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Difference between a static budget and a flexible budget

What is the difference between a static budget and a flexible budget? How does management use these budgets to gain insight into performance?

Describe the variable overhead variances. How does a manager plan for these variances?

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Budgets are effectively nothing more than educated best guesses on the future prospects and allocation of resources for a company. There's a couple things an organization can decide about structure before beginning such as whether a top down approach or a bottom up approach is the right way to go as there advantages and disadvantages to each, whether or not it should be product specific, regional, or based upon a customer base. Budgets are designed to be general guidelines; however some companies will get hung up on the actual variance rather than the causes of the variance, especially smaller or mid-size firms. In general, if you get with 5% variance you're performing in the top tier of planning and forecasting performance. 95% accuracy is "good enough" for most managers.

The static budget is the budget that is based on this projected level of output, prior to the start of the period usually a calendar year. In other words, the static budget is the "original" budget. A static budget variance is the difference between any line-item in this original budget and the corresponding line-item from the statement of actual results. Often, the line-item of most interest is the "bottom line" or the total cost of production for the factory and other cost centers; net income for profit centers.

In contrast, the flexible budget is a performance evaluation tool. It cannot be prepared before the end of the period. A flexible budget adjusts the static budget for the actual level of output. The flexible budget asks the question if I had known at the beginning of the period what my exact demand or sales volume would be, what would the budget have looked like, how would it have changed? The motivation for the flexible budget is to compare actual results to originally forecasted results. If a given factory produced 10,000 widgets, then management ...

Solution Summary

Solution discusses in practical terms the differnces betweens a static and a flexible budget and their implications for management. Solution also desribes variable overhead variances and how a manager can plan for them.

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