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Fixed and Flexible Budgets

Fixed Budget

This budget is drawn for one level of activity and one set of conditions. It has been defined as a budget which is designed to remain unchanged irrespective of the volume of output or turnover attained. It is rigid budget and is drawn on the assumption that there will be no change in the budgeted level of activity. It does not take into consideration any change in expenditure arising out of changes in the level of activity.

Thus, it does not provide for changes in expenditure arising out of change in the anticipated conditions and activity. A fixed budget will, therefore, be useful only when the actual level of activity corresponds to the budgeted level of activity.

A master budget tailored to a single output level of (say) 20,000 units of sales is a typical example of a fixed budget. But, in practice, the level of activity and set conditions will change as a result of internal limitations and external factors like changes in demand and prices, shortages of materials and power, acute competition etc.

It is hardly of any use as a mechanism of budgetary control because it does not make any distinction between fixed, variable and semi-variable costs and provides for no adjustment in the budgeted figures as a result of change in cost due to change in level of activity. It does not provide a meaningful basis for comparison and control. It is also not helpful at all in the fixation of price and submission offenders.

Flexible Budget

The Chartered Institute of Management Accountants, England, defines a flexible budget (also called sliding scale budget) as a budget which, by recognising the difference in behaviour between fixed and variable costs in relation to fluctuations in output, turnover, or other variable factors such as number of employees, is designed to change appropriately with such fluctuations. Thus, a flexible budget gives different budgeted costs for different levels of activity.

A flexible budget is prepared after making an intelligent classification of all expenses between fixed, semi-variable and variable because the usefulness of such a budget depends upon the accuracy with which the expenses can be classified.

Such a budget is prescribed in the following cases:

(i) Where the level of activity during the year varies from period to period, either due to the seasonal nature of the industry or to variation in demand.

(ii) Where the business is a new one and it is difficult to foresee the demand.

(iii) Where the undertaking is suffering from shortage of a factor of production such as materials, labour, plant capacity etc. The level of activity depends upon the availability of such a factor of production.

(iv) Where an industry is influenced by changes in fashion.

(v) Where there are general changes in sales.

(vi) Where the business units keep on introducing new products or make changes in the design of its products frequently.

(vii) Where the industries are engaged in make to order business like ship-building.

Comparison Chart

BASIS FOR COMPARISON FIXED BUDGET FLEXIBLE BUDGET
Meaning The budget designed to remain constant, regardless of the activity level reached is Fixed Budget. The budget designed to change with the change in the activity levels is Flexible Budget.
Nature Static Dynamic
Activity Level Only one Multiple
Performance Evaluation Comparison between actual and budgeted levels cannot be done accurately, if there is a distinction in their activity levels. It provides a good base for making a comparison between the actual and budgeted levels.
Rigidity Fixed Budget cannot be modified as per the actual volume. Flexible budget can be easily modified in accordance with the activity level attained.
Estimates Based on assumption Realistic and Practical

Utility (or Importance) of Flexible Budget

  1. Flexible budget provides a logical comparison of budgeted allowances with the actual cost i.e., a comparison with like basis.
  2. Flexible budget reckons operational realities and streamlines control function and profit planning. It gives balanced perspective on comparison. When flexible budget is prepared, actual cost at actual activity is compared with budgeted cost at actual activity i.e., two things to a like basis.
  3. Flexible budget recognises concept of variability and provides logical comparison of expenditure with actual expenditure as a means of control.
  4. With flexible budget, it is possible to establish budgeted cost for any range of activity.
  5. A flexible budget is very useful for purposes of budgetary control because it corresponds with changes in the level of activity.
  6. It is helpful in assessing the performance of departmental heads because their performance can be judged in relation to the level of activity attained by the organisation.
  7. Cost ascertainment at different levels of activity is possible because a flexible budget is prepared for various levels of activity.
  8. It is helpful in price fixation and sending quotations.

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