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.
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