# Concepts

#### B. Saleh

A static budget is a budget that does not change as volume changes. If a company’s annual master budget is a static budget, the budget for sales commission’s expense will be one amount such as \$200,000 for the year. In other words, in a static budget the budgeted amount for sales commission’s expense will remain at \$200,000 even if the actual sales during the year are \$3 million, \$4 million or \$5 million.
In contrast to a company’s static master budget, the company’s sales department might have a flexible budget. In the flexible budget, the sales commission’s expense budget might be expressed as 5% of sales. In that instance, the department’s budget for sales commission’s expense will be \$200,000 when actual sales are \$4 million, but it will decrease to \$150,000 when actual sales are \$3 million, and the budget will increase to \$300,000 when actual sales are \$6 million, and so on.

A flexible budget is a budget that adjusts or flexes for changes in the volume of activity. The flexible budget is more sophisticated and useful than a static budget, which remains at one amount regardless of the volume of activity.
Assume that a manufacturer determines that its cost of electricity and supplies for the factory are approximately \$10 per machine hour (MH). It also knows that the factory supervision, depreciation, and other fixed costs are approximately \$40,000 per month. Typically, the production equipment operates between 4,000 and 7,000 hours per month. Based on this information, the flexible budget for each month would be \$40,000 + \$10 per MH.
Now let’s illustrate the flexible budget by using some data. If the production equipment is required to operate for 5,000 hours during January, the flexible budget for January will be \$90,000 (\$40,000 fixed + \$10 x 5,000 MH). If the equipment is required to operate in February for 6,300 hours, then the flexible budget for February will be \$103,000 (\$40,000 fixed + \$10 x 6,300 MH). If March requires only 4,100 machine hours, the flexible budget for March will be \$81,000 (\$40,000 fixed + \$10 x 4,100 MH).
If the plant manager is required to use more machine hours, it is logical to increase the plant manager’s budget for the additional cost of electricity and supplies. The manager’s budget should also decrease when the need to operate the equipment is reduced. In short, the flexible budget provides a better opportunity for planning and controlling than does a static budget.

A rolling budget is also known as a continuous budget, a perpetual budget, or a rolling horizon budget. We will use the following example to explain the meaning of a rolling budget.
Let’s assume that a company’s accounting year ends on each December 31. Prior to the start of the year 2011, the company prepares its annual budget which is detailed by month for January through December 2011. This budget could become a rolling budget if after January 2011 the company drops the budget for January 2011 and adds the budget for January 2012. This rolling budget now covers the one year, or 12-month, period of February 1, 2011 through January 31, 2012. At the end of February 2011, the rolling budget will drop February 2011 and will add February 2012. At this point the rolling budget will cover the one year period of March 1, 2011 through February 29, 2012.
The benefit of a rolling budget is that the company’s management will always have a budget that looks forward for one full year.
A rolling budget could use 3-month periods or quarters instead of months. Also, a company might have a 5-year rolling budget for capital expenditures. In this case a full year will be added to replace the year that has just ended. This 5-year rolling budget means that management will always have a 5-year planning horizon.

A favorable budget variance indicates that an actual result is better for the company (or other organization) than the amount that was budgeted.
Here are three examples of favorable budget variances:
1. Actual revenues are more than the budgeted or planned revenues.
2. Actual expenses are less than the budget or plan.
3. Actual manufacturing costs are less than the amount budgeted for the period.
Occasionally, a favorable budget variance for revenues will be analyzed to determine whether it was the result of higher than planned selling prices, greater quantities, or a more favorable mix of items sold.
Similarly, a favorable budget variance for expenses will be analyzed to identify the cause of the lower expenses.