Question

What is the main difference between fixed and flexible budget? Why fixed budgets are preferred in

government departments? Discuss the benefits of both types of budgets.

Answer 1

Difference between fixed and flexible budget:

1) Meaning: A flexible budget refers to a budget that allows adjusting based on a change in the assumptions used to create the budget during management's process of planning. A fixed budget is a budget that remains the same even if there are significant changes from the assumptions made during planning.

2) Nature: Flexible budget is very dynamic and on contrary the fixed budget is always static.

3) Comparison: Under flexible budget comparison is easy because of the similarity in the activity levels and on contrary under fixed budget comparison is hard because the activity levels are different at actual level and budgeted level.

4) Estimation: Flexible budget is prepared with situations that are realistic and practical. Conversely the fixed budget is mostly estimated on anticipations and assumptions.

5) Rigidity: It is easy to modify the flexible budget in accordance with the activity level attained; but the fixed budget cannot be modified according to the actual volume.

In majority cases, for a governmental department, the budget represents the legal authority to spend money. Flexible budget in the public sector implies that a set of decisions has been made by the governing administrators and board that culminates in matching a government's resources with the entity's requirements. It is preferred because it makes them easier to handle the stressful and emergency situations

Benefits of flexible budget:

-- Helps management to know if there are any major differences among the estimated budgeted numbers and the actual ending numbers.

--Allows management to analyze the business areas that are meeting their budget targets and the areas or departments that require improvement

--It scale the initial budget to provide a meaningful comparison; thus informs whether the business is under or over-budget; and determine what caused business to fall or exceed below the expected gross profit.

-- Reducing the fluctuations in production reports

--Comparison of actual and budgeted results at various level of activity

-- Making the annual budget process more effective

--Flexible budgets provide better cost controls because it react more rapidly to adverse conditions.

-- These are constantly updated with current data thus managers are regularly updating their projections and cost controls with current information.

Benefits of fixed budget:

1) A fixed budget permits a business to measure both short-term as well as long-term budgets.

2) Since the budget is static thus makes it much more solid and the careful planning will make it simple to deal with stressful and emergency situations.

3) A fixed budget helps business to takes into account all of the expenses and thus plan according to their goals and needs

4) Fixed budget is easier to handle