(UGB253) - Fixed Budget vs Flexible Budget: Understanding Management Accounting for Business

UGB253 Management Accounting for
Business
A 1
A.
Flexible Budget vs Fixed Budget
Fixed budget
It is necessary to grasp what the terms "fixed budget" and "budget" mean before you can
comprehend the phrase "fixed budget." Budget refers to an estimate of the company's economic
activity, while "fixed" refers to anything that is "solid" or "stable." When profits and expenditures
are predetermined in advance, they are referred to as a "Fixed Budget" in this context since they stay
constant regardless of changes in activity levels. When it comes to budgeting, this kind of budget is
referred to as a Static Budget. Providing the company's conditions are stable and forecasting is
straightforward, fixed budgets are an ideal option for businesses that are not at danger of
unanticipated changes in their existing circumstances or external influences, which is the case in
most cases. It's also a good method to keep track of your spending. The management of a
corporation benefits from having a predetermined budget, but it lacks precision since it is hard to
accurately predict future demands and requirements in advance. Aside from that, it only operates on
a single level of activity at a time, which is quite restrictive. When the fixed budget was developed,
it was assumed that the current conditions would not alter in the foreseeable future; nevertheless,
this proved to be erroneous. As a result, it is possible that measures of efficiency and capacity may
be troublesome.
Flexible budget
Having a flexible budget indicates that an organization's financial operations may be readily
adjusted if the budget is kept flexible. In this way, a flexible budget is one that is capable of
accommodating a broad variety of activity levels. It may be possible to simply change or recast the
conclusion, depending on the situation. Because the expenses associated with different levels of
activity can be simply calculated, this is a reasonable and practical option. In the first stage of the
analysis, expenses are divided into three broad categories: fixed, variable, and semi-variable. Semi-
variable costs are further subdivided into fixed and variable costs, respectively. The budget is then
created in accordance with this information. In order to demonstrate how much money will be spent
at each step of the project's development, budgets for different production levels are prepared. They
are particularly appropriate for businesses that have a high degree of unpredictability in sales and
production, sectors that are quickly impacted by external variables or industries that see significant
variations in market circumstances, and so on.
1 | P a g e

What is the difference between Fixed Budget and Flexible Budget?
 In accordance with the following characteristics, budgets may be divided into two categories:
"fixed" and "flexible."
 In finance, a fixed budget is a budget that does not vary in response to actual production.
 The term "flexible budget" refers to a budget that may be quickly altered in response to
changes in production levels.
• A fixed budget remains static, whereas a flexible budget is constantly changing.
 In contrast to a set budget, a flexible budget is capable of operating at a variety of different
levels of output.
 Flexibility in budgeting is based on real facts, while rigidity in budgeting is based on
estimates.
 Due to the inability to recast fixed budgets in light of actual production, they are unable to be
made flexible. Flexible budgets are elastic because they may be altered quickly in response
to changes in production levels.
B.
Flexible Budget Pros:
1. Being able to adjust budgets as your business grows and income rises is more realistic than
having rigid budgets in place.
2. In the event of increasing demand or other external circumstances, this budget model may be
used to explain major deviations from the norm that may have happened.
3. If your spending and revenues are exactly equal to one another, you can automate your
budgeting process.
4. Do you have concerns about what the future may hold? With a flexible budget, it is possible
to account for the unexpected and the unplanned.
5. In the event that you are unclear of how much money you will generate, a flexible budget
model enables you to compare and contrast numerous different options.
Flexible Budget Cons:
1. Budgeting is difficult since there is not always a 1:1 relationship between income and
variable expenses.
2 This approach of budgeting will be ineffective for you if your expenditure is not precisely
proportional to your income.
C.
Behavioral aspects of budgeting
Symbolism: A firm's budget serves as a symbol of the goals and objectives that the organization has
established for itself. It is possible that achieving it will serve as a source of inspiration for other
people's efforts. Employees may underperform if their expectations are set too low, which may
result in a lack of motivation on the part of the organization. Underperformance may stem from
2 | P a g e

setting unrealistically high goals. If the objectives are seen by the personnel to be unreasonable and
unachievable, they may have given up on them. The belief that budget objectives are achievable will
increase employee motivation to strive toward meeting them, according to the study. The more
sophisticated a budget is, the more difficult it is to evaluate its effectiveness. If the budget is set too
low, it is possible that real performance may suffer. Employees may have low expectations as a
result of a lack of motivation. When a budget is set too high, real performance suffers as a result.
Employees who feel the budget is both unachievable and doable may give up on the project
altogether. They do not intend to participate in this activity in order to prevent squandering their
time or effort in any way.
Conduct that is out of whack If the budget and management goals are matched, actual performance
will be in line with or even better than anticipated. The phrase "goal congruence" is used to
characterize this phenomenon. This refers to the consistency and alignment between individual goals
and the aims of the company as a whole. The achievement of the company's objectives will pave the
way for managers to pursue their own personal aspirations. Inconsistency in goal setting has a
detrimental impact on the motivation of managers. The fact that they may put in little (or no) effort
toward the budget may have a detrimental influence on actual performance.
People who are participating in the process of distributing resources are involved in Participatory
Budgeting (also known as IBB). It is possible to construct a budget from the top down or from the
bottom up depending on the situation. The budget is developed from the top down by management,
and then communicated to all workers at the same time. Participants and communicators on the team
aren't doing their jobs well. Workers are more involved in budgeting when they have a say in it, as
research has shown. Incorporating them was a key part of the entire plan. A sense of responsibility
and a connection to the budget are instilled in them as a result. People are more likely to persevere in
the pursuit of their objectives if they have a sense of control over the process. It may be possible to
boost morale and reduce resistance to budget cutbacks by encouraging worker engagement. It's also
possible that it'll help to lessen tensions inside a company. This approach improves the overall
motivation, productivity, and efficiency of the workforce.
Budgetary Discrepancy When the allocated resources do not meet the demands of the situation,
there is financial slack. Throughout the budget formulation process, managers inject financial slack,
which is referred to as "padding the budget." Their expenditures and expenses will be overstated,
while their income will be understated If they make such a request, the organization may feel
obligated to provide them with more resources. The inclination for managers in practically any
business, regardless of sector, to participate in this conduct may be seen. When it comes to putting
up the budget, the management will depend on their previous expertise. Despite their budgetary
requests, they were allocated less money than they had sought. A 5 percent markup is typical of
what they'll add to their estimate in order to cover their costs. To put it another way, even if they cut
down on their spending, they will still get the same amount of money that they had originally
intended to receive. When managers underestimate income and overestimate costs, they create
financial slack in the organization.
A 2
Data
3 | P a g e