A flexible budget is dynamic budget which is designed to change with the level of the activity actually attained. It portrays costs, revenues and profits at the various level of activity budgeted. When the costs in a responsibility center are expected to vary with the volume of production, as is the case with most product departments, the use of a flexible budget becomes very helpful in controlling the cost. It is also known as a variable Budget.
Definition of Flexible Budget : The Institute of Cost and Works Accounts, England has defined a flexible budget in these words-
A budget, which, by recognising the difference between fixed, semi-fixed and variable costs is designal to change in relation to the level of activity actually attained.
Thus a flexible budget, as the term implies, is a budget which is designed to change in accordance with the level of activity. As total actual output may differ from the estimated output (on the basis of which the budget was drawn up) it is necessary that the budget itself should be modified according to the change in output. It is based on the assumption that the actual level of activity is often beyond the control of management.
Methods of Preparing a Flexible Budget:
There are two alternative methods of flexible budgeting : (i) Multi-activity Method, and (ii) Budget Cost Allowance Method.
The multi-activity method involves preparing budget figures for different levels of activity within a range. It takes into consideration the variable, semi variable and fixed costs while computing the budget figures for different levels of activity. A proforma of a flexible budget under this method will be as follows
Under the Budget Cost Allowance Method, a budget is first prepared for he expected normal level of activity and provision is made for an allowance for variable costs per unit of activity for the number of units by which the actual level differs from the budgeted level. To take an example, let us suppose that the
Overhead Expense Budget is estimated at USD 15 on the basis of nomial activity level which is 90% of capacity. Assuming that the expense budget consists of USD 6000 as fixed expenses and USD 9000/- as variable expenses, Now we may compute the variable cost per 1% level of activity like this; 9000/90=USD100. Now, if the actual level of activity attained is 96%, the variable overhead allowed will be USD100 x 96, i.e. USD 9600 .
Significance of Flexible Budgeting
Flexible budgeting is very useful and significant in modern times.
- It is an important tool of cost control.
- It provides for necessary allowance to be made in the budget figures and suggests what the figure should have been with the level of activity actually attained.
- It is very useful in cost control where yearly forecasts for overheads cannot be made with precision.
- A flexible budget should be prepared for one year and then, for different control periods within a year, separate fixed budgets can be prepared. This procedure makes possible to control the activity effectively within the budgeted period.
- For the departments where the nature of activities is flexible (for example sales department), the importance of flexible budgeting is obvious.
- A flexible budget is virtually a dynamic tool for cost control. In makes possible to estimate costs for any level of activity.
- It facilitates the comparison of actual results with the budgeted figures.