Question

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.

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

Understanding Difference between Static Budget & Flexible Budget- 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 2500 units over a six-month period would use 2500 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 2500 units, but only 1500 units were made, the flexible budget takes only 1500 units into account. The flexible budget shows the budgeted items from the static budget — such as cost and expected sales — and the actual results.

Advantages of using Flexible Budget Vs a Static Budget

Fixed budget is a budget that is not flexed with the changed production/sales volume or other significant variable.

Fixed budget is useful mainly when:

• the budget serves as a target
• there are not substantial changes in production/sales volume over time
• costs are largely fixed

Flexible budget is a budget that changes with the changed production/sales volume or other significant variable.

Flexible budget is useful mainly when

• the budget does not serve as a target
• there are substantial changes in production or sales volume
• costs are largely variable

In practice, flexible budgets are used less than fixed budgets mainly because:

• they are available with significant time delay as actual volumes must be known
• budgets usually serve as fixed targets
• the proportion of fixed costs on total costs is still increasing
• it may be difficult to split semi-variable costs into variable and fixed components or the result of doing so would be misleading.