FLEXIBLE BUDGETS
Flexible budgets are one way companies deal with different levels of activity. A
flexible budget provides budgeted data for different levels of activity. Another way of thinking of a
flexible budget is a number of static
budgets. For example, a restaurant may serve 100, 150 or 300 customers an evening. If a budget is prepared assuming 100 customers will be served, how will the managers be evaluated if 300 customers are served? Similar scenarios exit with merchandising and manufacturing companies. To effectively evaluate the restaurant’s performance in controlling costs, management must us a budget prepared for the actual level of activity. This does not mean management ignores difference in sales level, or customers eating in a restaurant, because those differences and the management actions that caused them need to be evaluated, too.
The
flexible budget shows an even higher unfavorable variance than the static budget. This does not always happen but is why flexible budgets are important for giving management an indication of what question need to be asked. The important thing to remember in preparing a
flexible budget is that if an amount, cost or revenue, was variable when the original budget was prepared, that amount is still variable and will need to be recalculated when preparing a
flexible budget. If, however, the cost was identified as a fixed cost, no changes are made in the budgeted amount when the
flexible budget is prepared. Differences may occur in fixed expenses, but they are not related to changes in activity within the relevant range. Budget reports can be a useful tool for evaluating a manager’s effectiveness only if they contain the appropriate information. When preparing budget reports, it is important to include in in the report items the manager can control. If a manager is only responsible for a department’s costs, to include all the manufacturing costs or net income for the company would not result in a fair evaluation of the manager’s performance .If, however the manager is the Chief Executive Officer, the entire income statement should be used in evaluating performance.