This lesson covers the use of budgets for performance control, with a focus on flexible budgeting. It explains the limitations of a static budget and how a flexible budget provides a more meaningful basis for performance evaluation by adjusting for actual activity levels.

• Static vs. Flexible Budgets: A static budget is prepared for a single, planned level of activity. It is useful for planning but is not an effective tool for performance control, as it does not reflect changes in actual activity levels. A flexible budget, conversely, is designed to adjust to different levels of activity . It separates variable and fixed costs, allowing the budget to be “flexed” to match the actual level of output, providing a fairer comparison of actual costs to what they should have been.

• Preparing a Flexible Budget: A flexible budget is constructed by identifying the variable and fixed cost behaviour patterns. The budgeted variable costs are then recalculated based on the actual level of activity achieved, while fixed costs remain at the budgeted amount. This results in a new budget, tailored to the actual output, which is then compared to the actual costs incurred .

• Flexible Budget Variances: The difference between the flexible budget and actual results is called the flexible budget variance. This variance isolates the impact of operational efficiency by removing the volume effect. Analysing flexible budget variances is a more powerful management tool, as it highlights cost control rather than forecasting accuracy.

• Budgetary Control and Management by Exception: Budgetary control is the process of using budgets to evaluate performance and take corrective action. It relies on comparing actual performance with budgeted performance, identifying significant variances, and investigating their causes. This is the core of “management by exception” . The focus is on understanding why a variance occurred, not just what it was, to enable improved performance .