Trending September 2023 # Objectives And Importanceof Flexible Budget # Suggested October 2023 # Top 17 Popular | Chivangcangda.com

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Definition of Flexible Budget

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Explanation

Two types of budgets exist, fixed budgets and flexible budgets. They are prepared to represent budgeted costs and revenues based on a specific activity level, such as the number of units produced, percentage of capacity utilized, or number of person-hours devoted. The flexible budget adjusts accordingly based on the actual activity level. Thus, the cost manager can use a flexible budget as a reference tool for measuring the variance with the actual performance and result.

Objectives of Flexible Budget

It is made to reference the actual results for calculating variances between the actual and budgeted results. Since it can be adjusted as per the actual activity level, it is easy for a cost manager to identify the budget applicable to the actual activity level at the time of variance analysis. This helps in a transparent and accurate calculation of variances.

How to Create A Flexible Budget?

Determine the fixed costs expected to be incurred during the period under consideration.

Identify the variable costs to be incurred and determine the price on a per-unit basis or as a percentage of activity level.

Plot the variable and fixed costs for the budgeted activity level, and this will create a flexible budget.

After the end of the accounting period, when the actual activity level is known, it is adjusted in line with the actual activity level to reflect the budgeted cost for the said activity level. Variances can be calculated based on the revised budget and the actual performance.

Example of a Flexible Budget

Let us consider the following information regarding the costs expected to be incurred by a company in the upcoming accounting period. The company wants to prepare based on a scheduled activity level of 70% of the production capacity. The number of units that can be designed at this production capacity is 7000.

Particulars

Variable costs $7,000

Fixed costs $10,000

Prepare a flexible budget for capacity levels of 80% and 90%.

Solution:

Particulars

70% 80%

Number of units 7000 8000 9000

Variable cost $7,000 $8,000 $9,000

Fixed cost $10,000 $10,000 $10,000

Total manufacturing costs $17,000 $18,000 $19,000

Here, the variable cost per unit is $1 per unit ($7,000 ÷7,000 units).

Types of Flexible Budget

Basic: In this budget, those expenses that vary with revenue are expressed as a percentage of sales or cost per unit and adjusted as the output level changes.

Intermediate: Some costs do not vary with revenue. Instead, they vary based on other measures, such as electricity expenses based on consumed units. A flexible intermediate budget takes into account changes in costs based on such other activity measures as well.

Importance

It is an essential tool for management. It helps set the expected costs, revenues, and profitability of the business. Further, since the flexible budget is not rigid, it can be adjusted according to the actual activity level at the end of the accounting period and used for variance analysis. The management can determine the performance of various departments based on variances determined. It helps in fixing accountability towards the company.

Advantages

It can determine budgeted sales, costs, and profits at different activity levels.

It helps the management decide the output level to generate profits for the business based on budgeted costs at different activity levels and budgeted sales.

It helps in variance analysis after comparison with the actual results and measures the performance of various departments.

It isn’t easy to prepare and requires experts for its preparation. It is for this reason that many companies need to prepare this budget.

Some costs are not fully variable and also consist of a fixed portion. It requires careful analysis of prices, and incorrect classification of costs can provide inaccurate results.

Many companies like service industries, where variable costs don’t have a major role, and companies do not require a flexible budget.

The factors of production are prone to certain limitations and are not in human control. Making a prediction based on these resources can be difficult.

Conclusion

It is helpful for manufacturing industries where costs change with a change in activity level. Companies must involve experts to make accurate budgets, ensuring there is less scope for error and improving variance analysis.

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