The master budget discussed before is a fixed budget.

A fixed budget is defined by:

  • Only one level of activity
  • Not adjusted to reflect actual activity level when change occurs

A fixed budget has the following limitations:

  • It provides little assistance at the planning stage. It does not give implication of various alternative strategies which management may wish to consider.
  • It fails to provide relevant and reliable base against which to measure actual performance where actual activity differs from the budget.
  • Little motivation to management to use the budgeting control system as a control aid.

Flexible budget is a budget which is designed to change in accordance with the level of activity attained. It involves budgeting at various levels in anticipation of changes. The original budget is adjusted (flexed) to reflect the actual conditions in which the performance was done.

It is more useful than fixed budgeting due to:

  • It provides a range of information at the planning stage which will assist in short term planning.
  • Control: It provides control data when compared with actual performance.
  • Motivation: More likely to be acceptable to management to provide a positive motivational stimulus because the control data is adjusted to conform with current activity level.

CHOICE OF BUDGET FLEXING BASIS

The most appropriate flexing basis should be considered in that it assists in the comparison of alternative budget data at the planning stage and for the comparison of budget and actual data at the control stage.

Different organizations use different flexing bases but the following are most commonly used.

  • Machine hours
  • Direct labour hours
  • Input to a cost centre
  • Output from a cost centre

For the above flexing bases to be used a number of requirements must be fulfilled.

  • The flexing bases should be correlated with the way in which costs vary. E.g. does the number of miles traveled by distribution vehicles affect the repairs and maintenance expenses?
  • The flexible bases should be easily understood by the management and not subject to manipulation.
  • The flexible bases should be readily obtainable.
  • It should be independent of other factors.

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