Flexible Budgets

Learning Objective 2 Examine the concept of a flexible budget and learn how to develop one

the budget that is adjusted (flexed) to recognize the actual output level
proportionately increase variable costs; keep fixed costs the same

A flexible budget calculates budgeted revenues and budgeted costs based on the actual output in the budget period. The flexible budget is prepared at the end of the period (April 2020 for Webb), after managers know the actual output of 10,000 jackets. The flexible budget is the hypothetical budget that Webb would have prepared at the start of the budget period if it had correctly forecast that actual output for April would be 10,000 jackets. Webb planned for an output of 12,000 jackets so the flexible budget is not the plan Webb initially had in mind for April 2020. In preparing Webb’s flexible budget, all costs are either completely variable or completely fixed with respect to the number of jackets produced. Note the following:

The budgeted selling price is the same $120 per jacket used in the static budget.
The budgeted unit variable cost is the same $88 per jacket used in the static budget.
$\begin{array}{rcl} Budgeted contribution margin per unit & = & Budgeted selling price - Budgeted \\ variable cost per unit \\ = & $ 120 per jacket - $ 88 per jacket \\ = & $ 32 per jacket \end{array}$
The budgeted total fixed costs are the same static-budget amount of $276,000. Why? Because the 10,000 jackets produced falls within the relevant range of 0 to 12,000 jackets for which budgeted fixed costs are $276,000.

The only difference between the static budget and the flexible budget is that the static budget is prepared for the planned output of 12,000 jackets, whereas the flexible budget is prepared retroactively based on the actual output of 10,000 jackets. In other words, the static budget is being “flexed,” or adjusted, from 12,000 jackets to 10,000 jackets.^*

Webb develops its flexible budget in three steps.

Step 1: IDENTIFY THE ACTUAL QUANTITY OF OUTPUT. In April 2020, Webb produced and sold 10,000 jackets.
Step 2: CALCULATE THE FLEXIBLE BUDGET FOR REVENUES BASED ON THE BUDGETED SELLING PRICE AND ACTUAL QUANTITY OF OUTPUT.

$\begin{array}{lll} Flexible ‐ budget revenues & = & $ 120 per jacket \times 10,000 jackets \\ = & $ 1,200,000 \end{array}$

Step 3: CALCULATE THE FLEXIBLE BUDGET FOR COSTS BASED ON THE BUDGETED VARIABLE COST PER OUTPUT UNIT, ACTUAL QUANTITY OF OUTPUT, AND BUDGETED FIXED COSTS.

<p>A table shows flexible-budget costs for Webb</p>

The table depicts flexible-budget costs for Webb. The details of the table are as follows:

1. Flexible-budget variable costs

Direct materials, 60 dollars per jacket times 10,000 jackets: 600,000 dollars
Direct manufacturing labor, 16 dollars per jacket times 10,000 jackets: 160,000 dollars
Variable manufacturing overhead, 12 dollars per jacket times 10,000 jackets: 120,000 dollars
Total flexible-budget variable costs: 880,000 dollars

2. Flexible-budget fixed costs: 276,000 dollars

3. Flexible-budget total costs: 1,156,000 dollars

These three steps enable Webb to prepare a flexible budget, as shown in Exhibit 7-2, column 3. The flexible budget allows for a more detailed analysis of the $93,100 unfavorable static-budget variance for operating income.

A table shows the level 2 flexible-budget-based variance analysis for Webb Company for April 2020.

The flexible budget variances, which are the difference of actual results and flexible budget, are classified as favorable or unfavorable effect on operation system denoted by “F” and “U” respectively.

Actual results (1)
- Units sold: 10,000
- Revenues: dollar 1,250,000
- Variable costs
  - Direct materials: 621,600
  - Direct manufacturing labor: 198,000
  - Variable manufacturing overhead: 130,500
  - Total variable costs: 950,100
- Contribution margin: 299,900
- Fixed manufacturing costs: 285,000
- Operating income: dollar 14,900
Flexible-budget variances (2) equals (1) minus (3)
- Units sold: 0
- Revenues: dollar 50,000 F
- Variable costs
  - Direct materials: 21,600 U
  - Direct manufacturing labor: 38,000 U
  - Variable manufacturing overhead: 10,500 U
  - Total variable costs: 70,100 U
- Contribution margin: 20,100 U
- Fixed manufacturing costs: 9,000 U
- Operating income: dollar 29,100 U
Flexible budget (3)
- Units sold: 10,000
- Revenues: dollar 1,200,000
- Variable costs
  - Direct materials: 600,000
  - Direct manufacturing labor: 160,000
  - Variable manufacturing overhead: 120,000
  - Total variable costs: 880,000
- Contribution margin: 320,000
- Fixed manufacturing costs: 276,000
- Operating income: dollar 44,000
Sales-Volume Variances (4) equals (3) minus (5)
- Units sold: 2,000 U
- Revenues: dollar 240,000 U
- Variable costs
  - Direct materials: 120,000 F
  - Direct manufacturing labor: 32,000 F
  - Variable manufacturing overhead: 24,000 F
  - Total variable costs: 176,000 F
- Contribution margin: 64,000 U
- Fixed manufacturing costs: 0
- Operating income: dollar 64,000U
Static budget
- Units sold: 12,000
- Revenues: dollar 1,440,000
- Variable costs
  - Direct materials: 720,000
  - Direct manufacturing labor: 192,000
  - Variable manufacturing overhead: 144,000
  - Total variable costs: 1,056,000
- Contribution margin: 384,000
- Fixed manufacturing costs: 276,000
- Operating income: dollar 108,000
Level 2:
- Flexible-budget variance: dollar 29,100 U
- Sales-volume variance: dollar 64,000 U
Level 1:
- Static-budget variance: dollar 93,100 U

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