Flexible vs Fixed budgeting

A fixed budget is prepared for a single, planned level of activity and is not changed once set; it is used mainly for planning (it is the original target). A flexible budget is adjusted (flexed) to the actual level of activity achieved — recalculating the variable costs at the actual output while leaving fixed costs unchanged; it is used mainly for control, because it allows a fair comparison of actual results with budget at the same activity level.

Flexed variable costs = 7 × 14,000 = $98,000. Fixed costs (unchanged) = $50,000. Flexed total cost = 98,000 + 50,000 = $148,000.

Original (fixed) budget = (12 × 10,000) + 60,000 = 120,000 + 60,000 = $180,000. Flexed budget = (12 × 11,500) + 60,000 = 138,000 + 60,000 = $198,000. Cost variance = flexed 198,000 − actual 205,000 = $7,000 Adverse.

Comparing the actual cost ($205,000) with the original fixed budget ($180,000) would suggest a $25,000 adverse variance, but most of that simply reflects the extra 1,500 units produced (a volume effect), not poor cost control. The flexed budget restates the budget at the actual output of 11,500 units, so comparing it with the actual cost gives a fair, like-for-like variance of $7,000 Adverse that genuinely measures how well costs were controlled at that output. This is why flexible budgeting is fairer for control.

Variable costs (such as direct materials and direct labour) change in proportion to output, so when the actual output differs from the planned level, the budgeted variable costs must be recalculated for the actual number of units — otherwise the comparison would be meaningless. Fixed costs (such as rent or insurance) do not change with output within the relevant range — the business incurs the same amount whether it makes a few more or fewer units — so they are left unchanged when flexing. Flexing only the variable costs gives the budget that should apply at the actual activity level.

A fixed budget is prepared for a single planned level of activity. When the actual level of activity turns out to be different, comparing the actual costs with the fixed budget is unfair and misleading: the variable costs will naturally differ simply because more or fewer units were made, so the resulting variance mixes the effect of volume with the effect of cost control. Managers could be wrongly blamed for an adverse variance that is really just higher output, or wrongly praised when output was lower.

A flexible budget is flexed to the actual level of activity — the variable costs are recalculated at the actual output while the fixed costs are kept unchanged. Comparing the actual results with this flexed budget is a like-for-like comparison at the same activity level, so the variances isolate performance/efficiency from volume. The variances are therefore meaningful and managers can be held fairly accountable, which also supports motivation. The difference between the fixed and flexed budgets separately shows the volume effect.

So while the fixed budget is useful for planning, the flexible budget gives the fairer, more meaningful information needed for control — which is why it is preferred for monitoring and assessing performance.

Variance = flexed budget − actual = 148,000 − 143,500 = $4,500 Favourable. As this compares the actual cost with the budget for the same (actual) level of output, the favourable variance indicates that the business controlled its costs well — it spent $4,500 less than it should have for that output. Because the comparison is at the actual activity level, the variance reflects genuine cost control/efficiency rather than any difference in volume.

Variable part = 4 × 13,000 = $52,000. Fixed part = $18,000 (unchanged). Flexed overhead = 52,000 + 18,000 = $70,000.

The difference between the fixed budget (at the planned activity) and the flexed budget (at the actual activity) represents the volume effect — the change in budgeted variable costs (and revenue) caused purely by the difference in output between planned and actual. Management should be aware of it because it is not a performance issue: it reflects only that more or fewer units were made or sold, not how efficiently costs were controlled. Separating this volume effect from the cost-control variance (actual vs flexed) ensures managers are not unfairly blamed or credited for changes in volume, and that attention is focused on the variances they can actually control.

(a) Setting the original annual plan → a fixed budget, because at the planning stage the actual activity is not yet known, so the budget is set for a single planned level as the target. (b) Assessing cost control → a flexible budget, because it is flexed to the actual activity, allowing a fair like-for-like comparison that isolates cost-control performance from the effect of volume.

Flexed revenue = 25 × 11,000 = $275,000. Flexed variable costs = 14 × 11,000 = $154,000. Fixed costs (unchanged) = $60,000. Flexed profit = 275,000 − 154,000 − 60,000 = $61,000. (Both revenue and variable costs are flexed to the actual 11,000 units; fixed costs stay the same.)