Flexible Budgets

Flexible Budgets

A budget manager must decide if the budget needs changed over time or needs to stay the same. A flexible budget can change based on the actual activity while a budget that does not change is a static budget. There are two different types of cost used in a flexible budget fixed and variable. A flexible budget must also lend itself to the CVP analysis. A cost-volume-profit (CVP) analysis is used to analyze the changes in cost and volume by using a company’s income statement and contribution margin. It is important to understand the types of budgets.

Fixed Cost vs. Variable Cost

A fixed cost refers to the total costs that constantly persist within a relevant range of activities, and have a likelihood of these activities to occur. For example, depreciation, fixed annual insurance premium, salary earnings, property tax, and annual fixed rental charges are defined as fixed costs for a limited time period. However, a change in plant capacity, machinery, labor, or other production elements can cause fixed costs to increase or decrease, which can affect the business profitability. Also, fixed unit cost fluctuates inversely with activities. For example, on a per unit basis, fixed cost decreases as the activity increases generating favorable or unfavorable variance depending on the planned activities being overstated or understated. (Edmonds, 2007)

A variable cost refers to cost that change in direct proportion to change in productivity output and on a per unit basis it remains constant. However, an increase in sales can be due to price reduction resulting in unfavorable cost variances and favorable revenue variance producing the higher contribution margin. The following are examples of variable costs: direct materials, hourly direct labor, tool, operating supplies, sales commission, etc. (Edmonds, 2007)

Fixed Costs and Variable Cost Differences

The main difference between fixed and variable cost is that the fixed cost remains constant regardless...