Flexible Budget
Flexible budget is budget typically in the form of an income statement that is adjustable to any level of activity such as units produced or units sold. In a simple flexible budget, fixed costs stay constant whereas variable and semi-variable costs change according to a standard predetermined at the beginning of an accounting period. Variable costs may be represented as percentages of some base figure such as number of units or revenue.
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. Any comparison between actual results and a flexed budget is more meaningful than a comparison with static budget especially if the actual activity level deviates significantly from the budgeted activity level. This makes a flexible budget a powerful performance evaluation tool.
Flexible budget variances may be used to determine any shortcomings in actual performance during a given period. Flexible budget variances are simply the differences between line items on actual financial statements with those on flexed budgets. Since the actual activity level is not available before the accounting periods closes, flexed budgets can only be prepared at the end of the period.
Flexible budget may also be useful in planning stage at the beginning of the accounting period. When flexible budgets are adjusted to a series of possible activity levels, the resulting data helps anticipate the effect of changes in activity levels on revenues and costs thus allowing management to make useful adjustments to plans.
Example
Following is the static budget and actual results of Yoga Inc. for the month of April 20X4.
| Actual | Static | |
|---|---|---|
| Units | 40,000 | 30,000 |
| Revenue | 236,000 | 180,000 |
| Variable Costs: | ||
| Material | 76,000 | 60,000 |
| Labor | 63,200 | 45,000 |
| Factory Overhead | 34,000 | 24,000 |
| Contribution Margin | 62,800 | 51,000 |
| Fixed Cots: | ||
| Factory Overhead | 12,880 | 12,000 |
| Office Expenses | 22,000 | 20,000 |
| Operating Income | 27,920 | 19,000 |
The management is pleased with the income higher than budgeted. However they understands that significant increase in units sold renders the comparison of actual results and the static budget unfair. You are required to prepare a flexible budget at actual level of output and calculate flexible budget variances.
Solution
Since revenues and variable costs vary directly with number of units, we need to calculate budgeted price and variable costs per unit by dividing static budget amounts by 30,000 budgeted units. This yields price per unit of $6.00, material cost per unit of $2.00, labor cost per unit of $1.50 per unit and variable factory overhead of $0.80 per unit. These figures are then multiplied by actual units sold i.e. 40,000 units to obtain flexible budget revenue and variable costs.
The fixed costs are constant and remain same in both static and flexed budgets. The next step is to subtract flexible budget amounts from actual figures to obtain the required variances.
| Actual | Flexed | Variance | ||
|---|---|---|---|---|
| Units | 40,000 | 40,000 | ||
| Revenue | 236,000 | 240,000 | -4,000 | U |
| Variable Costs: | ||||
| Material | 76,000 | 80,000 | -4,000 | F |
| Labor | 63,200 | 60,000 | 3,200 | U |
| Factory Overhead | 34,000 | 32,000 | 2,000 | U |
| Contribution Margin | 62,800 | 68,000 | -5,200 | U |
| Fixed Cots: | ||||
| Factory Overhead | 12,880 | 12,000 | 880 | U |
| Office Expenses | 22,000 | 20,000 | 2,000 | U |
| Operating Income | 27,920 | 36,000 | -8,080 | U |
For income items (revenue, contribution margin and operating income in this example), the flexible budget variance is favorable when actual numbers exceed flexible budget numbers and vice versa. For cost items, excess of flexible budget numbers over actual number means favorable variance and vice versa.
by Irfanullah Jan, ACCA and last modified on