Flexible budgeting can be defined as the use of budget that has capacity to adjust to changes occurring in the quantity of activities. A flexible budget is more complicated and important than a static budget which does not exhibit changes in amounts even when there are changes in activity volumes (Siegel & Shim, 2009). In the following example, the cost of running machines and electricity is $10. In addition, depreciation and supervisory activities in the factory cost $50000 every month. The duration of production activities is expected to be between 4000 and 7000 hours every month (Accounting Coach, 2011). On the basis of this data, the total monthly flexible budget would amount to $40000 (Accounting Coach, 2011).
The flexible budget can be shown using some information. For example, if the equipment involved in production functions for a total of 4000 hours in February, the cost of flexible budget in February will be $ 90000. Changes in the number of hours the equipment is supposed to operate in the subsequent months will lead to a change in the flexible budget for the month (Accounting Coach, 2011).
In cases where the factory manager is mandated to consume additional machine hours, it is prudent to raise the budget of the manager to cater for increased supplies and electricity costs. The budget the manager operates is expected to go down when equipment operations go down. In a nutshell, flexible budgeting makes it easier for managers to plan and control operations. This would definitely not be possible when static budgeting is used instead (Accounting Coach, 2011).
Importance of Flexible Budgeting
The importance of flexible budgeting highly depends on how accurate expenses are categorized into variable, semi-fixed and fixed expenses. Flexible budgeting is important in creating cost estimates for various activity levels. The measurement of these activity levels is based on activity outputs, inputs and levels. Below are some of the reasons that justify the use of flexible budgeting.
Flexible budgeting enables managers to take into consideration varied situations as they plan for the future. If it is not easy to accurately estimate future level of activity, the flexible budget can be run by the managers for more than one level of activity. This gives the managers a chance to generate both best and worst situations to be used in planning on how to use the resources of a company. The managers anticipate a downward shift in actual numbers between the best and worst case situations (Caplan, n.d).
Improved Performance Evaluation
Another reason justifying use of flexible budgeting is that it can be used in evaluating the performance of managers in various departments. However, a few areas like levels of production cannot be controlled by the managers. When there is an increase in the demand of the goods customers purchase, the demand must be accommodated through an increase in the level of production. This has the effect of increasing the expenses which form the basis on which managers are evaluated. In such a scenario, flexible budgeting is very important since it factors the effect of additional production and conducts the desired adjustment in the budget numbers. This facilitates fair and justified evaluation for the manager.
Useful Variance Analysis
Changes in activity levels lead to changes in cost of manufacturing. Variance analysis is involved in comparing budgeted costs with the real or actual cost (Caplan, n.d). When there is no change in budget numbers while there is an increase in the costs, this increases the variance. The impact is done away with by flexible budgeting since considerations of increase in costs brought about by increase in levels of activity are made.
It is crucial for some companies to monitor how their employees spent their time. For example, businesses that offer services are keen on time because it impacts the running of the businesses in terms of the cost incurred. In such businesses, employees are encouraged to utilize their time wisely since this may affect them in monetary terms. Time costing is not a new concept in companies and was introduced with the aim of gathering production, consumption of material and quality in a timely manner. The individual data scenarios are depicted as immediate response on cost, rate of production, consumption and quality to managers charged with production (Economist, 2009).
One of the most popular challenges facing implementation of time costing is the notion that it is a complex idea. However, once it is embraced, it becomes part of business operations and cannot be ignored. Increasing productivity lowers fixed costs but the question of what would happen to the quality remains. Improving quality at the expense of costs and productivity should be checked.
For example, majority of those who operate machines are aware of the fact that when there is an increase in the content of ash there is reduction in the cost of production. However, not many are aware of the exact value reduced. It might be difficult to assign cost and percentages to the decision. Time costing makes it possible for managers to get direct responses in terms of money regarding the savings made by increasing ash for example. Time costing happening after production can be used in determining shifts in production and improving accuracy of the targeted costs.
Issues regarding measurement of costs arise in decision making processes with the aim of determining if production of specific grades should continue. In the absence of time costing, the decision might be made devoid of crucial information. Time costing makes it possible to differentiate between costs and production decisions together with the quality and production level in order to come up with accurate decisions.
Activity Based Costing
Activity-based costing is defined as a process of allocating costs to services or products on the basis of resources used (Bradtke, 2007). It is aimed at transforming the way costs are enumerated. In activity based costing, overhead costs incurred in manufacturing are assigned in a manner that is more logical as opposed to merely assigning costs on the basis of the hours taken by machines. Cost is first assigned to procedures that are responsible for the overheads. To look at activity based costing and how it is different from time costing, let us use two products of one company. Product 40 is described as low volume and involves application of particular activities such as specialized testing and a myriad of machine operations since it is not ordered in large quantities. Another product of the same company, product 86 is described as possessing high volumes.
It runs in a continuous manner and does not require much attention and specialized procedures. If this company uses time costing, it is possible that the overhead costs for products would be allocated on the basis of machine hours. As a result, product 40 would get little allocation of overhead costs because of its little hours in machine operations. On the contrary, product 86 gets huge allocation because of its high volume. The result is that the accurate calculation of the overhead costs for each product will not be achieved (Economist, 2009).
Activity based costing takes cognizance of the fact that special procedures and other procedures lead to cost implications hence they cause companies to use more resources. Increase in overhead costs incurred during manufacturing has caused activity based costing to grow in importance in the recent years. The fact that there is no correlation between overhead costs incurred in manufacturing and machine hours recorded during production has also necessitated activity based costing.
Flexible budgeting involves preparing a budget that has the capacity to adjust to changes taking place in an organization. It is important in that it assists managers to make analysis of various activities that remain uncertain in order to make future decisions. It also helps in variance analysis where budget targets are compared with the real or actual costs. Certain businesses have seen it important to track time for employees and their attendance because time has cost implication in companies. Time costing is different from activity based costing in that the latter assigns costs first on the procedures that result in overhead costs.
Bradtke, D. (2007). Acitivity Based Costing. Norderstedt: GRIN Verlag.
Caplan, D. (n.d). Management accounting: concepts and techniques. Web.
Economic Coach, A. (2011). What is a flexible budget? Web.
Economist, T. (2009). Activity-based costing. Web.
Siegel, j., & Shim, J. (2009). Budgeting Basics and Beyond. New Jersey: John Wiley and Sons.