## **Learning Outcomes**

After reading this article, you will understand how flexible budgets support management control. You will be able to distinguish between fixed and flexed budgets, prepare a flexed budget to match actual activity, and analyse variances between budgeted and actual performance. You will learn how to prepare control reports for managers and evaluate performance using variance analysis, supporting managerial decision-making and corrective action.

## **ACCA Management Accounting (MA) Syllabus**

For ACCA Management Accounting (MA), you are required to understand the principles and application of flexible budgets and performance review within management accounting. In particular, you should focus on:

- The distinction between fixed and flexible budgets for control purposes
- The concept and calculation of flexed budgets
- The use of flexible budgets in variance analysis
- How to prepare control reports for performance review
- The interpretation and evaluation of variances in management reporting
- Responsibility accounting and its relationship to controllable costs

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Explain the main limitation of using a fixed budget for performance evaluation when actual output differs from budgeted output.
2. Define a flexed budget and outline when it is appropriate to use one.
3. True or false? It is always appropriate to compare actual costs with fixed budgeted costs when preparing performance reports.
4. List two purposes of control reports in budgetary control.

## **Introduction**

Budgetary control compares actual results with planned targets, highlighting differences (variances) and guiding corrective action. When actual activity diverges from the original budget, comparing actual results to a fixed budget can provide misleading conclusions. Flexible budgets remove this weakness by adjusting budgeted figures to the actual level of activity, enabling more accurate and fair performance review.

> **Key Term: fixed budget**  
> A budget set prior to the period, based on one estimated level of activity, which does not change, regardless of actual activity levels.
>
> **Key Term: flexible budget**  
> A budget that is adjusted to reflect the actual level of activity achieved, showing what costs and revenues should have been for that output.

## FIXED VS FLEXIBLE BUDGETS

### Fixed Budgets

A fixed budget is based on the initial anticipated level of output or sales. It remains unchanged regardless of what actually occurs during the period. If actual activity differs significantly from this planned level, direct comparison between actual and budgeted figures may lead to unfair variance analysis and potentially poor management decisions.

### Flexible Budgets

Flexible budgets are designed to flex, or adjust, to the actual level of activity. This means the budget is recalculated at the end of the period to show what costs and revenues should have been, given the actual output. This revised budget is known as a flexed budget.

> **Key Term: flexed budget**  
> The flexible budget re-calculated for the actual level of activity achieved in the period.

### Why Flexible Budgets are Essential

Comparing actual results with a flexed budget isolates only the variances due to efficiency, price changes, or cost control—removing misleading effects caused by output level differences.

### **Worked Example 1.1**

**A company budgets to produce 10,000 units with variable costs of \$3 per unit and fixed costs of \$25,000. Actual production is 8,000 units, with actual costs of \$52,000.**

**Question:** Prepare a flexed budget and compare it with actual costs to determine if costs were well controlled.

> **Answer:**  
> Flexed budget for 8,000 units:  
> Variable costs: 8,000 × \$3 = \$24,000  
> Fixed costs: \$25,000  
> Total flexed budget: \$49,000  
> Actual costs: \$52,000  
> Variance: \$52,000 - \$49,000 = \$3,000 adverse (costs exceeded expectation for this activity).

### **Exam Warning**

> Comparing actual costs at 8,000 units with budgeted costs at 10,000 units (fixed budget) would incorrectly suggest costs are lower than budget, obscuring the true performance.

## PREPARING A FLEXED BUDGET

To prepare a flexed budget:

1. Identify variable and fixed costs.
2. Adjust variable costs to match actual activity.
3. Keep fixed costs unchanged (unless known to change with activity).
4. Add the flexed variable and fixed costs to provide the total flexed budget.

Flexed budgets are most useful when output or sales levels vary significantly from the forecast.

### When to Use Flexible vs Fixed Budgets

- Use a fixed budget for planning before the period.
- Use a flexed (flexible) budget for control and performance assessment after the period, once actual activity is known.

### **Worked Example 1.2**

**Budgeted costs (for 5,000 units):**

- Variable production: \$8 per unit
- Fixed factory overheads: \$10,000

**Actual production:** 6,000 units  
**Actual costs:** \$59,800

**Question:** Calculate the flexed budget and identify the total cost variance.

> **Answer:**  
> Variable cost for actual output: 6,000 × \$8 = \$48,000  
> Fixed overheads: \$10,000  
> Flexed budget total: \$58,000  
> Total cost variance: \$59,800 - \$58,000 = \$1,800 adverse

## CONTROL REPORTS

Control reports are management reports that clearly set out flexed budget, actual results, and variances for specific areas of responsibility. They support decision-making by showing which areas require management attention.

> **Key Term: control report**  
> A statement comparing flexed budget with actual results, highlighting variances for management review.
>
> **Key Term: variance**  
> The difference between budgeted (or flexed budget) and actual results, classified as either favourable (F) or adverse (A).
>
> **Key Term: controllable cost**  
> A cost over which a specific manager or department has authority to incur or avoid in the short term.
>
> **Key Term: responsibility accounting**  
> The system of charging revenues and costs to the manager or centre responsible for those results.

### Structure of a Control Report

A standard control report includes:

- Flexed budget figures (for actual activity)
- Actual performance figures
- Variance (favourable or adverse) with explanation
- Often, recommendations for corrective actions

### Responsibility and Controllability

Control reports should reflect only those costs/revenues a manager can influence. This is called the principle of controllability.

## REVIEWING PERFORMANCE: VARIANCE ANALYSIS

Regular variance analysis is central to performance review. Once control reports are prepared, management reviews:

- Which variances are significant or recurring
- Possible causes (price changes, efficiency, poor forecasts)
- Whether action is required to address adverse trends

Variance reports typically use threshold values for reporting, so only significant variances are escalated.

### **Worked Example 1.3**

**Flexed budget for Department X:**  
Labour cost: \$20,000  
Actual labour cost: \$22,500  
Variance: \$2,500 adverse

**Manager's report:** Overtime premium of \$2,000 in the period due to machine breakdown.

**Question:** Should the adverse variance be investigated further?

> **Answer:**  
> The majority of the variance has a clear, non-recurring cause (breakdown). Only the remaining \$500 needs further review or investigation.

## USING CONTROL REPORTS FOR MANAGEMENT DECISION-MAKING

Management uses control reports and variance analysis to:

- Identify areas where performance is not satisfactory
- Mobilise corrective action (cost reduction, process change)
- Acknowledge areas of favourable performance
- Revise future plans or budgets based on findings

Control reports must be timely, relevant, reliable, concise, and understandable for effective use.

### **Revision Tip**

> When preparing or reviewing a performance report, always confirm that actual results are compared with a flexed budget at the actual activity level, not simply with the original fixed budget.

## LIMITATIONS OF FLEXIBLE BUDGETING AND CONTROL REPORTS

While flexible budgets and control reporting improve accuracy, some limitations remain:

- Not all costs are clearly variable or fixed—semivariable costs require extra attention.
- Budgets are based on forecasts—errors in assumptions can distort conclusions.
- Not all variances merit investigation—use cost-benefit analysis before acting.
- Managers can only control some variances; external factors may impact results.

## SUMMARY

Flexible budgets provide the basis for accurate control reporting when actual activity differs from plan. By comparing actual results to flexed budgets, variance analysis identifies true areas of performance difference, supporting fair evaluation and timely corrective action. Control reports must be prepared with the principle of responsibility accounting and controllable costs in mind.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- The purpose and limitations of fixed budgets for control
- Preparation of flexible (flexed) budgets to match actual output
- The structure and function of control reports in management accounting
- Use of variance analysis for performance review
- The importance of reporting on controllable costs and responsibility centres
- Interpreting control reports to support management decision-making

## **Key Terms and Concepts**

- fixed budget
- flexible budget
- flexed budget
- control report
- variance
- controllable cost
- responsibility accounting

Flexible budgets and control - Control reports and performance review