Flexible Budget

Learning Outcomes

  • Prepare a flexible budget for a manufacturing company

Let’s review GelSoft’s costs, both variable and fixed.

Variable costs, per the master budget, consist of direct materials, direct labor, and a small amount of variable manufacturing overhead (such as utilities and shipping supplies):

GelSoft
Variable costs per unit
Description Total
Direct Materials $   7.48
Direct Labor 10.00
Manufacturing Overhead 1.20
Single Line$  18.68Double line

 

Fixed costs included a long list of manufacturing overhead costs and selling, general, and administrative costs, summarized below:

GelSoft
Fixed Costs
Description Total
Manufacturing Overhead $   602,694
Selling,  General, and Administrative 1,850,000
Single Line$ 2,452,694Double line

 

Using a contribution margin format, we could create a static budget:

GelSoft
Flexible Budget
 for units =           172,405  
Description Total
Sales Revenue $5,861,770
Variable Costs 3,220,525
Contribution Margin Single Line2,641,245
Fixed Costs 2,452,694
Operating Income Single Line$188,551Double line

 

Variable costs are computed at $18.68 per unit times 172,405 units = $3,220,525 (rounded to the nearest whole dollar).

Notice that the operating income computed using the contribution margin format is different from the operating income computed in the master budgeting process because we used full absorption costing in the master budget and took into account beginning and ending inventories.

We could test our contribution margin statement format by adding a column for production because when we created contribution margin statements, we assumed that production was equal to sales:

GelSoft
Flexible Budget
 for units =  158,605                     172,405  
Description Total
Sales Revenue $5,392,570 $5,861,770
Variable Costs 2,962,741 3,220,525
Contribution Margin Single Line2,429,829 Single Line2,641,245
Fixed Costs 2,452,694 2,452,694
Operating Income Single Line-$22,865Double line Single Line$188,551Double line

 

Here, our total variable and fixed manufacturing costs are equal to the total variable costs we calculated in our master budget when we calculated cost of goods sold (off by $5 due to rounding):

GelSoft
Fixed Costs
Description Total
Variable Manufacturing Overhead $  2,962,741
Fixed Manufacturing Overhead 602,694
Single Line$  3,565,435Double line

 

Description Units Cost/Unit Total Costs
Beginning inventory 30,000 $    20.00 $  600,000
Goods produced during the period 158,605 $    22.48 3,565,440
Goods available for sale Single Line188,605 Single Line4,165,440
Less ending inventory 16,200 $    22.48 364,176
Cost of goods sold Single Line172,405Double line Single Line$3,801,264Double line

 

And so, the difference between our contribution margin statement and the master budget is the effect of sales volume versus production volume, and the effect of both beginning and ending inventory.

Let’s add one more column to our budget for a possible sales volume of 185,000 units:

GelSoft
Flexible Budget
                             for units =         158,605                172,405                 185,000
Description Total
Sales Revenue $5,392,570 $5,861,770 $6,290,000
Variable Costs 2,962,741 3,220,525 3,455,800
Contribution Margin Single Line2,429,829 Single Line2,641,245 Single Line2,834,200
Fixed Costs 2,452,694 2,452,694 2,452,694
Operating Income Single Line-$22,865Double line Single Line$188,551Double line Single Line$381,506Double line

 

We now have a flexible budget that accommodates three different scenarios:

  1. Sales of 158,605 units resulting in a loss for the company
  2. Sales of 172,405 upon which the master budget was prepared
  3. Sale of 185,000 which might represent a “best case” scenario

An actual flexible budget could be prepared using two or more scenarios, although more than three might not add to the usefulness, and could be presented in much more detail. In addition, the flexible budget will only be useful within a relevant range. For instance, increasing production enough to cover 185,000 in sales may change both fixed and variable costs.

Before we move on to compute variances, check your understanding of the flexible budget.

Practice Question