Question

Question 3. In 2018 Steve Company used static budgeting. They switched in 2019 to a different budgeting process and they were able to identify unnecessary spend in their advertising budget. Even though there was no variance identified in the advertising budget when they used the static budgeting process. What type of budgeting process did Steve Company switch to?

Answer 1

The type of budgeting process Steve Company switched to is Flexible budgeting process.

In static budgeting budget amounts are fixed and remain same as prepared and approved.

In flexible budgeting process, budget is prepared at different sales volumes. In flexible budgeting process budget amounts flex/change with changes in volume or activity. Flexible budget is more sophisticated and informative for analysis and decision making and hence is more useful.

Every expense item may have fixed portion and a variable portion. The variable portion of expense item changes with volume.

Hence when flexible budgeting process is adopted, the variable part of budgeted expense will change based on volume of activity. Variance analysis of flexible budget is much more relevant and useful in decision making and taking corrective steps.

In case of Steve Company, when they used static budgeting process there was no variance identified in advertising budget whereas when they switched to flexible budgeting process they could identify unnecessary spends in their advertising budget.

The advertisement budget must have had variable part. When they used static budgeting which was prepared for a higher level of activity, if the actual spend is same as budgeted (in case of static budgeting) no variance is identified even if actual sales volume is lesser than budgeted. But when flexible budgeting is used, the variable portion of advertisement budget will be lesser when actual sales volume is lesser. Flexible budget changes with change in volume. In such a scenario flexible budgeting process can identify unnecessary spends and this helps in taking corrective steps.