A flexible budget is a budget which is designed to change in accordance with the LEVEL OF ACTIVITY attained. [ see illustration how to compute the flexible budget]
It is also known as Variable budget as the budget recognizes the difference in cost behavior namely fixed and variable costs in relations to fluctuations in output or turnover. The budget is designed to change appropriately with such fluctuation.
For a fixed budget, the budget remains unchanged irrespective of the level of activity actually attained.
The fixed budget is prepared based only on one level of output.
Therefore, if the level of output actually achieved differs considerably from that budgeted, large variances will arise.
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For some companies, due to the nature of business does not suit fixed budget preparation:
- Affected by weather condition like the soft drink industry;
- Companies frequently introduce new product line like the food canning industry;
- Production is carried out only when orders are received from customers like shipbuilding,aircraft industries;
- Affected by changes in fashion like millinery trade;
- Export orientated business
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So, what are the difference between Fixed and Flexible Budget? They are:
- For a fixed budget, the figures are for a SINGLE level of activity while a flexible budget is prepared for DIFFERENT levels of activity;
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- Under fixed budgets, managers are held responsible for variances not under his control ( both fixed and variable cost);
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- The fixed budget is never able to assess properly the efficiency and actual performance of the manager.
For example, a fixed budget is set with a planned 8,000 hours but an actual 10,000 hours are recorded, from both the motivational or control point, it is difficult to gauge the efficiency of the manager(s) who are involved in the manufacture of the output at that actual level;
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- The flexible budget allows more meaningful comparison as it flexs to the actual volume. It computes what costs should have been for the actual level of activity and
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- The flexible budget has the advantage of assisting the managers deal with uncertainty by allowing them to see the expected outcomes for a range of activity;
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The steps involve in the preparation of the flexible budget as follows:
- Select the measure of activity like the units of production;
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- Define the relevant range of activity for the budgeted performance based on the step 1;
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- Identify the cost items to be included in the budget;
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- Determine the cost behavior of each item over the relevant range;
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- Separate the cost items into variable, fixed and mixed;
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- Select the specific levels of activity to be budgeted;
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- Use the cost behavior under item 4 to estimate the budgeted amounts for each cost item at the different levels selected in step 6.
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