Up to this point the budget has been fixed. This is quite appropriate for planning purposes but of little use for control purposes. The fixed budget does not respond to the actual level of activity. When organizations compile the master budget it is based on a certain level of output and sales. In most instances, the company may find that this operating level is not set at the actual level of activity. Indeed most organizations find it difficult to forecast the actual level of activity eg. There may be a seasonal characteristic to the company’ trading. In such cases the business may find it more useful to prepare flexible budgets. A flexible budget is ‘designed to change in accordance with the level of activity attained’ (CIMA).
A fixed budget is not designed to change with different levels of activity. It does not allow for the pre-determination of costs and revenues at different levels of output which would facilitate comparison with actual costs and the identification of variances.
A flexible budget is designed to recognize cost behavior at different levels of output so actual results can be compared with the expected results and the computation of variances and variance analysis is made possible.
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