Question

A flexible budget seeks to overcome the problem of differing levels of activity between budget and actual output volumes. A new ‘flexed’ budget is prepared at the actual output level to be used for variance analysis purposes. A simple example could be the budget given to you to grade test papers of 30 minutes per paper for 10 students = 300 minutes. If only 8 students sit the test your budget will be flexed to 240 minutes (8 x 30).)

Required:

In your own words, explain the meaning of ‘flexing the budget’ and why it is necessary.

Answer 1

A Master budget is a planning budget prepared at the beginning of the year for a fixed level of output or activity level. It is a static and rigid budget. But actual level of activity during the year can vary depending on different conditions. A Static budget does not help in meaningful comparison of actual results since the level of activity is different. Hence the Master budget should be flexed to ensure the comparison is like to like and get meaningful results. The variable costs are flexed to actual level of activity and fixed overheads are considered same as master budget. Hence flexible budget is more useful due to following reasons:

· It helps in estimating cost at various level of activities

· It helps in preparing profitablity statement at different levels of activities

· It helps in cost volume profitablity analysis and break even analysis

· It is helpful for performance evaluation of employees and departments,

· It is helpful for new product launches and product pricing

· It is helpful for decisions making like continue or discontinue products and services, make vs. buy, acceptance of special order, etc