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American Public University Advantages of Preparing a Flexible Budget Discussion

American Public University Advantages of Preparing a Flexible Budget Discussion

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STUDENT 1: Wendy

Hello Class,

This week we are discussing the advantages of preparing a flexible budget and whether or not it is worth the trouble given that it is prepared after the end of the period once actual results are known. According to Horngren, Datar, and Rajan, “the only difference between the static budget and the flexible budget is that the static budget is prepared for the planned output …, whereas the flexible budget is prepared retroactively based on the actual output” (2014, p. 253). This statement highlights the fact that the purpose of a flexible budget prepared at the end of the period differs from the purpose of the static budget prepared in advance. Flexible budgets are not so much a tool for planning, rather they are a tool for analyzing the static budget variance in a more detailed way.

For example, managers can perform a level 1 analysis by calculating the static budget variance between the actual results to the static budget for the period. This difference, however, is made up of many variables or variances which are difficult to analyze when they are all combined in one total. When a flexible budget is added to the analysis, managers can isolate the sales volume variance from the fixed budget variance. This is known as level 2 analysis, and it gives managers greater insight into how the actual results increased or decreased planned costs. In addition, the fixed budget variance can be separated into variances for individual line items such as selling price variance, direct materials variance, direct labor variance, variable overhead variance and fixed overhead variance (Horngren et al., 2014). Another advantage of preparing a flexible budget is that it facilitates level 3 analysis which breaks down the flexible variance even further into price, efficiency, and spending variances.

Although it will not change what has already occurred, the preparation of flexible budgets is much more than mere busy work. Lohrmann explains that “managers use a flexible budget system to set financial targets for their department and track progress towards those goals.” (1989, p. 38). If managers do not analyze why costs varied from the static budget, they will not have the information necessary to affect needed changes. Flexible budget analysis gives managers detailed cost information allowing them to focus on specific areas of concern and enables better decision making for future periods. On the other hand, ignoring this vital information could be detrimental to the success of the company.

– Wendy

References

Horngren, C. T., Datar, S. M., Rajan, M. V. (2014). Cost Accounting. [VitalSource Bookshelf]. Retrieved from https://bookshelf.vitalsource.com/#/books/97813234…

Lohrmann, G. M. (1989). Flexible budget system a practical approach to cost management. Healthcare Financial Management: Journal of the Healthcare Financial Management Association, 43(1), 38-7. Retrieved from https://search-proquest-com.ezproxy1.apus.edu/docv…

STUDENT 2: Susan

A flexible budget serves an important purpose for management in cost analysis. It flexes the static budget to reflect actual number of units sold, the actual selling price, and the variable costs per unit sold, while keeping all fixed costs the same as the static budget. Being able to see the costs of actual sales rather than budgeted sales, provides important insight into variances and efficiencies. It is also used as a planning and cost control tool for managers.

I would explain to my coworker how the flexible budget varies from the static budget, and how new information can be learned and applied to the next budget period by analyzing costs and variances, and to evaluate performance. I would emphasize that these variances are used for financial and nonfinancial purposes that help managers make decisions. Nonfinancial uses include setting reasonable goals for future periods and improving upon efficiencies, making product mix decisions, and evaluating managers’ performance. Financial uses for flexible budget analysis involve quite a few areas. For instance, if the selling price is lower than the budgeted selling price, this could indicate a change in the competition’s price or higher variable costs, such as direct materials. An unfavorable variance in the total number of units sold for the period could also indicate that consumer demand for the product has declined, or the competition undercut the firm’s price and the firm responded by reducing their price. Management may be interested to know why the competition was able to lower their costs. Are they accepting a lower profit margin for the short run, or were they able to reduce their fixed costs? Direct labor costs could also vary from the static budget. Looking at labor hours can help managers set standards for unit input in a future budget period that are more accurate. It can also be an indicator that production processes are not efficient enough. In this case, the firm might consider investing in newer technology for some of their processes.

Flexible budgets are also used to plan and control variable and fixed overhead costs. Flexible budgets help managers develop standards for inputs to be used in determining cost allocation bases for variable overhead cost allocation, and capacity levels for allocating fixed manufacturing overhead costs. Flexible budgets reveal spending and efficiency variances that bring to management’s attention, issues that may arise with input rates for electricity or wages (spending variances) or input quantities allowed for actual outputs, such as machine hours (efficiency variances). For fixed overhead costs, flexible budgets allow managers to zero in on any production-volume variances for the period. This helps in choosing the capacity level for allocating fixed costs, and determining used and unused capacity for the period. Knowing the cost per unit of capacity supplied, helps managers to make decisions about taking on additional products or reducing plant size, in the case of unfavorable variances.

Susan

Horngren, C. T., Datar, S. M., Rajan, M. V. Cost Accounting. [VitalSource Bookshelf]. Retrieved from https://online.vitalsource.com/#/books/97813234844…

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