1.7 Budgeting Approaches
1.7.1 Static and Flexible Budgeting
The budgets which we have looked at so far in this chapter can be called static budgets. This means that they predict a certain level of activity based on informed estimates, and then budget based on that level of activity . However, as engineers we know that the assumptions underlying our estimates carry a degree of uncertainty; the estimates we make even just one a single year in advance may not accurately reflect the amount that your company produces or expends on certain activities. If the actual levels of productivity observed do not match with our estimates, it can be useful to have more flexibility .
Flexible budgets still use estimates to prepare for a certain level of activity, but then can be used to continually review the variance between actual and expected levels of activity . The variance is simply the difference between the budgeted costs and actual costs for any line item on a budget, which can be either favourable or unfavourable depending on how it influences the bottom line of the budget. For example, raw material expenses being lower than budgeted would be favourable, but sales volume being lower than budgeted would be unfavourable. When flexible budgeting is applied to an activity based budget, it is known as an activity flexible budget.
The table below shows a flexible budget for the costs on the first month of a construction project. What can we learn from this?
| Budgeted | Actual | Variance | ||
| Materials | ||||
| Timber Piles | $4,500 | $8,755 | -$4.255 | |
| Concrete | $10,000 | $9,830 | $170 | |
| Rebar | $700 | $678 | $22 | |
| Steel Columns | $7,500 | $7,534 | -$34 | |
| Brick | $3,500 | $3,606 | -$106 | |
| Gravel Fill | $2,500 | $2,134 | $366 | |
| Total Materials | $28,700 | $32,537 | -$3,837 | |
| Payroll | ||||
| Managers | $14,000 | $13,567 | $433 | |
| Labourers | $40,000 | $41,233 | -$1,233 | |
| Machine Operators | $10,000 | $9,902 | $98 | |
| Total Payroll: | $64,000 | $64,702 | -$702 | |
| Overhead | ||||
| Utilities | $1,000 | $1,238 | -$283 | |
| Fuel | $2,500 | $2,637 | -$137 | |
| Equipment Depreciation | $1,000 | $1,000 | $0 | |
| General Administration | $3,000 | $2,516 | $484 | |
| Total Overhead: | $7,500 | $7,436 | $64 | |
| Total Cost | $100,200 | $104,675 | -$4,475 |
For this construction budget, no income is listed, so the unfavourable variances are all negative and marked in red, with the favourable variances marked in black. This flexible budget shows that the project is slightly overbudget, with some estimates being slightly under and some slightly over. For instance, the company might wish to investigate why it underestimated the payroll for its labourers, and whether they were needed to work additional hours or overtime that was not accounted for. However, the clear issue with this budget, which accounts for almost all of the negative variance, is that the actual cost for timber piles was almost double that of the budgeted pric