What are the Differences between “Fixed Budget” and “Flexible Budget”? – Explained!
It is a rigid budget and is drawn on the assumption that there will be no change in the budgeted level of activity. Fixed budget do not change when production level changes. Thus, it does not provide the changes in the expenditure arising out of change in anticipated conditions and activities.
However, in practice, fixed budget is rarely used. The main reason is that actual output is often significantly different from the budgeted output. In such a case the budget cannot be used for the purpose of cost control. The performance report may be misleading and will not contain very useful information.
A fixed budget can be usefully employed when budgeted output is close enough to the actual output. If output can be estimated within close limits, the fixed budget can be a good basis for performance measurement. Maximum managerial control may be exercised by making comparisons with actual operating figures (Fig. 26.3).
2. Variable or Flexible Budget:
Flexible budget is the opposite of fixed budget. According to ICWA. U.K., “a flexible budget is designed to change in accordance with the level of activity actually attained. It provides budgeted cost at different levels of activity, therefore, facilitates comparison of actual performance with budget at any volume of operation.
To prepare flexible budgets, all costs should be classified into fixed, variable and semi-variable costs. The degree of variability of variable and semi-variable costs should be determined.
Fixed costs, however, remain unchanged at any level of operation. Flexible budget is useful in business, where demand is unpredictable, or where production depends on nature or governed y some limiting factor (i.e. shortage of any factor of production).
1. It is flexible, i.e., easy to change with variation in production levels.
2. It facilitates performance measurement and evaluation.
3. It covers a range of activity (output).
Flexible budgeting procedure:
For preparation of flexible budget, the following steps are observed (Fig.26.4)
Conditions for flexible budgeting:
The flexible budget is suitable and used in the following cases:
(i) 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 a factor of production.
(ii) Where the level of activity during the year varies from period to period, either due to the seasonal nature of the industry or due to variation in demand.
(iii) Where there are general changes in sales.
(iv) Where the business is a new one and it is difficult to foresee the demand.
(v) Where an industry is influenced by changes in fashion.
Advantages of flexible budgeting:
According to Welsch, there are following benefits of flexible budget:
1. To provide expense goals for the managers of responsibility centres during the period covered by the profit plan.
2. To provide adjusted budget allowances for comparison purposes (against actual expenses) in the monthly performance reports.
3. To facilitate development of the departmental expense budgets for inclusion in the profit plans.