Code 1147 (ACC213)

Pelier, Christian C.

Reflection NO.3 – STATIC and FLEXIBLE BUDGETS

Static and flexible budgets are both based on the same per unit variable amounts
and the same total fixed costs. Both static and flexible budgets are prepared with the same
assumption for per unit variable costs and total fixed costs. One of the decisions that a
budget manager has to make is whether to allow budgets to change over the course of a
reporting period. A budget that never change is called static, while on the other hand flexible
budget is a budget that changes based on actual activity. A static budget is planned ahead
of time based upon your best educated guess about future actual activity. Static budgets are
usually planned a year in advance, broken out into smaller reporting periods such as months
and quarts. In contrary, flexible budgeting is a more sophisticated method because you can
make changes to the budget in the middle of the reporting period. However, you may not
have the time, experience or inclination to adjust the budget frequently. Also there may be
unexpected effects from an unexpected change in volume, for which you won’t know to plan.
Flexible budgets require knowing in advance which costs are variable or fixed, and how
expenses are affected by changes in revenue. Businesses can use these two kinds of
budgets. Many organizations choose to use both since static budgets are good for some
things and flexible budgets are good for others. They both play a part in good business
accounting and are often used in personal finance too.

Both approaches offer advantages and disadvantages for the new business owner.
Static budgets are great for keeping your production cost in line. They are useful to
encourage your procurement staff to obtain the goods and services you need at the lowest
possible price. On the other hand, flexible budgets can be enough for an entire company’s
budget in some industries. It’s best use as part of the larger overall budget. It’s the best
choice for things like a variable expense account. These two approaches have its own pros
and cons. The pros of a strategic budget includes easy to implement and follow since they
do not require constant updating, offers great insight into a company’s costs and profits
when you perform a variance analysis, built-in cost controls and accountability since there’s
no “wiggle room” built into the budget, great for a master budget, and lastly it simplifies taxes
and makes it easier to estimate taxes owned. Behind these pros of strategic budget is its
consequence which is it has no flexibility. If the budget is built on a certain production level,
and production volume changes significantly, the resources can’t easily be reallocated to
account for the change. On the other hand, flexible budget also has its pros and these are
better cost control, it allows you to roll with the punches so you can easily address changes
in your circumstances and market conditions such as business volume and market
fluctuations, provides a more accurate reflection of your current financial state, resource
allocation is less rigid, helps to account for unexpected expenses and makes it easier for you
to mitigate risk while pursuing new opportunities in your organization. Conversely, it has its
cons such as it limits the ability to plan in areas where the budget is changing, predictions
don’t last as long, flexible budgets are more time consuming and require additional oversight
and maintenance, and lastly there’s less accountability to stick to the original budget.

In applying these concepts of budgeting, they may differ thoroughly. The static
budget is commonly used in nonprofit, education, and government organizations because
these institutions are typically granted a specific amount of money. The static budget is a
useful tool for managers to use as a guide for any given period as it remains unchanged.
This means that managers can use it as a way to benchmark costs and revenue while others
in the organization can use it to assist with basic forecasting. Understanding what a static
budget is, how it is made, and why it is important will help you to determine if creating and
implementing a static budget is appropriate for your organization. A static budget is the result
of basic forecasting. The process of building a static budget is no different than any other
form of budgeting. Bear in mind that the budget is typically based on historical information
adjusted for expectations on changing demand, market expansion, and cost of goods sold
among other aspects. It is always important to start with good data and relevant, realistic
assumptions. You can choose to build your budget based on a percentage of revenue or
using actual values. It is typically recommended to use historical information to calculate a
percentage of revenue. In contrary, the flexible budget adjusts to changes in actual revenue
levels. Actual revenues or other activity measures are entered into the flexible budget once
an accounting period has been completed, and it generates a budget that is specific to the
inputs. The budget is then compared to actual expenses for control purposes. The steps
needed to construct a flexible budget are: First, identify all fixed costs and segregate them in
the budget model, then determine the extent to which all variable costs change as activity
measures change, create the budget model, where fixed costs are “hard coded” into the
model, and variable costs are stated as a percentage of the relevant activity measures or as
a cost per unit of activity measure, enter actual activity measures into the model after an
accounting period has been completed. These updates the variable costs in the flexible
budget and lastly, enter the resulting flexible budget for the completed period into the
accounting system for comparison to actual expenses. The greatest advantage that a
flexible budget has over a static budget is its adaptability. In the real world, change is real
and it is constant. A flexible budget can handle that reality and better position a company for
the challenges of the marketplace. A flexible budget can be created that ranges in level of
sophistication. Several variations on the concept are noted below. In short, a flexible budget
gives a company a tool for comparing actual to budgeted performance at many levels of
activity. So therefore, in conclusion, static budget exhibits greater importance toward
process innovation, while flexible budget exhibits greater importance toward product
innovation.