The key difference between the static budget and the flexible budget is the volume or sales units used in the projections. The static budget uses the original volume forecasted, while the flexible budget is updated for the actual volume. For example, if during May Year 1, the company budgeted 10,000 units, but actually sold 12,000 units, then the static budget would use 10,000 units and the flexible budget would use 12,000 units.
Why is removing volume from the budget vs actual analysis beneficial?
The main benefit of using actual volume in the flexible budget is that it removes the impact of volume when comparing the flexible budget to the actual results (in a budget vs actual analysis). For example, if the static budget had $1,000 of revenue and the actual revenue for the period was $1,500, then you might initially say that actual revenue was higher due to higher volumes.
However, if you updated the flexible budget for actual volumes and forecasted revenue was $1,250, then when compared to actual revenue of $1,500, volume is no longer an explanation for the variance. Instead, you will have to analyze the sales mix, pricing, etc.
What types of accounts are impacted when converting from a static to flexible budget?
Only accounts that are impacted by volume would be changed when converting the static budget to a flexible budget. This would basically just be revenue and variable cost accounts, which ultimately impact gross profit or contribution margin. Fixed costs will remain unchanged between the static and flexible budget.
What is a Flexible Budget Variance?
A flexible budget is a budget that shows differing levels of revenue and expense, based on the amount of sales activity that actually occurs. Typically, actual revenues or actual units sold are inserted into a flexible budget model, and budgeted expense levels are automatically generated by the model, based on formulas that are set at a percentage of sales.
A flexible budget variance is any difference between the results generated by a flexible budget model and actual results. If actual revenues are inserted into a flexible budget model, this means that any variance will arise between budgeted and actual expenses, not revenues. If the number of actual units sold is inserted into a flexible budget model, there can then be variances between the standard revenue per unit and the actual revenue per unit, as well as between the actual and budgeted expense levels.
In general, the total flexible budget variance should be smaller than the total variance that would be generated if a fixed budget model were used, since the unit volume or revenue level in a flexible budget model is adjusted to match actual results (which is not the case in a fixed model). If there is a large flexible budget variance, it may mean that the formulas inserted into the budget model should be adjusted to more accurately reflect actual results.
Example of a Flexible Budget Variance
For example, a flexible budget model is designed where the price per unit is expected to be $100. In the most recent month, 800 units are sold and the actual price per unit sold is $102. This means there is a favorable flexible budget variance related to revenue of $1,600 (calculated as 800 units x $2 per unit). In addition, the model contains an assumption that the cost of goods sold per unit will be $45. In the month, the actual cost per unit turns out to be $50. This means there is an unfavorable flexible budget variance related to the cost of goods sold of $4,000 (calculated as 800 units x $5 per unit). In aggregate, this works out to an unfavorable variance of $2,400.
Budgeting is how a business plans for future production cycles. An initial budget — known as a "static" budget — is a necessary planning tool; creating a second, flexible budget allows a business to evaluate its performance during the static budget period. Variances, or differences, in the flexible budget provide a small business with important information about various performance elements, including overhead costs and profit.
Static Versus Flexible Budget
A static budget is the budget with which the business starts off. For example, if the business period covers six months, the static budget is the budget created before the period starts to cover the six months of operation. A static budget is based on expected production figures; for example, a business that normally makes 1,000 units over a six-month period would use 1,000 units as the basis for the static budget calculation.
A flexible budget is prepared after the budget period ends. This type of budget shows the business what the static budget should have been by using actual output figures from the budget period. For example, if the static budget covered the production of 1,000 units, but only 600 units were made, the flexible budget takes only 600 units into account. The flexible budget shows the budgeted items from the static budget — such as cost and expected sales — and the actual results.
Flexible Budget Creation
A flexible budget shows the budget figures for each line item from the static budget, the actual figures as shown on business statements, and the variances between the figures. Line items vary by business type but commonly include individual overhead costs, such as materials, and labor costs. A favorable variance works to the business's advantage by increasing overall income, while an unfavorable variance represents unexpected costs or cost increases that negatively affected profit levels. Unfavorable variances represent areas the business must work on to improve profits and reduce overhead.
Flexible Budget Variance
A flexible budget variance is the difference between a line on the flexible budget and the corresponding information from actual business statements. For example, if the static budget for an output of 1,000 units shows a line labor cost of $1.40 each piece but the actual cost was $1.30 each piece, the budget variance is $100, or the number of units multiplied by the difference between the budgeted cost and the actual cost.
Flexible Budget Variance Benefits
A flexible budget allows a business to see more variances than a static budget. Making a static budget involves the use of assumptions and predictions about sales, the market, economic conditions and other factors that impact a business before the budget period begins; these assumptions might not be correct. The information from the flexible budget is based on actual results, allowing the business to adjust the static budget for accuracy and compare results. The business compares actual line-by-line costs and profits from the flexible budget with the estimations made in the static budget. Variance information, such as the difference between estimated and actual sales and estimated and actual operating costs, helps the business improve efficiency and identify problem areas. For example, if a static budget has a material cost of $45 each piece, but the flexible budget shows $65 each piece, the variance may indicate an issue with the material ordering or selection.