Activity based flexible budget differs from a conventional flexible budget
An activity-based flexible budget and a conventional flexible budget are two types of budgets used by organizations for planning and performance evaluation, and they differ in the way they account for variations in activity levels.
Conventional Flexible Budget:
Basis of Budgeting:
The conventional flexible budget is typically based on a single activity measure, such as units produced, sales volume, or machine hours. It assumes a linear relationship between activity levels and costs.
Fixed and Variable Costs:
Costs are often classified into fixed and variable categories. Fixed costs remain constant regardless of changes in activity levels, while variable costs change in proportion to changes in activity.
Budgeting Process:
The budget is created at the beginning of the period and remains fixed throughout the budget period. It does not adapt to changes in the actual level of activity. Performance
Evaluation:
The conventional flexible budget is used to evaluate performance by comparing actual results to the budgeted amounts based on the predetermined activity level. Variances are calculated based on the fixed budget.
Activity-Based Flexible Budget:
Basis of Budgeting:
The activity-based flexible budget considers multiple activity drivers that reflect the complexity and diversity of the organization's operations. It recognizes that different activities drive different costs.
Cost Drivers:
Instead of relying on a single activity measure, an activity-based flexible budget uses various cost drivers that align with different activities within the organization.
For example, in a manufacturing setting, machine hours might drive certain costs, while the number of setups may drive other costs.
Budgeting Process:
The budget is more dynamic and adjusts based on changes in the actual level of activity. It allows for a more accurate reflection of costs under different scenarios and activity levels. Resource Allocation: Resources are allocated based on the specific activities that drive costs, allowing for a more precise distribution of resources. It provides a better understanding of how resources are consumed across different activities.
Performance Evaluation:
An activity-based flexible budget allows for a more detailed and accurate evaluation of performance. Variances are analyzed based on the specific activities that influenced costs, providing insights into the root causes of deviations from the budget.
Strategic Planning:
Activity-based budgeting supports strategic planning by aligning budgeted activities with the organization's strategic objectives. It provides a more strategic view of resource allocation and cost management. In summary, while both types of flexible budgets aim to provide flexibility in adapting to changes in activity levels, the key difference lies in the approach to activity measurement and cost drivers.
The activity-based flexible budget recognizes the diverse nature of activities within an organization and provides a more nuanced and strategic approach to budgeting and performance evaluation. It allows for a better understanding of resource allocation and cost behavior across different activities, leading to more informed decision-making.