Figure 1.Flexible (http://www.1-hydroponics.co.uk/images/fans-and-filters/mediumsize/flexible-silencer.jpg)
There are two budget theories that used in managerial accounting, the first one is planning budget and the second one is flexible budget. Most of the companies always have planning budget but may not have flexible budget. However, when we only have planning budget, we cannot compare it to actual results performance, it will give an error on the evaluation because it is like comparing apple to oranges. There is difference in sales or activity. Thus flexible budget is used to accurately evaluate performance with actual results. However, not all companies use flexible budget because flexible budget has some disadvantages.
One of the disadvantages of flexible budget according to Davoren as written in her Article “The Disadvantages of Flexible Budget” is company should do continuous monitoring of change in business environment. Monitoring change in business environment needs more effort and time to do. Therefore company considers the cost and benefits to do flexible budget.
The second disadvantage, also from Davoren, is inaccurate adjustment. Even though sales is the main factor of adjusting flexible budget, there are other factor that need to be adjusted such as price of raw material, and interest rates. The factors are fluctuating throughout the period thus the adjustment might be inaccurate because there are a lot of adjustment. Again, the company considers the cost and benefits to do the adjusting for flexible budget.
The third disadvantage is complexity to do the flexible budget. To do flexible budget, company should differentiate fixed and variable cost accurately. Company should have an employee who has good expertise to categorize cost into fixed and variable cost accurately. This is not an easy task because there are a lot of costs that need to be processed and some of them can be tricky to be categorized in fixed and variable cost. If fixed and variable cost is not categorized correctly, the evaluation will become less useful because an increase in sales also increase in variable cost but not in fixed cost thus if categorization of fixed and variable cost is not accurate the performance may not accurate also (in that case, there is some variable cost should be considered as fixed cost). If there is no expert to categorize fixed and variable cost, company should not use flexible budget.
Beside the disadvantages of using flexible budget, there is another factor why company does not use flexible budget. The other factor is about employee or business owner psychological state. Business owner or expert who has “culture” to do planning budget does not want to admit that he or she made a mistake evaluating the performance of the company. Business owner is afraid that if he admits that he was wrong and the real performance was not as good as it seems then he gets embarrassed from his subordinate and also his employee motivation to do more might fall. For an expert if he made wrong evaluation, he might get fired thus the expert is afraid to report that he was wrong.
As a conclusion, there are disadvantages and factor that makes company does not use flexible budget. Most of the disadvantages are related to cost benefit. If company can overcome this disadvantage then flexible budget is useful to evaluate real performance of the company. If not then company should not use flexible budget.
Source:
Davoren.J.(n.d.) The Disadvantages of a Flexible Budget. SmallBusiness Chron. Retrieved from http://smallbusiness.chron.com/disadvantages-flexible-budget-57384.html
Garrison R.H, Brewer P.C., Noreen E.W., Cheng N.S., Yuen K.C.K. (2012). Managerial Accounting: An Asian Perspective. New York: McGrawHill
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