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flexible Budget with only .md file format

Flexible Budget

What is a Flexible Budget?

A flexible budget is a plan that changes based on how much a business actually produces or sells. It adjusts according to real activity levels, unlike a fixed budget, which stays the same no matter what.

For example, if a factory makes more products, costs like materials will increase. If it makes fewer products, those costs will decrease. A flexible budget helps businesses plan for these changes and track their money better.

Why is a Flexible Budget Useful?

  1. Adjusts to Real Activity: It changes when production or sales increase or decrease.
  2. Improves Cost Tracking: Businesses can see where they are spending too much or saving money.
  3. Helps Decision-Making: Managers can make better choices based on actual conditions.
  4. Works for Changing Costs: Especially helpful for costs that change with activity, like raw materials or commissions.

How Does a Flexible Budget Work?

In management accounting, the flexible budget separates costs into two categories:

  1. Fixed Costs: Costs that remain constant, no matter the activity level (e.g., rent, salaries).
  2. Variable Costs: Costs that change directly with the level of activity (e.g., materials, commissions).

A flexible budget recalculates the total budget based on actual activity levels, leaving fixed costs unchanged and adjusting variable costs accordingly.

Frame work to be followed:

Step 1: Understand the Purpose: A flexible budget adjusts based on actual levels of activity, like production or sales, to provide a more accurate financial plan.

Step 2: Break Down the Flexible Budget into Key Components

  1. Fixed Costs: Costs that stay the same regardless of activity (e.g., rent, salaries).
  2. Variable Costs: Costs that change with activity (e.g., raw materials, commissions).
  3. Total Costs: Formula: Total Costs = Fixed Costs + (Variable Cost Per Unit × Actual Units).

Step 3: Steps to Prepare a Flexible Budget

  1. Identify Fixed Costs: List expenses that remain constant, like rent and insurance.
  2. Determine Variable Costs: Calculate the cost per unit for variable expenses, like raw materials.
  3. Set Activity Levels: Define possible production or sales levels (e.g., 80%, 100%, 120%).
  4. Calculate Costs for Each Level: Use the formula: Total Costs = Fixed Costs + Variable Costs.

Summary

  • A flexible budget adjusts to changes in sales or production levels.
  • Fixed costs stay the same, but variable costs increase or decrease based on activity.
  • It's useful for businesses with fluctuating activities, helping them plan and control costs.
  • While it's more accurate, it requires time and good data to create and maintain.

Let us solve a question for better understanding

Draw up a flexible budget for production at 75% and 100% capacity on the basis of the following data for a 50% activity.

  • Materials - 100 Rs per unit
  • Labour - 60 Rs per unit
  • Direct Expense - 20 Rs per unit
  • Administrative expense (50% fixed) - 80000 Rs
  • Selling and distribution expense (60% fixed) - 100000 Rs
  • Fixed Expenses
    • Depreciation - 10000 Rs
    • Insurance - 5000 Rs

Present production (50% activity) – 1000 units

Basic Rule which will be followed:

  • Rule 1 → Fixed Cost
    • Total column Remain Constant
    • Only per unit column vary
  • Rule 2 → Variable Cost
    • Per unit column Remain Constant
    • Total column Vary

Flexible Budget

Date: ...

Particulars Capacity Level
50% (1000 units) 75% (1500 units) 100% (2000 units)
Per Unit Total Per Unit
Variable Cost
Material 100 1,00,000 100
Labour 60 60,000 60
Direct Expense 20 20,000 20
Total Variable Cost (a) 180 1,80,000 180
Semi-Variable Cost
Admin Expense (50% Fixed) 40 40,000 26.67
(50% Variable) 40 40,000 40
Selling & Dist Expense
(60% Fixed) 60 60,000 40
(40% Variable) 40 40,000 40
Semi-Variable Cost (b) 1,80,000 146.67
Fixed Cost
Depreciation 10 10,000 6.67
Insurance 5 5,000 3.33
Total Fixed Cost (c) 15 15,000 10
Total cost (a+b+c) 375 3,75,000 336.67

References

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