FIXED OR STATIC BUDGET
According to the Institute of Cost and Management Accountants of England, "a fixed budget is a budget designed to remain unchanged irrespective of the level of activity actually attained". Fixed budget is used as an effective tool of cost control. In case the level of activity usually attained is different from the level of activity for budgeting purpose, the fixed budget becomes ineffective. A budget may be prepared for, say, 1,00,000 units. Actual activity level may be say, 1,20,000 units. If it is a fixed budget, then absolute differences of budgeted figures and actual figures will be found out without any type of adjustment for change in level of activity. Such a budget is quite suitable for fixed expenses.
Fixed budgets are established only for short-term periods when the actual results are not anticipated to differ from the budget estimates. This is not a rigid budget, it can be modified, but the level of activity remains one or the same.
(i) When the nature of Business is not seasonal.
(ii) There is no impact of external factors on the business activities.
(iii) The demand of the product is certain and stable.
(iv) Supply orders ore issued regularly.
(v) The market of the product should be domestic rather than foreign.
(vi) There is no need of special labour or material in the production of the products.
(vii) Supply of production inputs is regular.
(viii) There is a trend of price stability.
Generally, all above conditions are not found in practice. Hence, Fixed Budget is not important in business concerns.
(i) Very simple to prepare.
(ii) Less time consuming.
(i) It is misleading. A poor performance may remain undetected and a good performance may go unrealised.
(ii) It is not suitable for long period.
(iii) It is also found unsuitable particularly when the conditions of the business are changing constantly.
(iv) It takes away the initiative from members of the administrative staff since they do not find any interest in their job.
(v) It is inadequate for control purposes.
(vi) It violates logic. Based on logic, comparison should be made between two things with a like base.
(vii) Accurate estimates not possible.
The idea of introducing budgets in a business organisation is to exercise control over day to day operations of the business. Control, in order to be effective, requires a standard or a target with which actual performance can be compared for the purpose of measurement of the results for timely action, if necessary. Such standard should take into consideration the characteristics and behaviour of cost. The Institute of Cost and Management Accountants of England defines a flexible budget as "a budget which, by recognising the difference between fixed, semi-variable and variable costs is designed to change in relation to the level of activity attained". It is assumed that fixed costs will remain fixed only upto a certain level of activity and after a certain level they may tend to vary, though not like variable costs. Extra efforts are made in analysing semi-variable items of expenditure in fixed and variable elements.
A flexible budget is a budget which, by recognising different cost behaviour patterns, is designed to change as volume of output changes. Flexible budget is also known as variable or sliding scale budget. The main characteristic of flexible budget is that it shows
the expenditure appropriate to various levels of output. If the volume changes, the expenditure appropriate to it can be established from the flexible budget for comparison with actual expenditures as a means of control. The flexible budget provides a logical comparison of budget allowances with actual cost, i.e., a comparison with a like basis.
Now-a-days, the Flexible Budget plays an important role in the business and industry. It is prepared by most of the business concerns, firms and industries in present competitive era.
CLASSIFICATION OF COSTS
For the preparation of Flexible Budget Costs may be divided into three categories - Fixed, Variable and Semi-variable cost.
(i) Fixed Costs - It is also known as 'Period Costs', 'Capacity Costs' and 'Supplementary Costs'. It represents and includes all the expenditure/costs that are not affected by the increase or decrease in the volume of production. All these expenditures remain constant up to the installed capacity of the firm. It is important to note that total fixed costs remain constant up to the installed capacity of the firm but average fixed cost per unit decreases according to increase in the volume of production. Generally, fixed costs include the expenditures incurred on salary of the employees, rent and tax of the building, insurance premium, depreciation etc.
(ii) Variable Costs - It is also known as 'Marginal Cost'. It includes all those expenditures which are affected by the volume of production. Variable cost increases or decreases according to proportionate change in the volume of production. It is important to note that total variable costs change as per change in the volume of product but average variable cost per unit remains constant at all levels of activity. Variable costs include the following costs -
(a) Prime Cost or Direct Cost - Direct Material, Direct Labour, Direct Expenses.
(b) Factory overheads or Indirect Expenses - Power, Commission etc.
(iii) Semi-variable Costs - It is also known as Semi-Fixed Costs. It includes all the expenditures that are not changed according to proportionate change in the volume of production. Semi-variable costs increase with the increase in production volumes but not proportionately. It remains constant up to a certain level of production and change after the specified levels with uneven proportion.
Semi-variable cost includes both the components of fixed and variable costs and because of this it is known as Semi-variable costs or Semi-Fixed costs. Generally, it includes indirect material, indirect labour, repairs and maintenance, telephones expenses and sundry office expenses.
NEED FOR FLEXIBLE BUDGET
The need for preparation of flexible budget arises in the following circumstances
(i) Seasonal fluctuations in sales an/or production-for example, in soft drinks industry.
(ii) A company which keeps on introducing new products or make changes in the design of its products frequently.
(iii) Industry engaged in make-to-order business like ship building.
(iv) An industry which is influenced by changes in fashion; and
(v) General changes in sales.
NEED FOR FLEXIBLE BUDGET
(i) Adjustable according to Business Conditions.
(ii) Prepared in advance for various levels of activity.
(iii) It is a dynamic budget.
(iv) Control possible over unfavourable impact of change in future.
(v) Classification of cost in the form of Fixed, Semi-variable and Variable cost.
(vi) Related to a particular period.
(vii) Production possible at any level of activity.
ADVANTAGES/MERITS/IMPORTANCE OF FLEXIBLE BUDGET
The main advantages of Flexible Budget are given below:
1. Easy Calculation - With the help of Flexible Budget, the sales, costs and profit may be calculated easily by the business at various levels of production capacity.
2. Easy Adjustment of Change - In Flexible Budget, adjustment is very simple according to change in business conditions.
3. Knowledge about the impact of cost - In Flexible Budget, the cost is classified into three categories, namely, fixed cost, semi-variable cost and variable cost and because of this it is very easy to know the real impact of cost factors on business profits.
4. Comparable - With the help of Flexible Budget, the actual cost of production may be easily compared with budgeted cost in business and industry and right decisions may be taken by the management well in time.
5. Cost Control - After the completion of the year, the actual cost may be compared with budgeted cost and steps may be taken to minimise the variance. Hence, it helps the management in controlling cost.
6. Determination of Production Level - Flexible Budget shows budgeted cost with classification at various levels of activity along with sales and profits. Hence, the management can easily select the level of production which shows the profit predetermined by the owners of the business. It also shows the quantity of product to be produced to earn determined profit.
7. Other Advantages
(i) Free from the impact of future business uncertainties.
(ii) Knowledge about the impact of external factors on economic activities of the business.
(iii) Marginal analysis is possible.
(iv) Free from the disadvantages of Flexible Budget.
(v) More useful for business and industry whose nature is dynamic and seasonal and affected from the change in the income, habit, interest of the consumers and the business which is also affected from the changing government policy, demonstration effect, business cycles and works under the conditions of perfect and monopolistic competition.
LIMITATIONS OR DEMERITS OF FLEXIBLE BUDGET
1. The formulation of Flexible Budget is possible only when there is a proper accounting system maintained.
2. Flexible Budget also requires the system of standard costing in business.
3. The formulation of Flexible Budget depends upon availability of cost experts in the business.
4. The formulation of Flexible Budget is possible only when the perfect knowledge about the factors of production and variable business circumstances is available.
5. It is very expensive and labour oriented.