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?
- Adjusts to Real Activity: It changes when production or sales increase or decrease.
- Improves Cost Tracking: Businesses can see where they are spending too much or saving money.
- Helps Decision-Making: Managers can make better choices based on actual conditions.
- 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:
- Fixed Costs: Costs that remain constant, no matter the activity level (e.g., rent, salaries).
- 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
- Fixed Costs: Costs that stay the same regardless of activity (e.g., rent, salaries).
- Variable Costs: Costs that change with activity (e.g., raw materials, commissions).
- Total Costs: Formula: Total Costs = Fixed Costs + (Variable Cost Per Unit × Actual Units).
Step 3: Steps to Prepare a Flexible Budget
- Identify Fixed Costs: List expenses that remain constant, like rent and insurance.
- Determine Variable Costs: Calculate the cost per unit for variable expenses, like raw materials.
- Set Activity Levels: Define possible production or sales levels (e.g., 80%, 100%, 120%).
- 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 Analysis
This document presents a flexible budget analysis, showing how costs change at different production levels. The analysis is based on a scenario with three capacity levels: 50%, 75%, and 100%, corresponding to 1000, 1500, and 2000 units, respectively.
Capacity Levels
The analysis considers three capacity levels:
- 50% Capacity: Represents a production level of 1000 units.
- 75% Capacity: Represents a production level of 1500 units.
- 100% Capacity: Represents a production level of 2000 units.
Cost Categories
Costs are categorized into three main types:
- Variable Costs: Costs that change in direct proportion to the level of production.
- Semi-Variable Costs: Costs that have both a fixed and a variable component.
- Fixed Costs: Costs that remain constant regardless of the production level.
Detailed Cost Breakdown
Variable Costs
| Particular | Per Unit | 50% (1000 Units) | 75% (1500 Units) | 100% (2000 Units) |
|---|---|---|---|---|
| Material | 100 | 1,00,000 | 1,50,000 | 2,00,000 |
| Labour | 60 | 60,000 | 90,000 | 120,000 |
| Direct Expense | 20 | 20,000 | 30,000 | 40,000 |
| Total | 180 | 1,80,000 | 2,70,000 | 3,60,000 |
- Material: Cost is directly proportional to the number of units produced.
- Labour: Cost is directly proportional to the number of units produced.
- Direct Expense: Cost is directly proportional to the number of units produced.
Semi-Variable Costs
| Particular | Per Unit (50%) | 50% (1000 Units) | Per Unit (75%) | 75% (1500 Units) | Per Unit (100%) | 100% (2000 Units) |
|---|---|---|---|---|---|---|
| Admin Expense (50% Fixed) | 40 | 40,000 | 26.67 | 40,000 | 20 | 40,000 |
| (50% Variable) | 40 | 40,000 | 40 | 60,000 | 40 | 80,000 |
| Selling & Dist Expense | ||||||
| (60% Fixed) | 60 | 60,000 | 40 | 60,000 | 30 | 60,000 |
| (40% Variable) | 40 | 40,000 | 40 | 60,000 | 40 | 80,000 |
| Total | 1,80,000 | 146.67 | 2,20,000 | 130 | 2,60,000 |
- Admin Expense: 50% is fixed and 50% is variable which means the variable component changes with output levels while fixed part remains constant.
- Selling & Distribution Expense: 60% is fixed and 40% is variable which means the variable component changes with output levels while fixed part remains constant.
Fixed Costs
| Particular | Per Unit (50%) | 50% (1000 Units) | Per Unit (75%) | 75% (1500 Units) | Per Unit (100%) | 100% (2000 Units) |
|---|---|---|---|---|---|---|
| Depreciation | 10 | 10,000 | 6.67 | 10,000 | 5 | 10,000 |
| Insurance | 5 | 5,000 | 3.33 | 5,000 | 2.5 | 5,000 |
| Total | 15 | 15,000 | 10 | 15,000 | 7.5 | 15,000 |
- Depreciation: Remains constant regardless of production levels.
- Insurance: Remains constant regardless of production levels.
Total Costs
| Category | 50% (1000 Units) | 75% (1500 Units) | 100% (2000 Units) |
|---|---|---|---|
| Total Variable Cost | 1,80,000 | 2,70,000 | 3,60,000 |
| Total Semi-Variable Cost | 1,80,000 | 2,20,000 | 2,60,000 |
| Total Fixed Cost | 15,000 | 15,000 | 15,000 |
| Total Cost | 3,75,000 | 5,05,000 | 6,35,000 |
Key Observations
- Variable Costs: Increase proportionally with production levels.
- Semi-Variable Costs: Increase with production but not in direct proportion as they have a fixed component.
- Fixed Costs: Remain the same regardless of the production level.
- Total Costs: Increase with production, driven mainly by the increase in variable and semi variable costs.
Conclusion
This flexible budget provides a clear overview of how costs behave at different production levels. It is a useful tool for planning, controlling, and making informed decisions based on varying production scenarios. The analysis helps in understanding the cost structure and the impact of changing production volumes on total costs.