BUDGETARY CONTROL NOTES
QUESTION: Explain the difference between Fixed and Flexible Budgets. Explain in detail with reasons the circumstances in which flexible budgets are useful?
The fixed budget is a budget for a given level of activity or capacity. It does not provide for any change in expenditure arising out of changes in the level of activity or capacity. When the actual level of activity differs from the budgeted level of activity, the use of fixed budget as a basis of performance evaluation does not give correct picture. This budget can be used only when budgeted and actual activity levels are the same.
A flexible budget is a budget that adjusts or flexes with changes in volume or activity. The flexible budgets are more sophisticated and useful than a static budgets.
For costs that vary with volume or activity, the flexible budgets will flex because the budgets will include a variable rate per unit of activity instead of one fixed total amount. In short, the flexible budgets is a more useful tool when measuring a manager’s efficiency.
DIFFERENCE BETWEEN FIXED AND FLEXIBLE BUDGET
|BASIS OF DIFFERENCE||FLEXIBLE BUDGET||FIXED BUDGET|
|Meaning||The budget designed to change with the change in the activity levels is Flexible Budgets.||The budget designed to remain constant, regardless of the activity level reached is Fixed Budgets.|
|Flexibility||Due to its nature of flexibility, it may be quickly re-organized according to the level of production.||After the commencement of a period, fixed budgets cannot change according to actual production.|
|Condition||Flexible budgets may change according to change in conditions.||Fixed budgets are based on the assumption that conditions will remain unchanged.|
|Cost classification||Classification of costs is done according to the nature of their variability.||It is suitable for fixed costs only; no classification is done in case of fixed budgets.|
|Comparison||Comparisons of actual figures with revised standard figures are done according to change in the production level of a concern.||If there is change in production level, then it is not possible to do a correct comparison.|
|Ascertainment of cost||It is easy to ascertain costs even at different levels of activity.||If there is change in the production level or circumstances, it is not possible to ascertain costs correctly.|
|Cost control||It is used as an effective tool to control costs.||Due to its limitations, it is not used as cost control tool.|
|Nature||This is dynamic||This is static.|
|Simplicity and ease of preparation||Flexible budget is quite complex and not easy to prepare.||Fixed budgets are quite simple and easy to prepare.|
|Estimates||Its preparation is realistic and practical.||Its preparation is based on assumptions.|
|Level of activity||Under it, series of budgets are prepared for different levels of activity.||Only one budget at a fixed or one level of activity is prepared due to an unrealistic expectation on the part of the management i.e. all conditions will remain unaltered.|
|Fixation of prices & submission of tenders||It helps in fixation of price and submission of tenders due to correct ascertainment of costs.||If the budgeted and actual activity level varies, the correct ascertainment of costs and fixation of prices become difficult.|
CIRCUMSTANCES IN WHICH FLEXIBLE BUDGETS ARE USEFUL:
Flexible budgets are useful in the following cases:
Where the level of activity during the year varies form period to period, either due to seasonal nature of industry or due to variation in the demand.
Where the business is a new one and it is difficult to foresee the demand.
Where the undertaking is suffering from shortage of a factor of production such as materials, labour, plant capacity etc. The level of activity depends upon the availability of such factor of production.
Where an industry is influenced by the changes in fashion and changes in trends.
Where there are general changes in sales.
Where the business units keep on introducing new products or make changes in the design of its products frequently.
Where the industries are engaged in make to order business like ship building.
Where in comparison, it is extremely difficult to forecast output and sales with accuracy.
So, flexible budget is a budget which is designed to change in accordance with the level of activity actually attained. The figures used in this type of budget requires the classification of all the costs or expenses into fixed, variable and semi-variable. Fixed cost remains fixed or constant at all levels of activity, semi-variable costs vary with different levels of activity while variable costs vary directly in proportion with the changes in the volumes or output levels. So preparation of flexible budgets is highly useful than preparation of fixed budgets.