11.7 FLEXIBLE BUDGETING
Flexible budgeting, or variable budgeting as it is sometimes called, is a technique for budgeting based on the future variability of business volumes. It is generally used to develop budgets for expense accounts that flex or change according to specific actual business volumes, such as units of product manufactured, personnel employed, claims processed, or patients served. Flexible budgeting usually involves recording these key business volumes using general ledger statistical accounts.
THE VARIABLE NATURE OF COSTS
To fully understand the reason for flexible budgeting, one must appreciate the variable nature of costs . As an example, consider production volume in a manufacturing environment and its effect on different classifications of manufacturing costs:
Figure 11-17 Detailed Budget Listing Comparing the Original and Revised Budgets. Adapted from Budgeting and Profit Planning Manual, 2nd edition, by James D. Willson. Copyright © 1983, 1989 by Warren, Gorham & Lamont, Inc. All rights reserved.
1. Variable Costs. These change in direct proportion to production volume.
2. Semivariable Costs. These costs vary with production volume, but not in direct proportion. Supervision expense, gas and electric utility expenses, and accounting department salaries are examples of semivariable costs: twice the volume requires more expense, but quite twice as much. With semivariable costs, the relation between cost and volume can be linear, nonlinear, or a step function.
3. Fixed Costs. Fixed costs do not vary with production volume. Rent, executive salaries, and insurance are examples of fixed costs that remain fixed for a reasonable variation of business volumes.
With such sensitivity between costs and volumes, an anomaly can arise when using fixed budgeting to budget certain of these costs. Business volumes may affect a budget manager's ability to meet a predetermined, fixed budget, but that budget manager can have no ability to control the business volume itself.
Because the budgeting system is designed to segment the budget goals of the entire organization into specific budget goals for which each budget manager is accountable, it is desirable to separate the elements that the budget manager cannot control and monitor his performance by the items that he can control. Flexible budgeting does this. Given the three types of costs mentioned above, flexible budgeting techniques help develop effective budgets for expense accounts containing variable and semivariable costs. Expense accounts containing fixed costs may be managed according to a fixed budget that is not affected by business volumes.
DEFINING A FLEXIBLE BUDGET
In a flexible budget the budget manager creates a budget for one account that is dependent on another account's actual activity. The budget for direct labor expense may be defined according to actual production volume that occurs during the same period, for example. Flexible budgeting uses this relationship in developing the budget of the dependent account.
System Set-up. The budgeting system defines the flexible budget for an account based on the computation:
Flexible Budget = Fixed Budget Amount + Budgeted Rate x Business Volume Indicator
The system can accommodate this calculation through an input screen such as the one shown in Figure 11-19. This screen allows for multiple "Actual Amount" accounts to be specified. Note how this differs from the calculated account budgets discussed earlier. Budget calculation relies on other budget amounts to calculate a budget line item, whereas flexible budgeting usually calculates the budget based on actual performance of the business volume indicator.
In an environment where the nature of operating costs are more complex, the budgeting system may be required to calculate a flexible budget according to more sophisticated methods. Some semivariable costs may best be represented using nonlinear relations between the Business Volume Indicator and the Fleixible Budget. Examples include using a logarithmic relation or a step function For example, suppose one plant supervisor is required for every 500 units of output. This flexible budget would require entry of the various breakpoints of 500, 1000, and 1500 units and the number (or cost) of supervisors associated with each breakpoint.
NEXT MONTH'S TOPIC: FLEXIBLE BUDGETING EXAMPLE
Material in this chapter has been adapted and reprinted with the permission of Warren, Gorham & Lamont, Inc., from Chapter 43, “Automated Budget Systems,” in Budgeting and Profit Planning Manual, 2nd edition, by James D. Willson. Copyright 1983, 1989 by Warren, Gorham & Lamont, Inc. 210 South Street, Boston, MA 02111. All rights reserved.