Depar

tmentofAccount
ing&Fi
nance

CHAPTERTHREE
FLEXI
BLE&STATI
CBUDGET
1.I
ntr
oduct
ion
Aswehav eseeni nchapter2,f
ormal budget
ingproceduresresul
tincompr
ehensi
veoperat
ional
andfi
nancialplansforfutur
[Link] sguidemanagersandemployeesast hey
makethei
rdailydecisi
onsandast heyt r
ytoanti
cipat
ef utur
eprobl
emsandopportuni
ti
es.

3.
1MASTERBUDGETVSFLEXI
BLEBUDGET

Allmasterbudget
sdiscussedintheprevi
ousuni est
tar at
icorinf
lexi
blebecauset
heyassume
fi
xedlevelofacti
vi
[Link] erbudgetorst
atcbudgeti
i sprepar
edf oronl
yoneacti
vit
ylevel
(f
orexampleonev ol
umeofsal esacti
vi
ty)
.

Thisuni
tintr
oducesflexibl
ebudgets,whi
charebudgetsdesi
gnedtodirectmanagementto
areasofactualfi
nancialperf
ormancethatdesi
reat
tent
[Link]
scanappl ythi
ssame
basicpr
ocesstocontr
ol i
mportantar
easofper
for
mancesuchasquali
tyorcust
omerservi
ce.

Exampl e(1)
:Elsu Company pr epar
es a budgetbased on detail
ed expect
ation forthe
for
[Link] spl
’ antail
oredtoasi ngl
esalesl evel
,i.
e.,9,000units.
Howev ,sal
er esvol
umeuni tsturnedouttobeonl y7,000unit
sinsteadoft heori
ginal9,000
uni
[Link]
hemast erbudgetvari
ancef
oreachitem gi
venbel
ow.

Tabl
e1:El
suCompanyPer
for
manceRepor
t
Master Master Budget
Par
ti
cul
ars Act
ual
Budget Var
iances
Units 7,000uni t
s 9,
000uni ts
Sales Br.217,000 Br.279,000
VariableExpenses:
*Manuf acturi
ng Br.151,270 Br.189,000
*Sel l
ing 5,000 5,
400
*Admi nistr
ati
ve 2,000 1,
800
Total Variabl
eExpense Br.158,270 Br.196,200
Cont ri
but i
onMar gin Br.58,730 Br.82,800
FixedExpenses:
*Manuf acturi
ng Br.37,300 Br.37,000
*Sell
ing&Admi nist
rati
ve 33,000 33,000
Total FixedExpenses Br.70,300 Br.70,000
Oper ati
ngI ncome( Loss) Br.(11,570) Br.12,800
[Link]
N. erbudgetvar i
ance(
stati
cbudgetvar
iance)ist hevari
anceofact
ualr
esul
tfr
om t
he
mast
erbudget
.
I
tiscust
omar
ytol
abelv
ari
ancesf
avor
abl
e(F)orunf
avor
abl
e(U)
.Thel
abeli
ndi
cat
eswhet
her
t
het
argetort
heact
ualf
igur
eisl
arger
.Thewayi
nwhi
chl
abel
sar
eappl
i
eddependsont
hei
tem
f
orwhi
chav
ari
ancei
scomput
ed.I
fthei
tem f
orwhi
cht
hev
ari
ancei
scomput sar
edi evenueor
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s Page1of
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pr
ofi
tit
em,f
avor
abl
evar
iances ar
ethose f
orwhi
ch act
uali
s gr
eat
ert
han t
he t
arget
;
unf
avor
abl
evar
iancesar
ethosef
orwhi
chact
ual
isl
esst
hant
het
arget(
ort
hebudget
).

I
fthei
tem f
orwhi
cht
hev
ari
ancei
scomput sacostorexpensei
edi tem,f
avor
abl
evar
iances
ar
ethosef
orwhi
chact
uali
slesst
hant
het
arget
.Ther
efor
e,i
fact
ualcosti
sgr
eat
ert
hant
arget
cost
,thev
ari
ancewi
l
lbel
abel
edunf
avor
abl
e.

3.
2FLEXI
BLEBUDGET(
DYNAMI
CBUDGET)

Act
ualact
ivi
tymaydi
ff
ersi
gni
fi
cant
lyf
rom budget
edact
ivi
tybecauseofanunexpect
edl
abor
st
ri
ke,cancel
lat
ionofanor
der
,anunexpect
edl
argenew pr
oduct
ioncont
ract
,andot
her
f
act
[Link]
ualr
esul
tsdi
ff
erconsi
der
abl
yfr
om pl
ans,af
ixedorst
ati
cbudgetmaynotbe
par
ti
cul
arl
yef
fect
ivei
nsuppor
ti
ngmanager
s.I
nsuchcasessev
eralbudget
spr
epar
edf
ora
v
ari
etyofact
ivi
tyl
evel
smaybemor
eusef
ul.

I
ncont
rastt
otheper
for
mancer
epor
tbasedonl
yoncompar
ingt
hemast
erbudgett
otheact
ual
r
esul
ts,a mor
e usef
ulbenchmar
kforanal
ysi
sist
he f
lexi
ble budget
.A f
lexi
ble budget
(
somet
i edav
mescal
l ari
abl
ebudget
)isbudgett
hatcaneasi
lybeadj
ust
edf
ordi
ff
erencesi
n
t
hel
evelofact
ivi
ty.I
tpr
ovi
desmanager
smor
eusef
uli
nfor
mat
ionf
orpl
anni
ngandbet
terbasi
s
f
orcompar
ingper
for
mancet
han,
ast
ati
corf
ixedbudget
.

I
nper
for
manceev
aluat
ion,amast
erbudgeti
skeptf
ixedorst
ati
ctoser
veasabenchmar
kfor
ev
aluat
ingper
f mance.I
or tshowsr
evenuesandcost
satonl
ytheor
igi
nal
l
ypl
annedl
evel
sof
act
ivi
[Link]
,af
lexi
blebudgetwi
llbepr
epar
edatt
heact
ualact
ivi
tyl
evel
.

Thef
lexi
blebudgeti
sident
icalt
othemast
erbudgeti
nfor
mat
,butmanager
smaypr
epar
eit
f
oranyl
evelofact
ivi
ty.

3.
2.1 Di
sti
ngui
shi
ngFeat
uresofFl
exi
bleBudget

Fl
exi
blebudget
shav
esev
eral
desi
rabl
echar
act
eri
sti
[Link]
:

a)Coverarangeofact
ivi
ty
b)Aredynamic
c)Faci
li
tat
eperfor
mancemeasur
ement
.
a) Fl
exi
bleBudgetCoveraRangeofAct
ivi
ty:Accur
atepr
edi
cti
onsofact
ivi
tyl
evel
sar
e
somet
imeshar
dtomake,
andmanymanager
sfi
ndt
heymakemor
eef
fect
ivedeci
sionswi
tht
he
ai
doff
lexi
blebudget
s.I
ndev
elopi
ngaf
lexi
blebudgetoneact
ivi
tyl
evelateachext
remeoft
he
r
elev
antr
angei
ssel
ect
ed,
wit
honeormor
einbet
ween.

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b) Fl
exi
bleBudgetAr
eDynami
c:Fl
exi
blebudget
sal
l
owmanager
stoadj
ustpl
anseasi
l
ywhen
act
ivi
tyl
evel
dif
fer
sfr
om t
heexpect
edl
ev .Suchbudget
el saddr
ess“
whati
s”r
athert
han“
what
was”or“
whatwasexpect
ed”
.Thi
sdy
nami
cnat
ureoff
lexi
blebudgetmakest
hem av
eryusef
ul
deci
si
onmaki
ngt
ool
formanagement
.

c)Fl
exi
bleBudgetFaci
li
tat
ePer
for
manceMeasur
ement
:Measur
ingef
fi
ciencyi
sani
mpor
tant
r
ole ofper
for
mance r
epor
t. Fi
xed budget
s ar
e usef
ulf
ormeasur
ing ef
fect
iveness,i
.e.
,
achi
evementofgoal
.Insomecases,
howev
er,
fixedbudget
sdonoti
dent
if
ythequest
ion,
“what
shoul
dther
esul
tbe,gi
vent
heact
uall
evelofact
ivi
ty”
.Inot
herwor
ds,t
hef
lexi
ble-
budget
appr
oachsay
s,“
Giv
emeanyact
ivi
tyl
evely
ouchoose,andI
’
llpr
ovi
deabudgett
ail
oredt
othat
par
ti
cul
arl
evel
.”To summar
ize,whenev
eract
ualand budget
ed act
ivi
ty ar
e si
gni
fi
cant
ly
di
ff
erent
,af
lexi
blebudgetv
ari
ancer
epor
tpr
ovi
desabet
termeasur
eofef
fi
ciencyt
hanar
epor
t
basedonaf
ixedbudget
.

3.
2.2 Fl
exi
bleBudget
ingPr
ocess

Thef
oll
owi
ngst
epsar
eneededt
odev
elopaf
lexi
blebudget
.

i
)Det
ermi
net
her
angeofact
ivi
tyt
hebudgetshoul
d cov
er(
becausecostbehav
ior
pat
ter
nsmaybedi
ff
erenti
ndi
ff
erentr
angesofact
ivi
ty)
i
i
)Det
ermi
net
hecostbehav
iorpat
ter
nforeachcosti
ncl
udedi
nthebudget
.
i
i
i)Sel
ectt
heact
ivi
tyl
evel
sforwhi
chbudget
swi
l
lbepr
epar
ed.
i
v)Pr
epar
edaf
lexi
blebudgetusi
ngt
hecostbehav
iordat
aandt
hesel
ect
edact
ivi
tyl
evel
.

Exampl
e(2)
:El
suCompanyi
spl
anni
ngt
ouseaf
lexi
blebudget
ingsy
stem t
opl
anandcont
rol
i
tsoper
ati
[Link]
sumadet
hef
oll
owi
ngcostest
imat
esf
orbudget
ingpur
poses:

BudgetFor
mul
aPerUni
t
Sal
es Br
.31.
00
Vari
ableCost s:
*Manuf actur
ing Br
.21.
00
*Sell
ing 0.
60
*Admi ni
strat
ive 0.
20
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Tot
alVari
abl
eCost
s Br
.21.
80
Cont
ri
buti
onMargi
n Br
.9.
20
BudgetFor
mul
aPerMont
h
Fi
xedCosts:
*Manufact
uri
ng Br.37,
000
*Sel
li
ngandadmi ni
str
ati
ve 33,000
Tot
alfi
xedcosts Br.70,
000
Requi
red:
a) Pr
epar
edaf
lexi
blebudgetf
ort
henextmont
husi
ng7,
000,8,
000,and9,
000uni
tsas
act
ivi
tyl
evel
.El
suCompany
’scostf
unct
ionsorf
lexi
blebudgetf
ormul
asar
ebel
i
eved
t
obev
ali
dwi
thi
nther
angeof7,
000t
o9,
000uni
ts.
b) Atwhatl
evel
ofact
ivi
tydost
hecompanybr
eakev
en?

Tabl
e2:El
[Link]
exi
bleBudget
Fl
exi
bleBudget
sForVar
iousAct
ivi
tyLev
els
7,
000uni
ts 8,
000uni
ts 9,
000unit
s
Sales
VariableCost s
*Manuf acturi
ng
*Sel l
ing
*Admi ni
st r
ati
ve
Total Vari
ableCost s
Cont ri
butionmar gin
Fixedcost s
*Manuf acturi
ng
*Sell
ingandadmi n.
Total fi
xedcost s
Oper ati
ngi ncome( l
oss)
BEP(
inuni ts)=Tot alf
ixedcost
s
Uni
tCont
ri
but
ionMar
gin
BEP(
inbi
rr
s)=Tot
alf
ixedcost
s=
CM-
rat
io

 Compar
ingt
hef
lexi
blebudgett
oact
ualr
esul
tsaccompl
i
shesani
mpor
tantper
for
mance
eval
uat
ion pur
[Link]
e ar
e basi
cal
l
ytwo r
easons whyact
ualr
esul
ts mi
ghtnothav
e
conf
ormedt
othemast
erbudget
:
(
a)Sal
esandot
hercost
-dr
iveract
ivi
ti
eswer
enott
hesameasor
igi
nal
l
yfor
ecast
ed.
(
b)Rev
enuesorv
ari
abl
ecost
speruni
tandf
ixedcost
sperper
iodwer
enotasexpect
ed.
 Fl
exi
bleBudgetVar
iances:Anyvar
iancesbet
weent
hef
lexi
blebudgetandact
ualr
esul
ts
cannotbeduet
oact
ivi
tyl
evel
[Link]
iancesbet
weent
hef
lexi
blebudgetandact
ual
resul
ts
ar
ecal
l
edf
lexi
blebudgetv
arancesandmustbeduet
i odepar
tur
eofact
ualcost
sorr
evenues
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exi
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f
rom f
lexi
ble-
budgetf
ormul
aamount
s.

 Act
ivi
tyl
evelvar
iances:Anydi
ff
erencesorvar
iancesbet
weent
hemast
erbudgetandt
he
f
lexi
blebudgetar
eduet
oact
ivi
tyl
evel
[Link]
ff
erencesar
ecal
l
edact
ivi
ty-
lev
elv
ari
ances.

Thesum oft
heact
ivi
tyl
evelvar
iancesandt
hef
lexi
blebudgetvar
iancesequalt
het
otalof
t
hemast
erbudgetvar
iances.

Exampl
e(3)
:Ref
ert
hedat
agi
veni
nexampl
e(1)and(
2).Pr
epar
eacondensedt
abl
eshowi
ng
t
hest
ati
c(mast
er)budgetv
ari
ance,
thesal
esact
ivi
tyv
ari
ance,
andt
hef
lexi
ble-
budgetv
ari
ance.

Tabl
e3:El
[Link]
yofPer
for
mance
Actual Fl
exibl
e Master Fl
exi
ble Budget Sal
es Acti
vi
ty
Result
s Budget Budget Vari
ance Vari
ances
Units 7,
000 7,
000 9,
000 - 2,
000U
Sales
Variablecosts
Cont ri
buti
on
mar gin
Fi
xedCost s
Oper ati
ng
I
ncome( loss)
*
UorFindicateswhethert
hev
ari
ancesar
eunf
avor
abl
eorf
avor
abl
e,r
espect
ivel
y.

Tot
almast
erbudgetv
ari
ance(
TMBV)=ALF+FBV
Wher
eTMBV=Tot
alMast
erBudgetVar
iance ALF =Act
ivi
tyLev
elVar
iance
FBV =Fl
exi
bleBudgetVar
iance
Thus,t
het
otalmast
erbudgetv
ari
ancef
orEl
[Link]
stoBr
.24,
370U(
Br.5,
970U+Br
.
18, .Thesum oft
400U) heact
ivi
ty-
levelvar
iancesher
eequal
ssal
es-
act
ivi
tyvar
iances
becausesal
esar
etheonl
yact
ivi
tyusedasacostdr
iver
.

 Manager
susecompar
isonsbet
weenact
ualr
esul
ts,
mast
erbudget
s,andf
lexi
blebudget
sto
ev
aluat
e or
gani
zat
ionalper
for
[Link] ev
aluat
ing per
for
mance,i
tis usef
ult
o
di
sti
ngui
shbet
weenef
fect
iveness-
thedegr
eest
owhi
chagoal
,obj
ect
ive,ort
argeti
smet
-
andef
fi
ciency
-thedegr
eet
owhi
chi
nput
sar
eusedi
nrel
ati
ont
oagi
venl
evel
ofout
put
s.

 Per
for
mancemaybeef
fect
ive,
eff
ici
ent
,bot
h,ornei
ther
.Forexampl
e,El
[Link]
er
budgetobj
ect
iveofmanuf
act
uri
ngandsel
l
ing9,
000uni
[Link]
y7,
000uni
tswer
eact
ual
l
y
madeandsol
d,howev
[Link]
for
mance,asmeasur
edbysal
es-
act
ivi
tyvar
iances,was
i
nef
fect
ivebecauset
hesal
esobj
ect
ivewasnotmet
.

 WasElsu’
sperf
ormanceef f
ici
ent
?Manager
sjudget
hedegr
eeofef
fi
ciencybycomparing
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act
ualout
put
sachi
eved (
7,000 uni
ts)wi
th act
uali
nput
s(such ast
he costofdi
rect
mat
eri
alsanddi
rectl
abor
).Thel
essi
nputusedt
opr
oduceagi
venout
put
,themor
e
ef
fi
cientt
heoper
ati
[Link]
suwasi
nef
fi
cienti
nit
suseofanumberofi
nput
s. Lat
eri
n
chapt
er–f
ive,di
rectmat
eri
al,di
rectl
aborandv
ari
abl
eandf
ixedov
erheadf
lexi
ble-
budget
v
ari
anceswi
l
lbedi
scussedi
ndet
ail
.

 Fl
exi
ble-
budgetvar
iancesmeasur
etheef
fi
ciencyofoper
ati
onsatt
heact
uall
evelofact
ivi
ty.
Thef
lexi
ble-
budgetv
ari
ancesshowni
ncol
umn(
4)ofExhi
bit3.
3tot
alBr
.5,
970unf
avor
abl
e.
Thet
otalf
lexi
ble-
budgetvar
iancear
isesf
rom sal
espr
icesr
ecei
vedandt
hevar
iabl
eand
f
ixedcost
sincur
[Link]
[Link]
ff
erencebet
weenact
ual
sal
espr
iceandt
hef
lexi
ble-
budget
edsal
espr
ice,
sot
hef
ocusi
sont
hedi
ff
erencesbet
weenact
ualcost
sandf
lexi
ble-
budget
edcost
satact
ual
7,000-
uni
tlev
elofact
ivi
ty.

 Sal
es-
act
ivi
tyvar
iances measur
e how ef
fect
ive manager
s have been i
n meet
ing t
he
pl
annedsal
esobj
ect
ive.I
nEl
suCo.
,sal
esact
ivi
tyf
ell
2,000uni
tsshor
toft
hepl
annedl
evel
.
Thesal
es-
act
ivi
tyv
ari
ances(
tot
ali
ngBr
.18,
400U)ar
eunaf
fect
edbyanychangesi
nuni
t
pr
icesorv
ari
abl
ecost
[Link]
?Becauset
hesamebudget
eduni
tpr
icesandv
ari
abl
ecost
s
ar
eusedi
nconst
ruct
ingbot
hthef
lexi
bleandmast
erbudget
[Link]
efor
e,al
luni
tpr
icesand
v
ari
abl
ecost
sar
ehel
dconst
anti
ncol
umns(
2)and(
3)oft
abl
e.3.

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