Flexible Budget
Estimation of future levels of activity with any accuracy is extremely difficult in
some businesses because of presence of external incontrollable influences. For example,
a business which provides luxury goods & services may be very sensitive to changes
occurred in the economic climate. Weather may affect some business & prediction
of weather conditions is difficult. In such cases, if comparison is done between actual
results & budgeted figures, the result may be extremely misleading. It would not
be clear without making detailed investigation, for example, whether either because
of overspending or merely because the business activity level was above the budgeted
level or both, there had arisen a large adverse cost variance. As a result, it becomes
really difficult to control & appraisal of performance.
With the preparation of a flexible budget the problem can be solved. Thus, a flexible
budget can be defined as a range of budgets which covers a number of different expected
levels of activity. It becomes possible to draw up an appropriate ‘flexible’ budget
from the range once actual production is known, also the expenses can be set out which
would be appropriate to the achieved level of activity.
The main requirement of a flexible budget is that the analysis of expenses should be
done into three distinct categories:
- Fixed expenses, i.e. irrespective of the levels of activity, these
expenses would be remaining the same.
- Variable expenses, i.e. with the change in levels of activity,
these expenses would change in proportion to that level.
- Semi-variable expenses, i.e. analysis of these expenses into fixed & variable elements are needed to be done.
As already stated, the advantage of flexing a budget is that, for the purposes of control & appraisal of performance, the comparison can be done of the actual performance with the flexed budget.
Illustration1: For the production of 10000 units of a product,
the following are the budgeted expenses:
$
(per unit)
Direct material 30
Direct Labour 15
Variable overhead 12.50
Fixed overhead ($ 75000) 7.50
Variable expenses (direct) 2.50
Selling expenses (10% fixed) 7.50
Administration expenses ($ 25000 rigid for all production levels) 2.50
Distribution expenses (20% fixed) 2.50
Total cost of sale per unit 80.00
Prepare a budget for production of 12000, 14000 & 16000 units showing distinctly
marginal cost & total cost.
Solution: Flexible
Budget
Per
unit 12000 units 14000
units 16000 units
$ $ $ $
Direct Material 30 360000 420000 48000
Direct Labour 15 180000 210000 240000
Direct Variable expenses 2.50 30000 35000 40000
Variable Overhead:
Production 12.50 150000 175000 200000
Selling (Workings 1) 6.75 81000 94500 108000
Distribution (Workings 2) 2.00 24000 28000 32000
Marginal Cost 137.50 825000 962500 1100000
Fixed Production Overhead 75000 75000 75000
Administration Overhead 25000 25000 25000
Selling Overhead (Workings 1) 7500 7500 7500
Distribution Overhead (Workings 2) 5000 5000 5000
Fixed Cost 112500 112500 112500
Total Cost 937500 1075000 1212500
Cost per unit 78.125 76.78 75.78
Workings:
(1) Selling Expenses:
Total for 10000 units is $ 75000. 10% of this i.e. $ 7500 is fixed & the
balance of $ 67500 is variable. Hence, variable cost per unit is $ 6.75.
(2) Distribution expenses:
Total for 10000 units is $ 25000. 20% of this i.e. $ 5000 is fixed & the balance
of $ 20000 is variable. Hence, variable cost per unit is $ 2.
Illustration 2: At a capacity level of 2500 units for
article P, the cost per unit is $ 7.50. The details are given under A below.
A B
Material cost $
70000 100% varying
Labour cost $
30000 100% varying
Power $ 4000 80%
varying
Repairs $ 6000 75%
varying
Stores $ 2000 100%
varying
Inspection $ 1200 20%
varying
Depreciation $
20000 100% fixed
Administration overhead $
10800 20% varying
Selling overhead $ 6000__ 50%
varying
$
1500000
Calculate the cost per unit of the product, showing at production levels of 2000 units & 3000
units, the individual expenses.
Solution: Flexible
Budget
Per
unit 2000 units 2500
units 3000 units
Production $ $ $ $
Variable Cost:
Material 28.00 56000 70000 84000
Labour 12.00 24000 30000 36000
Stores 0.80 1600 2000 2400
Power (Workings 1) 1.28 2560 3200 3840
Repairs (Workings 2) 1.80 3600 4500 5400
Inspection (Workings 3) 0.096 192 240 288
Administration Overhead
(Workings 4) 0.864 1728 2160 2592
Selling Overhead
(Workings 5) 1.20 2400 3000 3600
Total Variable Cost (a) 46.04__ 92080 115100 138120
Fixed Cost:
Depreciation 20000 20000 20000
Power (Workings 1) 800 800 800
Repairs (Workings 2) 1500 1500 1500
Inspection (Workings 3) 960 960 960
Administration Overhead (Workings 4) 8640 8640 8640
Selling Overhead (Workings 5) 3000 3000 3000
Total Fixed Cost (b) 34900 34900 34900
Total Cost (a +b) 126980 150000 173020
Cost per unit 63.49 60.00 57.673
Workings:
(1) Power:
Total for 2500 units is 4000. 80% of this i.e. $ 3200 is variable & the balance
20%, i.e. $ 800 is fixed. Variable cost per unit is $ 1.28.
(2) Repairs:
Total for 2500 units is 6000. 75% of this i.e. $ 4500 is variable & the balance
25%, i.e. $ 1500 is fixed. Variable cost per unit is $ 1.80.
(3) Inspection:
Total for 2500 units is 1200. 20% of this i.e. $ 240 is variable & the balance
80%, i.e. $ 960 is fixed. Variable cost per unit is $ 0.096.
(4) Administration Overhead:
Total for 2500 units is 10800. 20% of this i.e. $ 2160 is variable & the
balance 80%, i.e. $ 8640 is fixed. Variable cost per unit is $ 0.864.
(5) Selling Overhead:
Total for 2500 units is 6000. 50% of this i.e. $ 3000 is variable & the balance
50%, i.e. $ 3000 is fixed. Variable cost per unit is $ 1.20.
Illustration 3:
A single product is manufactured by PS ltd. which is facing severe competition
in selling it at $ 100 per unit. At 60% level of activity, the company is operating & at
that level sales are $ 2400000.Variable costs are $ 60 per unit. At $ 180000,
when output is nil, the semi-variable costs may be considered as fixed & the variable
element is $ 500 for each additional 1% level of activity. At the present level of
activity, fixed costs are $ 300000 but these costs are expected to increase by $ 100000,
if a level of activity of 80% or above are reached.
To cope with the competition, a proposal of reducing the selling price by 5% is being
considered by the management of the company. You are required to prepare a statement
showing the operating profit at level of activity of 60%, 70% & 80% assuming that:
- the selling price remaining at $ 100, &
- there is a reduction in the selling price by 5%.
Also show the number of units which will be required to be sold for maintaining the present profits if the company decides to reduce the selling price of the product by 5%.
Solution: Flexible
Budget
Activity level 60% 70% 80%
Sales units 24000 28000 32000
$ $ $
Variable costs $ 60 per unit 1440000 1680000 1920000
Add: $ 500 for every 1% of activity 30000 35000 40000
Total Variable costs 1470000 1715000 1960000
Fixed Costs (including fixed parts
Of
semi-variable costs) 480000 480000 580000
Total costs 1950000 2195000 2540000
Sales @ $ 100 per unit 2400000 2800000 3200000
Profit 450000 605000 660000
Sales @ 95 per unit 2280000 2660000 3040000
Profit 330000 465000 500000
Volume of sales to maintain existing profit of $ 450000 with reduced selling price
of $ 95.
Contribution per unit: $
Sales at 60% level 2280000
Variable costs 1470000
Total contribution 810000
Contribution per unit = $ 810000 = $ 16.875
24000
Volume of Sales required: $
Desired profit 450000
Fixed costs 480000
Contribution required 930000
Volume of sales required = Contribution required = $ 930000 = 55111 units.
Contribution
per unit 16.875
Illustration 4:
A factory is currently running at 50% capacity & produces 5000 units at a cost
of $ 90 per unit as per below details:
Material $
50
Wages $
15
Factory overheads $
15 (40% fixed)
Administration overheads $
10 (50% fixed)
The current selling price is $ 100 per unit. Material cost per unit, at 60% capacity,
increases by 2% whereas selling price per unit falls by 2%. However, material cost
per unit increases, at 80% capacity working, by 5% & selling price per unit falls
by 5%.
Prepare a marginal cost statement showing for the three capacity levels, the total
cost & profit. Also comment on the profitability at these levels of performance.
Solution: Marginal
Cost Statement
50%
capacity 60%
capacity 80%
capacity
5000
units 6000
units 8000
units
Per
unit Total Per
unit Total Per
unit Total
$ $ $ $ $ $
Variable costs:
Materials 50 250000 51 306000 52.50 420000
Labour 15 75000 15 90000 15 120000
Factory Overheads 9 45000 9 54000 9 72000
Administrative Overheads 5 25000 5 30000 5 40000
Total
Variable Costs 79 395000 80 480000 81.50 652000
Sales 100 500000 98 588000 95.00 760000
Contribution 21 105000 18 108000 13.50 108000
Fixed Costs:
Factory Overhead 30000 30000 30000
Administrative Overheads 25000 25000 25000
Total Fixed Costs 55000 55000 55000
Profit 50000 53000 53000
% of profit on sale 10% 9% 7%
Comments:
- When the level of activity has been raised from 50% to 60%, profit increases from
$ 50000 to $ 53000 whereas when the level of activity raised to 80% capacity, profit
does not increase further.
- % of profits on sales gradually decreases as the level of activity rises.
- The increase of production up to 60% level of activity is profitable & not beyond that.
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