Flexible budgeting
A comparison of budgeted costs at the budgeted activity level with actual costs at the actual activity level is meaningless if there is a significant difference between budgeted and actual activity levels.
If actual costs are dramatically higher than budget, it does not necessarily mean that costs are out of control, if sales levels are dramatically higher than planned.
Actual fixed costs should be the same as budgeted, regardless of changes in sales levels – only the variable costs should change.
It is essential that actual costs and revenues are compared with planned amounts.
However, to make the comparison meaningful, it is essential to adjust the variable cost element of the budget to reflect the actual activity levels.
This process is referred to as ‘flexing the budget’.
