7.4 Prepare Flexible Budgets
3 min read•june 18, 2024
Flexible budgets adjust for actual activity levels, providing a more accurate basis for performance evaluation. They help managers distinguish between volume-related variances and other factors affecting performance, making them crucial for effective cost control and decision-making.
Understanding is key to creating flexible budgets. By identifying fixed and variable costs, managers can adjust budgets for different production levels, enabling more precise comparisons between actual results and expectations.
Flexible Budgets
Flexible budgets for sales volumes
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- Flexible budgets adjust budgeted amounts based on actual activity levels enables more accurate performance evaluation by considering changes in volume (sales or production)
- Steps to create a :
- Determine the budgeted variable cost per unit and total fixed costs
- Multiply the actual sales or production volume by the budgeted variable cost per unit to calculate total variable costs
- Add the total budgeted fixed costs to the total variable costs calculated in step 2
- Comparing actual results to the helps identify variances due to factors other than changes in volume provides insight into the efficiency and effectiveness of operations (cost control, pricing strategies)
- Budget performance reports compare actual results to flexible budget figures, highlighting variances for management review
Static vs flexible budgets
- Static budgets prepared for a single level of activity do not adjust for changes in actual sales or production volume useful for planning and setting initial expectations (revenue targets, cost limits) limited usefulness in performance evaluation when actual volume differs from budgeted volume
- Flexible budgets adjust budgeted amounts based on actual activity levels provide a more relevant comparison to actual results help distinguish between volume variances and other factors affecting performance (material prices, labor rates) more useful for performance evaluation when actual volume differs from budgeted volume
- Flexible budgets are an essential tool in , allowing managers to be evaluated based on factors within their control
Budget adjustments for production levels
- Identifying fixed and variable costs:
- Fixed costs remain constant within a , regardless of changes in activity level (rent, depreciation, salaries)
- Variable costs change in direct proportion to changes in activity level (direct materials, direct labor, variable overhead)
- Adjusting budgets for different production levels involves multiplying the budgeted variable cost per unit by the actual production volume while fixed costs remain the same
- Calculating the total flexible budget:
- Sum of the adjusted variable costs and the fixed costs
- Example: If budgeted variable cost per unit is 5,000, then: 10 \times 1,000,units) + 15,000$
Understanding Cost Behavior and Budgeting
- Cost behavior refers to how costs change in response to changes in activity levels
- The is the range of activity within which cost behavior patterns are expected to hold true
- is a comprehensive financial plan that includes various sub-budgets (e.g., sales budget, production budget, )
- is the difference between actual results and budgeted amounts, which can be analyzed to improve future performance
Key Terms to Review (24)
Activity-Based Budgeting: Activity-based budgeting is a budgeting approach that focuses on the activities and processes required to produce products or provide services, rather than just the traditional line-item budgeting method. It aims to allocate resources more accurately by understanding the cost drivers behind different organizational activities.
Budget Performance Report: A budget performance report is a financial document that compares a company's actual financial results to its budgeted or planned financial results. It is used to evaluate how well a business is performing against its predetermined goals and objectives, and to identify any variances or discrepancies that may require further investigation or corrective action.
Budget Variance: Budget variance is the difference between the budgeted amount and the actual amount for a particular expense or revenue item. It is a key metric used to analyze and evaluate the performance of a business or organization against its planned financial targets.
Cost Behavior: Cost behavior refers to the relationship between a company's costs and its level of business activity or output. It describes how different types of costs, such as variable costs and fixed costs, respond to changes in the volume of production or sales.
Cost behaviors: Cost behaviors describe how costs change in relation to changes in a company's level of activity. These behaviors are essential for budgeting, forecasting, and decision-making processes.
Cost-Volume-Profit Analysis: Cost-Volume-Profit (CVP) analysis is a managerial accounting technique that examines the relationship between a company's costs, volume of output, and profitability. It provides insights into how changes in these factors can impact a business's overall financial performance, helping managers make informed decisions.
Flexibility: Flexibility refers to the ability of a budget or financial plan to adapt to changing circumstances and accommodate fluctuations in revenue, expenses, and other factors. It is a crucial characteristic of budgeting that allows organizations to respond effectively to dynamic business environments and unexpected events.
Flexible budget: A flexible budget adjusts for changes in the level of activity, such as sales volume or production levels. It provides a more accurate comparison of actual results to budgeted amounts by accommodating fluctuations in operational conditions.
Flexible Budget: A flexible budget is a type of budget that adjusts to changes in activity or volume levels, allowing for more accurate planning and control of costs. It is a crucial tool for managing and evaluating a company's performance, particularly in the context of operating budgets, flexible budgets, and overhead variance analysis.
Master budget: The master budget is a comprehensive financial planning document that consolidates all of an organization’s individual budgets. It includes projections for sales, production, direct materials, labor, overhead, and administrative expenses to provide a complete picture of financial performance.
Master Budget: The master budget is a comprehensive financial plan that integrates all of an organization's individual budgets into a cohesive whole. It serves as the primary tool for planning, coordinating, and controlling a company's operations and finances for a specified time period, typically a fiscal year.
Operating budget: An operating budget is a detailed projection of all expected income and expenses during a specific period, usually one fiscal year. It serves as a financial plan that guides an organization in achieving its operational goals.
Operating Budget: An operating budget is a comprehensive plan that outlines an organization's expected revenues and expenses for a specific time period, typically a year. It is a critical tool used by managers to forecast, control, and monitor the financial performance of a business or department within the organization.
Relevant range: The relevant range is the span of activity levels within which specific cost behaviors are valid. Outside this range, fixed and variable cost estimates may not hold true.
Relevant Range: The relevant range is a concept in managerial accounting that refers to the range of activity levels over which certain assumptions about cost behavior can be considered valid. It is a critical factor in understanding and predicting cost behavior patterns, estimating variable and fixed cost equations, comparing costing methods, and preparing flexible budgets.
Responsibility accounting: Responsibility accounting is a system of accounting that segregates revenue and costs into areas of personal responsibility to assess performance. It allows for accountability by holding managers responsible for the financial results of their specific segments or units.
Responsibility Accounting: Responsibility accounting is a management accounting system that assigns revenue and cost items to the individuals or departments responsible for their incurrence. It is a crucial component of managerial accounting, as it enables organizations to track and evaluate the performance of various responsibility centers within the company.
Static budget: A static budget is a financial plan that remains unchanged irrespective of variations in actual output or sales levels. It is typically established before the start of a period and does not adjust for actual activity levels encountered during that period.
Static Budget: A static budget is a type of budget that is prepared based on a single, predetermined level of activity or volume. It does not change in response to actual activity levels, unlike a flexible budget which adjusts to fluctuations in activity.
Variability: Variability refers to the degree of change or fluctuation in a particular measure or characteristic. It is a fundamental concept in various fields, including managerial accounting, that describes the ability of a variable to deviate from a standard or expected value. Understanding variability is crucial in analyzing business situations and preparing flexible budgets.
Variance analysis: Variance analysis is the process of comparing budgeted financial performance to actual financial performance to identify discrepancies. It helps managers understand why variances occur and how to address them for better future planning.
Variance Analysis: Variance analysis is a management accounting technique used to identify and evaluate the differences between actual and expected or budgeted performance. It provides insights into the causes of these variances, enabling managers to make informed decisions and take corrective actions to improve operational efficiency and financial performance.
Zero-based budgeting: Zero-based budgeting is a method where each new budget period starts from a 'zero base,' and every expense must be justified. Unlike traditional budgeting, past budgets are not considered, making this approach more flexible and accurate in allocation.
Zero-Based Budgeting: Zero-based budgeting is a budgeting method where all expenses must be justified for each new budget period. Instead of using the previous year's budget as a starting point, zero-based budgeting requires managers to build a budget from scratch, evaluating each cost and determining whether it is necessary for the upcoming period.