fixed & flexible budgets

8/13/2019 Fixed &Amp; Flexible Budgets

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Lesson-21

Fixed and Flexible Budgets

Learning Objectives

To know about fixed budgets

To know about flexible budgets

To understand how to prepare fixed budgets

To understand how to prepare flexible budgets

Fixed and Flexible Budgets

Any budget in any functional area of an operation can be established as a fixed budget or

a flexible budget. A fixed budget is established for a specific level of activity and is not

adjusted to the actual level of activity attained at the time of comparison between thebudgeted and actual results. Naturally, a fixed budget is established only for a short

period of time where the budgeted level of activity is expected to be attained to themaximum possible extent. It is more suitable for fixed expenses, i.e. the expenses which

have no relation with the level of activity. This budget does not indicate that it cannot be

changed at all. It can be revised if the actual level of activity is likely to differ widely

from the budgeted level of activity.

A fixed budget cannot be used as an effective tool of cost control while computing the

variations between the budgeted result and the actual result. The variance cannot beexplained properly. Also, it is not possible to say whether the variance is due to the

changes in the level of activity or due to the efficiency or inefficiency of the executiveresponsible for the execution of the budget.

A flexible budget is designed to change with the fluctuations in the level of activity and

provides a basis of comparison for any level of activity actually attained. A flexiblebudget is more elastic and practical. It can be properly used as an effective tool for the

evaluation of performance and cost control. It explains the variations between the

budgeted and actual results. It also states the variations which are due to changes in the

level of activity (which is beyond the control of operating executive) and which are dueto the operational efficiency or inefficiency (for which the operating executive is

responsible.)

For the purpose of establishment of flexible budgets, it is necessary to classify the costs

as fixed costs, variable costs and semi-variable costs. The fixed costs remain same at all

levels of activity whereas the variable costs change directly in proportion to the level ofactivity. As far as the semi-variable costs are concerned, each item of cost is examined

and classified into its fixed and variable elements and a trend is established regarding the

nature and behavior of each item of cost.


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Illustrations

1. The manager of repairs and maintenance department has submitted the following

budget estimates. These will be used while constructing a flexible budget to be used

during the coming budget year.

Details of Cost Planned at 6000 Planned at 9000

Direct Repairs Direct Repair

Hours Hours

Employees salaries 30,000 30,000

Indirect repair materials 40,200 60,300Miscellaneous costs 13,200 16,800

(a) Prepare a flexible budget for the department upto an activity level of 10,000 repairhours (use increment of 1000).

(b) What would be the budget allowance at 8,500 repair hours?

Solution8500 Hours 10000 Hours

Employees salaries 30,000 30,000

Indirect repair materials 56,950 67,000Miscellaneous costs 16,200 18,000

1,03,150 1,15,000

Working Notes

Following are the observations made from the analysis of above-mentioned costs:

(a) Employee salaries are fixed costs as they remain constant for both 6000 repair hoursand 9000 repair hours.

(b) Indirect repair material is variable cost as it varies proportionately from 6000 hours to

9000 hours. This cost neither remained constant nor increased proportionately at the

activity level of 6000 hours to 9000 hours. The cost increased by Rs. 3,600 for theincrease of 3000 hours. This means that the variable portion of this cost is Rs. 1.20

per hour. Hence, out of total miscellaneous cost of Rs. 13,200 for 6000 hours, Rs.

7,200 is the variable portion and balance Rs. 6,000 is the fixed portion.

2. Vivek Elementary School has a total of 150 students consisting of 5 sections with 30

students per section. The school plans for a picnic around the city during the weekendto places such as zoo, amusement park, planetarium etc. A private transport operator

has come forward to lease out buses for the picnic. Each bus has a maximum capacity

of 50 seats (excluding two seats reserved for the teacher accompanying the students).The school will employ two teachers for each bus paying them an allowance of Rs.

50 per teacher. It will also lease out the required number of buses. The following are

the other cost estimates:


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Cost per student Rs.

Breakfast 5

Lunch 10

Tea 3Entrance fee at zoo 2

Rent 650 per bus

Special permit fee 50 per busBlock entrance fee of the planetarium 250

Prizes to the students for games 250

No costs are incurred in respect of the accompanying teachers (except the allowance of

Rs. 50 per teacher).

(i) Prepare a flexible budget estimating the total cost for the levels of 30, 60, 90, 120

and 150 students. Each item of cost is to be indicated separately.(ii) Compare the average cost per student of these levels.

(iii) What are your conclusions regarding the breakeven level of students if the schoolproposes to collect Rs. 45 per student?

Solution

No. of Students 30 60 90 120 150

a. Variable cost 600 1200 1800 2400 3000

b. Semi-fixed costs

Rent of the bus 650 1300 1300 1950 1950

Permit fees 50 100 100 150 150

Allowances to teachers 100 200 200 300 300

c. Fixed costs

Entrance fees 250 250 250 250 250

Prizes to students 250 250 50 250 250

Total costs 1900 3300 3900 5300 5900

Average cost per student 63.33 55.00 43.33 44.17 39.33

3. Prepare a flexible budget for overheads on the basis of data given below. Ascertain

the overheads rates at 50%, 60% and 70% capacity.

Variable overheads At 60% capacity

Rs.Indirect material 6,000


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Indirect labor 18,000

Semi-variable overheads

Electricity

(40% fixed, 60% variable) 30,000

Repairs and maintenance(80% fixed, 20% variable) 3,000

Fixed overheadsDepreciation 16,500

Insurance 4,500

Salaries 15,000Total overheads 93,000

Estimated direct labor hours 1,86,000

Solution

Calculation of Overheads Rates

50% 60% 70%

Capacity Capacity Capacity

Rs. Rs. Rs.

Variable overheads

Indirect material 5,000 6,000 7,000

Indirect labor 15,000 18,000 21,000

Semi-variable overheads

Electricity 27,000 30,000 33,000

Repairs and maintenance 2,900 3,000 3,100

Fixed overheads

Depreciation 16,500 16,500 16,500

Insurance 4,500 4,500 4,500

Salaries 15,000 15,000 15,000

Total overheads 85,900 93,000 1,00,100

Estimated directI

Labor hours 1,55,0001, 86,000

2,17,000

Overhead rate

(Labor hour rate) Re 0.55 Re 0.50 Re 0.46

4. A factory can produce 60,000 units per annum at its 100% capacity. The estimated


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costs of production are as below:

Direct materials Rs. 3 per unit

Direct labor Rs. 2 per unit

Indirect expenses

Fixed Rs. 1,50,000 per annum

Variable Rs. 5 per unitSemi-variable Rs. 50,000 per annum upto 50% capacity and

extra expenses of Rs. 10,000 for every 20%

increase in capacity or part thereof

The factory produces only against orders.If the production program of the factory is asindicated below and the management desires to ensure a profit of Rs. 1,00,000 for theyear, work out the average selling price at which each unit should be quoted.

For three months of the year-- 50% capacity

Remaining nine months of the year-- 80% capacity

Solution

Calculation of Total Cost

50% 80% Total

capacity capacity capacity

Number of units produced 7,500 36,000 43,500

Direct material-- Rs. 22,500 1,08,000 1,30,500

Direct labor-- Rs. 15,000 72,000 87,000

Variable expenses-- Rs. 37,500 1,80,000 2,17,500

Fixed expenses-- Rs. 37,500 1, 12,500 1,50,000

Semi-variable expenses-- Rs. 12,500 32,500 45,000

Total cost 1, 25,000 6,30,000

5,05,000

Thus, the total cost during the year is likely to be Rs. 6,30,000. If it is desired to earn a

profit of Rs. 1,00,000, the total amount to be covered by the units to be sold will have tobe Rs. 7,30,000 (Rs. 6,30,000 + Rs. 1,00,000). As the total units produced are estimated

to be 43,500, the above amount will have to be covered by 43,500 units. Hence, the

average selling price per unit will be= Rs. 7,30,000

43,500

= Rs. 16.78 per unit (approx.)


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Working Notes

(i) It is assumed that whatever units are produced can be sold.

(ii) It is also assumed that the production and the incidence of all the indirect

expenses are equally spread during the year.

5. From the following details, prepare a flexible budget for three months ending on 30th

September showing the estimated sales, sales cost and profit for 60%, 80% and 100%

capacity. Assume that all items produced are sold.

Fixed expenses Rs.

Management salaries 4,20,000

Rent and taxes 2,80,000

Depreciation on machinery 3,50,000Sundry office cost 4,45,000

14,95,000

Semi-variable expenses

At 50% capacity Rs.

Plant maintenance 1,25,000

Indirect labor 4,95,000

Salesmens salary and expenses 1,45,000Sundry expenses 1,30,000

8,95,000Variable expenses

At 50% capacity

Materials 12,00,000

Labor 12,80,000

Sales mens commission 1,90,00026,70,000

Semi-variable expenses remain constant between 41% and 70% activity, increase by 10%of the above figures between 71 % and 80% activity, and increase by 15% of the above

figures between 81 % and 100% activity. Fixed expenses remain constant whatever may

be the level of activity. Sales are Rs. 51,00,000 at 60% activity,Rs. 68,00,000 at 80%activity and Rs. 85,00,000 at 100% activity.

Solution

Flexible Budget

60% 80% 100%

capacity capacity capacity


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Rs. Rs. Rs.

(A) Sales 51,00,000 68,00,000 85,00,000

(B) Sales cost

(1) Fixed expenses

Management salaries 4,20,000 4,20,000 4,20,000

Rent and taxes 2,80,000 2,80,000 2,80,000

Depreciation on machinery 3,50,000 3,50,000 3,50,000

Sundry office cost 4,45,000 4,45,000 4,45,000

14,95,000 14,95,000 14,95,000

60% 80% 100% capacity capacity capacity

Rs. Rs. Rs.

(2) Semi-variable expenses

Plant maintenance 1,25,000 1,37,500 1, 43,750

Indirect labor 4,95,000 5,44,500 5,69,250

Salesmens salary and expenses 1,45,000 1, 59,500 1,66,750

8,95,000 9,84,500 10,29,250

(3) Variable expenses

Material 14,40,000 19,20,000 24,00,000

Labor 15,36,000 20,48,000 25,60,000

Salesmans commission 2,28,000 3,04,000 3,80,000

32,04,000 42,72,000 53,40,000

Total sales cost 1 + 2 + 3 55,94,000 67,51,500 78,64,250

(C) Profit A B 4,94,000 48,500 6,35,750

Numericals on Flexible Budget

1. A company produces a standard product. The estimated cost per unit is given below:

Rs.

Raw materials 10


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Direct wages 8

Direct expenses 2Variable overhead 5

Fixed overheads are estimated to be Rs. 70,000 and selling price per unit is Rs. 40.

Prepare a flexible budget at 50%, 70% and 90% level of activity. Assume that output at100% level of activity is 10,000 units.

2. The following expenses relate to a cost center operating at 80% of normal capacity.Sales are Rs. 1,20,000. Draw up flexible administration, selling and distribution costs.

Budget is operating at 90%, 100% and 110% of normal capacity.

Administration costs

Office salaries Rs. 3,000General expenses 1.5% of sales

Depreciation Rs. 1,500Rates and taxes Rs. 1,750

Selling costs

Salaries 4 % of salesTraveling expenses 1.5% of sales

Sales office expenses 1 % of sales

General expenses 1 % of sales

Distribution costs

Wages Rs. 3, 000

Rent 0.5% of salesOther expenses 2% of sales

3. The expenses budgeted for the production of 10,000 units in a factory are furnished

below:

Per unit Rs.

Materials 70.25

Labor 20.10

Variable overheads 5Fixed overheads (Rs. 1,00,000)

Variable expenses (Direct) 13.75

Selling expenses (10% fixed)Distribution expenses (20% fixed)

Administrative expenses (Rs. 50,000)

Total cost of sale per unit


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(to make and sell) 155

Prepare a budget for the production of:

(i) 8,000 units

(ii) 6,000 units

Assume that administrative expenses are rigid for all levels of production.

4. Following are the details for the year 1985:

Rs.

Sales 20,000 units @ Rs. 3 per unit 60,000Raw material 26,500

Direct labor cost 5,000

Variable overheads 8,000Fixed overheads 10,000

The management expects the following estimates in 1986.

a) Sales to increase to 30,000 units, selling price to remain unchanged

b) Raw materials prices to increase by 10%

c) Wage rate to increase by 10%d) Labor productivity to improves by 5%

e) Fixed overheads to increase by Rs. 2,000

You are required to prepare the budget for 1986.

5. Production costs of a factory for a year are as follows:

Direct wages Rs. 90,000Direct materials Rs. 1,20,000

Production overheads:

Fixed Rs. 40,000

Variable Rs. 60,000

During the forthcoming year, the following are anticipated:

The average rate for direct labor remuneration will fall from 90 paise to 75 paise

per hour

Production efficiency will be reduced by 5%

Price per unit of direct material and other materials and services which compriseoverheads will remain unchanged

Direct labor hours will increase by 33 1/3

Prepare the budget and compute factory overhead rate, the overheads being absorbed on

direct wages.


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6. ABC Ltd. manufacturing a single product is facing a severe competition in selling atRs. 50 per unit. The company is operating at 60% level of activity at which sales level

are Rs. 12,00,000. Variable costs are Rs. 30 per unit. Semi-variable costs may be

considered as fixed at Rs. 90,000 in case output is nil and variable element is Rs. 250

for each additional 1% level of activity. Fixed costs are Rs. 1,50,000 at the presentlevel of activity, but at the level of activity of 80% or above these costs are expected

to increase by Rs. 5,000.

To cope up with the competition, the management of the company is considering a

proposal to reduce the selling price by 5%.

(a) Prepare a statement showing the operating profit at levels of activity of 60%, 70%

and 80%, assuming that the selling price remains at Rs. 50 per unit.

(b) If selling price is reduced by 5%, show the number of units which will be requiredto be sold to maintain the present profits.

7. A company producing electronic watches estimates the following factory overheads

costs for producing 5,000 units:

Indirect materials Rs. 16,000

Indirect labor Rs. 30,000Inspection cost Rs. 16,000

Heat, light and power Rs. 8,000

Expendable tools Rs. 8,000Supervision costs Rs. 8,000

Equipment depreciation Rs. 4,000Factory rent Rs. 4,000

Indirect labor, indirect material and expendable tools are entirely variable. Heat, light andpower and inspection costs are variable to the extent of 50% and 40% respectively. Other

costs are fixed costs for a month. Prepare a flexible budget for the overheads for the

production of 4,000 and 6,000 units per month. Also find out the average factory

overheads per unit for these two production levels.

8. Anil and Avinash Enterprises is currently working at 50% capacity and produces

10,000 units. Estimate the profits of the company when it works at 60% and 70%capacity.

At 60% capacity, the raw materials cost increases by 2% and the selling price falls by3%. At 70% capacity, the raw materials cost increases by 4% and selling price falls

by 5%. At 50% capacity, the product costs Rs. 180 per unit and is sold for Rs. 200 per

unit.

The unit cost of Rs. 180 is made up as below:


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Materials cost Rs. 100

Wages Rs. 30Factory overheads Rs. 20 (40% fixed)

Administration overheads Rs. 30 (50% fixed)

9. ABC Ltd. manufactures a single product for which market demand exists foradditional quantity. The present sales of Rs. 60,000 per month utilizes only 60%

capacity of the plant. The sales manager assures that with a reduction of 10% in the

price, he would be in a position to increase the sales by about 25% to 30%.

The following data is available:

Rs. 10 per unit(a) Selling price

(b) Variable cost

(c) Semi-variable cost

(d) Fixed cost

Rs. 3 per unit

Rs. 6000 per unit Rs. 0.50 per unitRs. 20,000 at present level, estimated to be Rs. 24,000 at 80%

output

You are required to submit the following statements to the board:

The operating profits at 60%, 70% and 80% levels at current selling price and atproposed selling price

The percentage increase in the present output which will be required to maintainthe present profit margin at the proposed selling price

10. A manufacturing company has an installed capacity of 1,20,000 units per annum. Thecost structure of products manufactured is given below:

Variable cost (per unit)

Materials Rs. 8Labor Rs. 8 (subject to a minimum of Rs. 56,000 per month)

Overheads Rs. 3

Fixed overheads Rs. 1,04,000 per annumSemi-variable overheads Rs. 48,000 per annum at 60% capacity which increases

by Rs. 6000 per annum for the increase of every 10% of

the capacity utilization or any part thereof

The capacity utilization for the next year is estimated at 60% for 2 months, 75% for 6

months and 80% for the remaining year. If the company is planning to have a profit of

25% on the selling price, calculate the estimated selling price for each unit of production.Assume that there is no opening or closing stock.

11. The monthly budget for manufacturing overhead of a company at two levels of


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capacity is as follows:

Capacity 60% 100%

Budgeted production (units) 600 1000

(Rs) (Rs)

Wages 1,200 2,000

Consumable stores 900 1,500

Maintenance 1,100 1,500

Power and fuel 1,600 2,000

Depreciation 4,000 4,000

Insurance 1,000 1,000

9,800 12,000

(a) Indicate which of the items are fixed, variable and semi-variable.(b) Prepare a budget for 80% capacity.(c) Find out the total cost, both fixed and variable, per unit of output at 60%, 80%

and 100% capacity.

12. From the following data, prepare a flexible budget for the production of 40,000 units,

60,000 units and 75,000 units, distinctly showing variable and fixed costs as well as

total costs. Also indicate the element-wise cost per unit.

Budgeted Output and Budgeted Cost per unit

Budgeted Output 100,000 units

Per unit cost Rs.

Direct material 90

Direct labor 45

Direct variable expenses 10Manufacturing variable overheads 40

Fixed production overheads 5

Administration overheads (fixed) 5

Selling overheads 10 (10% fixed)

Distribution overheads 15 (20% fixed)

13. The budget manager of Progressive Electrical Limited is preparing a flexible budgetfor the accounting year commencing on 1

stApril 1995. The company produces only

one product called Kaypee. Direct material costs Rs. 7 per unit. Direct labor average

is Rs. 2.50 per hour and requires 1.60 hours to produce one unit of Kaypee. Salesmenare paid a commission of Re 1 for every unit sold. Fixed, selling and administration

expenses amount to Rs. 85,000 per year.


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Manufacturing overheads under specified conditions of volume have been estimatedas below:

Volume of Production (units) 1,20,000 1,50,000

Rs. Rs.

Indirect materials 2,64,000 3,30,000

Indirect labor 1,50,000 1,87,500Inspection 90,000 1,12,500

Supervision 1,98,000 2,34,000

Depreciation 90,000 90,000Engineering services 94,000 94,000

------------------------------------------

Total manufacturing overheads 9,70,000 11,50,000

Normal capacity of production of the company is 1,25.000 units. Prepare a budget of totalcost at 1,40,000 units of output.

14. Excellent Manufacturers can produce 4000 units of a certain product at 100%

capacity. The following information is obtained from their books:

June 94 July 94

Units produced 2,800 3,600

Rs. Rs.Repairs and maintenance 500 560

Power 1,800 2,000

Shop labor 700 900Consumable stores 1,400 1,800

Salaries 1,000 1,000

Inspection 200 240

Depreciation 1,400 1,400

The rate of production is 10 units per hour. Direct materials cost is Re 1 and direct wages

per hour is Rs. 4.

(a) Compute the cost of production at 100%, 80% and 60% capacity showing the

variable, fixed and semi-fixed items under the flexible budget.(b) Find out the overhead absorption rate per unit at 80% capacity.

15. The following data is available for a manufacturing company for a yearly period:

Fixed expenses Rs. in lakhs


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Wages and salaries 9.5

Rent, rates and taxes 6.6Depreciation 7.4

Sundry administrative expenses 6.5

Semi-variable expenses (at 50% capacity)

Maintenance and repairs 3.5

Indirect labor 7.9Sales department salaries 3.8

Sundry administrative salaries 2.8

Variable expenses (at 50% capacity)

Material 21.7Labor 20.4

Other expenses 7.9------

98.0

Assume that fixed expenses remain constant at all levels of production and semi-variable

expenses remain constant between 45% and 65% of capacity, increasing by 10% between65% and 80% capacity and by 20% between 80% and 100% capacity.

The sales at various levels are as follows:Rs. in lakhs

50% capacity 100

60% capacity 120

75% capacity 15090% capacity 180

100% capacity 200

Prepare a flexible budget for the year at 60% and 90% capacities and estimate the profitsat these levels of output.

16. A factory is currently running at 50% capacity and produces 5,000 units at a cost ofRs. 90/- per unit as per details below:

Rs.Material 50

Labor 15

Factory overheads 15 (Rs. 6 fixed)Administrative overheads 10 (Rs. 5 fixed)

The current selling price is Rs. 100 per unit.


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At 60% working, material cost per unit increases by 2% and selling price per unit falls by2%. At 80% working, material cost per unit increases by 5% and selling price per unit

falls by 5%.

Estimate the profits of the factory at 60% and 80% working and give your comments.

fixed & flexible budgets

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