Chapter 21: Fixed and Flexible Budgets

Flexible Budget Preparation and Flexible Budget Performance Report Interpretation 1. Purpose of Budgets and Budget Reports • • • Budgets assist managers in aligning actual performance with planned objectives and controlling operations. Budget reports compare budgeted outcomes to actual results, which helps in identifying variances and taking corrective actions. These reports are adaptable to various time periods, commonly monthly, quarterly, or annually. 2. Master Budgets and Budgeting Types • A master budget sets performance targets based on an anticipated level of activity, like expected sales volume. o Fixed Budget (Static Budget): Prepared for a single activity level, making it useful only if the actual activity aligns closely with this level. o Flexible Budget (Variable Budget): Accounts for multiple activity levels, providing insights across different sales or production volumes and adjusting costs accordingly. 3. Fixed vs. Flexible Budget Performance Report • • Fixed Budget Performance Report: Compares actual results with a fixed budget; variances may be less meaningful when actual activity varies significantly from the budgeted level. o Variances can be:  Favorable (F): When actual revenue or income exceeds budgeted figures or actual costs are lower.  Unfavorable (U): When actual revenue or income falls short of the budget or actual costs are higher. Flexible Budget Performance Report: Adjusts for actual activity levels, offering a more accurate comparison. Prepared after the period, it allows managers to evaluate performance by matching the budget to actual activity levels. 4. Purpose of Flexible Budgets in Performance Evaluation • • Before the Period: Enables scenario planning for various activity levels (e.g., best-case, worst-case), allowing management to strategize for profit maximization or loss minimization. After the Period: Facilitates “apples-to-apples” comparisons by adjusting budget expectations to the actual activity level, isolating the effects of variances. 5. Steps in Preparing a Flexible Budget • • • Identify Activity Levels: Define expected sales or production levels. Classify Costs: Distinguish between variable costs (which change with activity) and fixed costs (which remain constant). Compute Budgeted Amounts: Calculate sales, variable costs, and income based on activity levels. For example, using the formula for total budgeted costs: Total Budgeted Costs=Total Fixed Costs+(Variable Cost per Unit×Units of Activit y) This formula allows for quick recalculations at different activity levels. 6. Flexible Budget Performance Report • • Provides a detailed variance analysis after adjusting for actual activity levels. Allows managers to focus on significant variances: o Favorable variances: Such as higher-than-expected sales revenue due to increased selling prices. o Unfavorable variances: Such as higher-than-expected costs for direct materials or labor, indicating potential areas for operational adjustments. 7. Managerial Interpretation Example • When actual activity exceeds planned levels, fixed budgets may misinterpret higher costs as inefficiencies. Preparing a flexible budget based on actual activities provides a fairer assessment by adjusting expectations to real-time performance and isolating true performance discrepancies. Summary • Fixed budgets are best suited for stable activity levels, while flexible budgets provide a dynamic tool for varying levels, helping managers evaluate and adapt to actual performance accurately. This budget flexibility enhances operational control and enables informed decision-making regarding resource allocation and efficiency improvements.