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A budget is a plan comprising many line values such as production costs, net profit, production volume, and other factors for a specific period aimed at evaluating performance.
The fundamental differences between static and flexible budgets are that a static budget does not change as volume changes whereas a flexible budget changes line values to reflect the level of activity.
Static budget, the most common type of budget, projects a fixed level of expected input, output, costs of production, and net income before the start of the budgeting period. The values specified in static budgets very often vary from the actual results derived at the end of the budget period.
Flexible budget, also known as variable or dynamic budget, recognizes the fact that per-unit fixed and variable production costs change based on the level of output, and as such change line values in accordance with fluctuations in output. This type of budget is prepared by adjusting the line values in static budget to match the actual level of output derived at the end of the budget period. Another approach is drawing up multiple static budgets that feature alternative estimates for various line items such as production costs and net income, to anticipate costs and revenues for different projected level of output, and at the end of the budget period, adopting the budget where projected level of output matches the actual level of output.
For instance, in a static budget, the company’s annual budgeted amount for sales commission will be $100,000 irrespective of the volume of sales. Flexible budget would have different projections. A projected sales volume of $10 million will have budget sales commission at $100,000, a projected sales volume of $20 million will budget sales commission at $200,000 and so on. Thus, in a flexible budget the percentage remains the same while the values change to reflect changes in output. In static budget, the values remain rigid irrespective of output, making a correct comparison difficult.
Image Credit: flickr.com/Jeff Keen
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Comparing flexible vs. static budgets, flexible budget allows commercial organizations to effect a correct comparison between budgeted performance and actual performance. For instance, if actual production is 10,000 units and the static budget estimates 9,000 units, revising the original budget to 10,000 units makes possible a precise comparison between budgeted costs and actual costs. Retaining the budget values to reflect a production of 9,000 units would indicate cost overruns or a distorted per-unit production cost.
Flexible budget helps plan for potential changes in production costs or sales volume; it allows businesses to respond quickly to changes and maximize profits by seizing the opportunity.
Flexible budgets also provide for a greater degree of management control, for by eliminating sales volume as a source of variance, any variances highlight other causative factors.
Static budgets find use in setting limits. For instance, a static budget allocating $100,000 as sales commission provides the sales department with both a fixed target and a guideline, based on which the department works out department level guidelines on sales commissions.
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Most commercial businesses that operate in volatile circumstances or uncertain business environments prefer variable budgets.
Static budgets find uses in many entities and organizations such as government institutions and charitable organizations that only compare budgets with actual figures at the end of the period and do not concern themselves with financial statement results. Organizations with a smooth flow and stable production levels also find static budgets useful.
Many organizations have both static and flexible budgets, with a static master budget and variable budgets for individual departments
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- Caplan, Dennis. Management Accounting. Concepts and Techniques. Oregon State University College of Business. Retrieved from http://classes.bus.oregonstate.edu/spring-06/ba422/Management%20Accounting%20Chapter%205.htm. on 07 October 2010
- CliffsNotes.com. Flexible Budget. retrieved from http://www.cliffsnotes.com/study_guide/Flexible-Budgets.topicArticleId-21248,articleId-21241.html on 07 October 2010