In: Accounting
You are a newly licensed CPA working for Hurricane Glass, a glass manufacturing company. Your manager is considering implementing flexible budgeting.
Prepare a memo to your manager describing flexible budgeting and its advantages and disadvantages.
I understand that for the first time, our company is considering
the implementation of flexible budgeting for the upcoming fiscal
year. I think this will serve us very well going forward, as it
represents an improved approach to understanding the variances that
naturally result when actual performance differs from our budgeted
projections.
The key attribute of the flexible budget is that by using actual
volume totals, the flexible budget provides an expected cost
structure and bottom-line result based on an adjusted volume figure
that differs from the original master budget. Put another way, if
everything was exactly in line with what we budgeted except for
volume, how would that have changed our overall costs and bottom
line? From here, we compare the "flexible budget" output to actual
results for both revenues and costs in order to determine the
impact of variances outside of pure volume differences. As with the
implementation of any new methodology, it is important to
understand the advantages and disadvantages of moving
forward.
There are advantages to using flexible budgeting. Flexible
budgeting allows us to look at different volume levels in order to
determine where we may have achieved cost efficiencies and
inefficiencies. We can also use flexible budgeting to forecast
bottom-line profits or losses based solely on selling more or fewer
units than the master budget predicts. However, volume alone is not
enough to explain variances between budgets and actuals. Flexible
budgeting facilitates variance analysis by isolating per-unit
revenue, per-unit variable costs, and overall fixed costs from
volume for comparisons between actuals and budgets.
Flexible budgeting does have disadvantages. Per-unit revenues,
per-unit variable costs, and fixed costs are required to utilize
flexible budgeting and, as such, the accuracy of these numbers from
a budgeting standpoint is critical. Also assessing the relevant
range is extremely important because within this range, cost
behaviors are expected to hold true; outside of this range,
standards per unit and fixed costs may vary dramatically.
I am excited that we are considering this path as a potential
budgeting methodology in the future. If you have any questions
regarding the information I have provided here, I am happy to meet
with you to further discuss this approach.