Budgeting Basics and Beyond

7.5. Fixed Budgets versus Flexible Budgets and Performance Reports

A fixed (static) budget presents budgeted amounts at the expected capacity level. It is best used when the department's activities (e.g., sales) are stable. A deficiency with the static budget is the lack of flexibility to adjust to unexpected changes.

The fixed budget is suitable for a department whose workload does not have a direct relationship to sales, production, or other volume related to a department's operations. The workload is determined primarily by management decision instead of sales volume. Some examples of departments in this category are administrative and marketing. Fixed budgets may be used for projects involving fixed appropriations for specific programs, such as capital expenditures, advertising and promotion, and major repairs.

A flexible budget is a tool that is extremely useful in cost control. In contrast to a static budget, the flexible budget

• Is geared toward a range of activity rather than a single level of activity

• Is dynamic in nature rather than static. By using the flexible budget formula, a series of budgets can be easily developed for various levels of activity.

Four steps are involved in creating a flexible budget:

1. Estimate the range of expected activity for the period.

2. Analyze cost behavior trends, whether fixed, variable, or mixed.

3. Separate costs by behavior, that is, break up mixed costs into variable and fixed.

4. Determine what costs will be incurred at different levels of activity. ...