Question

Explain and demonstrate the difference between a static and flexible budget

Answer 1

KEY DIFFERENCES STATIC BUDGET AND FLEXIBLE BUDGET:

1. A static budget does not change with the actual volume of the output achieved. A Flexible budget is designed to change appropriately with the level of activity attained.

2. A static budget cannot ascertain costs correctly in case of any change in circumstances. Flexible budget can easily ascertain costs in different levels of activities.

3. A static budget is prepared under the assumption that all the conditions will remain unchanged. While Flexible budget is prepared at different levels of activities considering the possible changes in the operational aspect of a business.

4. A static budget has a limited application and is ineffective as a tool for cost control. A flexible budget has a wide application as an effective tool for cost control.

5. Static budget is prepared without classifying the costs according to their variable nature. Flexible budget is prepared by classifying the costs according to their variable nature.

For example, if a company produces 900 units of X material against the Static budget of 1000 units, all the variances related to variable cost will not be meaningful as the production levels (900 against 100) being compared are not equal and hence will not show the true picture.

In the same case, a flexible budget will be brought down to 900 units and then the variances between the flexible budget and actual results will show the correct picture of variation in cost and the comparison will be meaningful.

However, in both the cases fixed costs will remain the same as Fixed cost do not change with the change in the level of production.