FLEXIBLE BUDGETS

A static budget or master budget shows the

expected results for only one activity level.

Once the budget has been determined, it is not
changed, even if the activity changes.
One disadvantage of the static budget is that it
does not adjust for changes in activity levels.
However, they are commonly used by many
service companies as well as some
administrative functions of manufacturing
companies.

 A flexible budget or a variable budget is a

budget that adjusts for changes in sales volume
and other cost driver activities.
It provides estimates of what costs should be for
any level of activity within a specified range and
the changes in costs that should occur as a
consequence of changes in activity.
A flexible budget can be used in performance
evaluation where a department manager can be
evaluated by comparing actual expenses (costs)
to the budgeted amount for actual activity rather
than the budgeted costs from the original budget.

Purpose of flexible budgets

1. The primary purpose of a flexible budget
is to help managers evaluate past
performance. It is especially useful for
evaluations because it reflects the
different levels of activities in different
amounts of revenues and costs.

2. A flexible budget is also used to evaluate

the adequacy of the companys cash
position by assuming different levels of
activity.
Similarly, the number of employees, the
amounts of materials, and the necessary
equipment and storage facilities can be
evaluated for a variety of different
potential activity levels.

Preparing a flexible budget

Steps involved:
Determine the budgeted selling price per
unit, the budgeted variable costs per unit
and the budgeted fixed costs.
Determine the Actual Quantity of the
Revenue Driver

Contd.
Determine the flexible budget for revenue
based on the budgeted unit revenue and
the actual quantity of the revenue driver
Determine the actual quantity of the cost
driver
Determine the flexible budget for costs
based on the budgeted unit variable costs
and fixed costs and the actual quantity of
the cost driver.

Using Flexible Budgeting concept in

Performance Evaluation
Variance analysis
The difference between the standard and
the actual costs are called variances.
A variance is favorable if actual cost is
less than the standard cost (at actual
volumes) shown by F
It is unfavorable if actual cost is more than
standard cost (at actual volumes). U

What do variances reveal?

Variances are usually identified in
performance reports. Two attributes of
performance are commonly measured:
Effectiveness this is the degree to
which predetermined objective/goal/target
is met.
Efficiency the relative amount of inputs
used to achieve a given level of output.

 The variances between the flexible budget

and actual results are called flexible
budget variances.
In contrast, any differences between the
master (static) budget and the flexible
budget are called activity-level variances
because they are due to activity levels.

Flexible-budget variances measure the

efficiency of operations at the actual level
of activity and can be subdivided into price
and usage variances.
Price variance is the difference between
actual price and the standard price.
Usage or quantity or efficiency variance
is the difference between actual quantity of
input used (such as direct materials) and
the standard quantity of input that should
have been used multiplied by the standard
price.

 Price variance = {Actual price Standard

price} x Actual quantity
Quantity variance = {Actual quantity
Standard quantity} x Standard price

Direct Labor variances

Direct labor rate variance - This is the

difference between the actual rate per
hour and the standard rate per hour
multiplied by the actual hours worked.
Direct labor efficiency variance - This
is difference between the actual hours
worked and the standard hours at actual
production, multiplied by the standard
rate per hour.

The overhead cost variances

Overhead cost variance = Actual overhead
incurred - Standard overhead applied.
A spending variance occurs when the
amount paid for an incurred overhead is
different from the standard price. For
instance, the actual wage rate paid for
indirect labor might be higher than the
standard rate

 An efficiency variance occurs when the

standard direct labor hours (the allocation
base) expected for actual production are
different from the actual direct labor hours
used. This efficiency variance is unrelated
to whether variable overhead is used
efficiently. Instead it results from whether
or not the overhead allocation base is
used efficiently.

 A Volume variance occurs when there is

a difference between the actual volume of
production and the standard volume of
production. The volume variance
measures the use of fixed overhead
resources. The budgeted fixed overhead
amount remains the same regardless of
actual volume of production (within the
relevant range).

HUMAN BEHAVIOR AND BUDGETING

In the budgeting process, the company
goals, departmental goals and individual
goals are established. As a result,
human behavior problems can arise for
various reasons such as:
1. If budget is too tight and unachievable.
2. If it is too easy to achieve (loose budget).
3. If there is a conflict between the goals of
the company and those of employees.