Question

1) Describe an example of how an unfavorable variance between actual and budget amounts in a fixed static (master) budget can become a favorable variance in a flexible budget report.

2) Also, since flexible budget is more accurate in measuring performance, can company just develop flexible budget without the static budget? Why or why not?

Answer 1

1) Describe an example of how an unfavorable variance between actual and budget amounts in a fixed static (master) budget can become a favorable variance in a flexible budget report.:

Unlike a static budget, a flexible budget changes or fluctuates with changes in sales, production volumes, or business activity. A flexible budget might be used, for example, if additional raw materials are needed as production volumes increase due to seasonality in sales. Also, temporary staff or additional employees needed for overtime during busy times are best budgeted using a flexible budget versus a static one.

For example, let's say a company had a static budget for sales commissions whereby the company's management allocated $50,000 to pay the sales staff a commission. Regardless of the total sales volume–whether it was $100,000 or $1,000,000–the commissions per employee would be divided by the $50,000 static-budget amount. However, a flexible budget allows managers to assign a percentage of sales in calculating the sales commissions. The management might assign a 7% commission for the total sales volume generated. Although with the flexible budget, costs would rise as sales commissions increased, so too would revenue from the additional sales generated.

Lets, assume in above that actual commission would be $60,000 paid by the company.

Now As per static budget it is a unfavourable variance by $10,000.

While at $1,000,000 sales 7% commission would be $70,000 and paid only $60,000 then it wiil be favourable variance in the flexible budget.

2) Also, since flexible budget is more accurate in measuring performance, can company just develop flexible budget without the static budget? Why or why not?

Company can not just develope flexible budget without developing first the static budget, because

A static budget is the budget with which the business starts off. For example, if the business period covers six months, the static budget is the budget created before the period starts to cover the six months of operation. A static budget is based on expected production figures; for example, a business that normally makes 1,000 units over a six-month period would use 1,000 units as the basis for the static budget calculation.

A flexible budget is prepared after the budget period ends. This type of budget shows the business what the static budget should have been by using actual output figures from the budget period. For example, if the static budget covered the production of 1,000 units, but only 600 units were made, the flexible budget takes only 600 units into account. The flexible budget shows the budgeted items from the static budget such as cost and expected sales and the actual results.

A flexible budget shows the budget figures for each line item from the static budget, the actual figures as shown on business statements, and the variances between the figures. Line items vary by business type but commonly include individual overhead costs, such as materials, and labor costs. A favorable variance works to the business's advantage by increasing overall income, while an unfavorable variance represents unexpected costs or cost increases that negatively affected profit levels. Unfavorable variances represent areas the business must work on to improve profits and reduce overhead.