8 Flexible Budgeting
- Given a master budget, prepare flexible budgets for levels of sales that differ from predicted sales
- Understand how variable costs behave in a flexible budget
- Understand how fixed costs behave in a flexible budget
The Theory
Preparing a master budget is a traditional way to plan for future events, but it relies on a prediction of sales volume that may not actually happen, especially if the economy is volatile.
A flexible budget is very similar to a master budget, but it is not based on a single estimate of sales. Instead, it is prepared for a range of sales levels, so that managers can get a better picture of what costs and income should be given different outcomes. Flexible budgets allow managers to perform sensitivity (what-if) analyses and provide better benchmarks than the master budget for evaluating actual results.
The Method
Usually, a flexible budget is presented in a spreadsheet, with a column for each potential sales level. To prepare a flexible budget, use the master budget as a starting point. Keep fixed costs for each sales level the same as they are in the master budget, but adjust revenues and variable costs for each different sales level. The different sales levels can be expressed as sales units or revenues, or they can be expressed as percentages, such as 10% higher or lower than sales on the master budget.
If different levels of sales units are given, divide the revenues or variable costs on the master budget by the sales units on the master budget to find the per-unit sales price or cost. Then, multiply the per-unit amount by each of the different sales unit estimates to find the amount in each flexible budget column.
If percentages higher or lower than master budget sales are given, first multiply the sales units on the master budget by one plus a percentage higher or one minus a percentage lower to find the sales units in each flexible budget column, then use the procedure above.
After calculating revenues and all costs for each flexible budget level, calculate cost of goods sold, gross margin, and operating income for each.
Illustrative Example
MaciaCorp has prepared the following budget for January of next year:
| Description | Amount | Total |
|---|---|---|
| Sales revenue (for 75,000 units) | 3,750,000 | |
| Cost of goods sold | ||
|
Direct materials used |
1,125,000 | |
|
Direct labor |
900,000 | |
|
Variable factory overhead |
600,000 | |
|
Fixed factory overhead |
200,000 | 2,825,000 |
|
Gross margin |
|
925,000 |
|
Operating expenses |
||
|
Variable |
375,000 |
|
|
Fixed |
300,000 |
|
|
Operating income |
|
Single Line250,000Double Line |
Prepare a flexible budget for MaciaCorp for January if sales are as expected, 5% above expectations, 5% below expectations, 10% above expectations, and 10% below expectations.
First, find the sales estimates for each level of the flexible budget:
- 10% below: 75,000 units × 90% = 67,500 units
- 5% below: 75,000 units × 95% = 71,250 units
- 5% above: 75,000 units × 105% = 78,750 units
- 10% above: 75,000 units × 110% = 82,500 units
Next, copy fixed expenses from the master budget:
|
Sales level |
Expected |
10% below |
5% below |
5% above |
10% above |
|
Unit sales |
75,000 |
67,500 |
71,250 |
78,750 |
82,500 |
|
Revenue |
3,750,000 |
|
|
|
|
|
Cost of goods sold: |
|
|
|
|
|
|
Direct Materials |
1,125,000 |
|
|
|
|
|
Direct Labor |
900,000 |
|
|
|
|
|
Variable MOh |
600,000 |
|
|
|
|
|
Fixed MOh |
200,000 |
200,000 |
200,000 |
200,000 |
200,000 |
|
Total cost of goods sold |
2,825,000 |
|
|
|
|
|
Gross margin |
925,000 |
|
|
|
|
|
Variable operating |
375,000 |
|
|
|
|
|
Fixed operating |
300,000 |
300,000 |
300,000 |
300,000 |
300,000 |
|
Operating income |
250,000 |
Next, divide revenues and each variable cost by unit sales on the master budget (75,000), and multiply by unit sales in each column:
|
Sales level |
Expected |
10% below |
5% below |
5% above |
10% above |
|---|---|---|---|---|---|
|
Unit sales |
75,000 |
67,500 |
71,250 |
78,750 |
82,500 |
|
Revenue |
3,750,000 |
3,375,000 |
3,562,500 |
3,937,500 |
4,125,000 |
|
Cost of goods sold: |
|
|
|
|
|
|
Direct Materials |
1,125,000 |
1,012,500 |
1,068,750 |
1,181,250 |
1,237,500 |
|
Direct Labor |
900,000 |
810,000 |
855,000 |
945,000 |
990,000 |
|
Variable MOh |
600,000 |
540,000 |
570,000 |
630,000 |
660,000 |
|
Fixed MOh |
200,000 |
200,000 |
200,000 |
200,000 |
200,000 |
|
Total cost of goods sold |
2,825,000 |
|
|
|
|
|
Gross margin |
925,000 |
|
|
|
|
|
Variable operating |
375,000 |
337,500 |
356,250 |
393,750 |
412,500 |
|
Fixed operating |
300,000 |
300,000 |
300,000 |
300,000 |
300,000 |
|
Operating income |
250,000 |
|
|
|
|
Finally, calculate subtotals and total operating income:
|
Sales level |
Expected |
10% below |
5% below |
5% above |
10% above |
|---|---|---|---|---|---|
|
Unit sales |
75,000 |
67,500 |
71,250 |
78,750 |
82,500 |
|
Revenue |
3,750,000 |
3,375,000 |
3,562,500 |
3,937,500 |
4,125,000 |
|
Cost of goods sold: |
|
|
|
|
|
|
Direct Materials |
1,125,000 |
1,012,500 |
1,068,750 |
1,181,250 |
1,237,500 |
|
Direct Labor |
900,000 |
810,000 |
855,000 |
945,000 |
990,000 |
|
Variable MOh |
600,000 |
540,000 |
570,000 |
630,000 |
660,000 |
|
Fixed MOh |
200,000 |
200,000 |
200,000 |
200,000 |
200,000 |
|
Total cost of goods sold |
2,825,000 |
2,562,500 |
2,693,750 |
2,956,250 |
3,087,500 |
|
Gross margin |
925,000 |
812,500 |
868,750 |
981,250 |
1,037,500 |
|
Variable operating |
375,000 |
337,500 |
356,250 |
393,750 |
412,500 |
|
Fixed operating |
300,000 |
300,000 |
300,000 |
300,000 |
300,000 |
| Operating income | 250,000 | 175,000 | 212,500 | 287,500 | 325,000 |
Palmer Company has prepared the following budget for March:
| Description | Amount | Total |
|---|---|---|
| Sales revenue (for 28,000 units) | 4,200,000 | |
| Cost of goods sold | ||
| Direct materials used |
840,000 |
|
| Direct labor |
1,260,000 |
|
| Variable factory overhead |
560,000 |
|
| Fixed factory overhead |
400,000 |
3,060,000 |
| Gross margin |
|
1,140,000 |
| Operating expenses | ||
| Variable |
700,000 |
|
| Fixed |
200,000 |
|
| Operating income |
|
Single Line240,000Double Line |
Selling price per unit, variable cost per unit, and total fixed costs are anticipated to remain constant each month.
Prepare a flexible budget for March for sales levels 10% and 20% above and below expectations.
Lecture Examples
Your firm’s master budget for the period is as follows:
|
Units sold |
12,000 |
|---|---|
|
Revenues |
1,440,000 |
|
Variable costs |
|
|
Direct materials |
720,000 |
|
Direct labor |
192,000 |
|
Variable MOh |
144,000 |
|
Total |
1,056,000 |
|
Contribution margin |
384,000 |
|
Fixed costs |
276,000 |
|
Operating income |
108,000 |
- Prepare a flexible budget for sales 25% higher and 25% lower than planned.
A budget that is prepared for a range of sales estimates instead of a single estimate of sales
A “what-if” analysis in which managers examine different predicted scenarios, which can be useful when economic conditions are uncertain
