Question

The company has been preparing a static budget for the last few months. Your manager doesn't understand why the static budget is so dramatically different than actual results. After you examine the results, you see that the budgeted units manufactured is different that the actual production. Explain to your manager how a flexible budget could be used.

Answer 1

A static budget keeps same irrespective of the no. of units actually produced in the month therefore these show unrealistic variances. As there could be possibility that the static budget was made for 8,000 units whereas actually 6,000 or 10,000 units were produced in a month. Whereas flexible budget is adjusted for the changes in the volume of activities. Here is a small example to understand this:

	Static budget (8,000 units)	Actual (10,000 units)	Variance (Static to Actual)	Flexible budget (10,000 units)	Variance (Flexible to Actual)
Sales ($75 per unit)	$6,00,000	$8,00,000	$2,00,000	$7,50,000	$50,000
Less: variable cost ($50 per unit)	4,00,000	5,60,000	(160,000)	5,50,000	(10,000)
Less: Fixed cost	50,000	63,000	(13,000)	50,000	(13,000)
Net Profit	$1,50,000	$1,77,000	$27,000	$1,50,000	$27,000

In the above table if we look at the variance of sales and variable cost these are very high in case of static budget whereas in flexible budget it is showing the correct picture of variances that might took have place due to increase in variable cost and sales price this gives us the right direction to investigate the variance. Static budget variance always includes one major reason of variance which is change in volume of product produced.

Flexible budgets are required to be prepared every month according to the actual activity or sales of the Company and then it should be compared to the actual results.