Flexible budgets are budgets that are prepared to reflect the expected revenue and expenses based on the actual level of activity (Accounting Tools, n.d.). Variance is the difference between the flexed revenue and expenses and the actual revenue and expenses (Assad, n.d.). Variance analysis provides businesses with important information about the performance of the various budget items including overheads, expenses, and profits (Assad, n.d.). Unlike a static budget that is prepared at the start of the period, flexible budgets are prepared at the end of the period in order to capture the actual activity level (Assad, n.d.). A static budget is prepared based on an expected or projected level of activity.
A favorable variance improves the overall income of the business while a negative variance indicates an unexpected rise in costs or reduction in revenues that reduces the overall income of the business. Negative variances identify areas that businesses must improve on in order to boost their profitability (Assad, n.d.). For instance, if the static budget has material cost of $30 per item, while the flexible budget has a material cost of $40, this would indicate a negative or adverse variance on material cost. The business may need to investigate the cause of the negative material variance. Some of the possible reasons for the negative material variance would include a planning error, increase in material prices, or use of higher quality material.
Reference list
Accounting Tools. (n.d.). What is a flexible budget variance? - Questions & Answers –
AccountingTools. Retrieved February 24, 2016, from http://www.accountingtools.com/questions-and-answers/what-is-a-flexible-budget-variance.html
Assad, A. (n.d.). Why Would a Company Find a Flexible Budget Variance More Informative?
Retrieved February 24, 2016, from http://smallbusiness.chron.com/would-company-flexible-budget-variance-informative-34699.html
