other factors like shipping costs. With a flexible budget, you’ll prepare the company to adapt to changes more easily. Through this analysis, you can better manage your finances. Comparing flexible and static budgets over a longer period of time, such as six months, will give you a better idea of what needs to change. If you find the company continually makes unexpected purchases, for example, you must evaluate the need for these purchases.
Create your budget with set fixed costs that will not change and variable costs depicted as percentages that can be adjusted based on actual revenue. Because a flexible budget adjusts regularly to reflect a company’s current revenue, this type of budget cannot be used to compare actual expenses or revenue to expected expenses or revenue. This can make it difficult to determine if a company’s revenue is above or below what was expected. This type of budget takes into account the variation and ranges of expenses based on each category of a company’s budget.
A typical budget is usually formatted with five columns. The first column lists the sales and expense categories for the company. The second column lists the variable costs as a percentage or unit rate and the total fixed costs. The next three columns list different levels of output and the changes in variable costs based on the increased or decreased sales. 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.
Fixed costs will be constant within relevant range of operations where the variable costs will continue to increase as production increases. 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. General and Administrative Expenses. This flexible budget is unchanged from the original because it consists only of fixed costs which, by definition, do not change if the activity level changes. The flexible budget shows an even higher unfavorable variance than the static budget. This does not always happen but is why flexible budgets are important for giving management an indication of what questions need to be asked.
These are fixed bills with little room for change . This also will generally include housing costs, not much month-to-month negotiating on your rent, as well as medical expenses and loan payments. Ideally you would like this section to account for less than half of your take home pay. How can you keep on top of unexpected expenses and the odd financial surprise? The flexible budget solves this problem, providing both senior executives and middle management with dynamic guidance on how much to spend based on the business’ changing reality. Other expenses though are not so simple. For example, a hiring plan may hinge on signing a large new customer to a long term contract.
Production managers are evaluated using the flexible budget because the usage of direct materials, direct labor, and manufacturing overhead will depend on the actual number of units produced. A flexible budget is a budget prepared at different levels of operating activity. It is appropriate for any activity that has variable costs. It is not necessary for the control of fixed costs since fixed costs do not vary with changes in the level of activity.Choice “c” is incorrect. Both of these budgets have variable cost components, so flexible budgets would be meaningful at different levels of activity.Choice “d” is incorrect. The marketing budget would have variable costs, making a flexible budget appropriate for control over marketing costs.Choice “b” is incorrect. The direct materials usage budget includes variable costs, making a flexible budget appropriate for control over direct material usage costs.
The lack of a variance indicates that costs in total were the same as planned. 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. The $262,500 is 17,500 trucks times $15 per truck.
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. D. Efficient or bookkeeping inefficient use of the cost driver (e.g., machine hours) for variable overhead. Variable costs are usually shown in thebudgetas either a percentage of total revenue or a constant rate per unit produced.
Flexible Budget Definition
By incorporating these changes into the budget, a company will have a tool for comparing actual to budgeted performance at many levels of activity. A flexible budget is a revised master budget that represents expected costs given actual sales.
Unless the company has extremely stable revenue and expenses then this rigidity can become problematic. These variances are used to assess whether the differences were favorable or unfavorable . If an organization’s actual costs were below the static budget and revenue exceeded expectations, the resulting lift in profit would be a favorable result. Conversely, if revenue didn’t at least meet the targets set in the static budget, or if actual costs exceeded the pre-established limits, the result would lead to lower profits.
A flexible budget is actually a series of several budgets prepared for many levels of operating activity. A flexible budget is designed to allow adjustment of the budget to the actual level of activity before comparing the budgeted activity with actual results. This flexibility is important if costs vary with the activity level.
Actual net income is unfavorable compared to the budget. What is not known from looking at it is why the variances occurred.
The sales-price variance and the fixed-overhead volume variance. The sales-price variance and sales-volume variance. The sales-price variance and fixed-overhead budget variance.
When you must adjust your spending on an ad hoc basis, most often you end up short-changing your savings. By flexing its budget a company can anticipate and accommodate its needs. For example, a seasonal business might create a a flexible budget is appropriate for flexible budget that anticipates changing staff levels as customers come and go over the course of the year. Or a company that conducts product development might allow for greater research investment in case of strong sales.
Creates Spending Awareness
A flexible budget allows a company to see when changes to certain costs should be made. Sales decline, but direct labor costs do not decline at the same rate, because management elected to retain the production staff. The biggest advantage to a flexible budget is that it more accurately reflects the state of your finances. The alternative, static budgeting, can’t account for unexpected expenses or changing income. In a static budget, the company would not have the ability to tweak the budget to manage the changes if that large client contract doesn’t materialize or if sales grow faster than anticipated. The greatest advantage that a flexible budget has over a static budget is its adaptability.
- The direct materials usage budget includes variable costs, making a flexible budget appropriate for control over direct material usage costs.
- This type of budget is most often based on changes in a company’s actual revenue and uses percentages of revenue rather than static numbers.
- is a special kind of budget that provides detailed information about budgeted expenses at various levels of output.
- A flexible budget can be difficult to formulate.
- Following is the static budget and actual results of Yoga Inc. for the month of April 20X4.
The company might have purchased inferior rather than quality equipment, for example, and your budget comparisons may show this choice didn’t pay off. For understanding the term fixed budget, first, know the meaning of the two words fixed and budget. Fixed means firm or stable, and budget is an estimate of economic activities of the business. So in this way, Fixed Budget refers to an estimate of pre-determined incomes and expenditures, online bookkeeping which once prepared, does not change with the variations in the activity levels achieved. 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. Flexible budget, on the other hand, is a budget that is flexible as per the needs of the hour.
Lack Of Revenue Comparison
If you buy a new pair of jeans in September, the odds are you won’t need another in October. Not too many people buy a phone two months in a row. A flexible personal budget is the individual equivalent of this process. In this case, you create a personal budget based on your finances, income, needs and expenses.
To account for actual sales and expenses differing from budgeted sales and expenses, companies will often create flexible budgets to allow budgets to fluctuate with future demand. Control of fixed factory overhead but not direct materials and direct labor.Control of direct materials and direct labor but not selling and administrative expenses. Any level of activity.Control of direct labor and direct materials but not fixed factory overhead.Show ResultCorrect – Your answer is correct. When a flexible budget is adjusted to actual activity level, we call it a flexed budget. It is the budget which would have been prepared at the beginning of the period, had the management known the exact actual output. This makes a flexible budget a powerful performance evaluation tool. A static budget is a type of budget that incorporates anticipated values about inputs and outputs that are conceived before the period in question begins.
Income taxes are budgeted as 40% of income before income taxes. The flexible budget for income before income taxes is $20,625, and 40% of that balance is $8,250. Actual expenses are lower because the income before income taxes was lower. Enter the resulting flexible budget for the completed period into the accounting system for comparison to actual expenses.
For example, a restaurant may serve 100, 150, or 300 customers an evening. If a budget is prepared assuming 100 customers will be served, how will the managers be evaluated if 300 customers are served? Similar scenarios exist with merchandising and manufacturing companies. To effectively evaluate the restaurant’s performance in controlling costs, management must use a budget prepared for the actual level of activity. Using static and flexible budgets together is a powerful tool in evaluating the performance of a company. A technique called variance analysis is used by accountants to compare static budgets and flexible budgets.
Related Accounting Q&a
Not all line items in a budget can be flexible. For example, a company’s rent expense is likely fixed for the entire year. It’s unrealistic to expect that to change every month or even every quarter. In either a flexible or static budget, the rent is what it is. Flexible budgets can also be used after an accounting period to evaluate the successful areas and unsuccessful areas of the last period performance. Management carefully compares the budgeted numbers with the actual performance statistics to see where the company improved and where the company needs more improvement. A flexible budget cannot be preloaded into the accounting software for comparison to the financial statements.
This is particularly common in manufacturing operations. If revenue comes in lower than anticipated at just $400,000, then the marketing budget will automatically reduce based on that change in revenue. At $400,000, the marketing budget would reduce to $60,000.
Author: Gene Marks