Classification According to Time Covered

A well-organized decision by management consists of two planning phases. First of these phases is attaining the short-term objectives and the second phase is attaining the long-term objectives, which is possible through the first one. Therefore, companies prepare two types of budgets; one for short-term objectives and the other for long-term objectives.

Short-term budgets determine the goals to reach in the short-term period, which is usually a 12 months period. Even if the budget covers 12 months, companies also prepare quarterly budgets as subcomponents in order to keep the operations under control and have the opportunity to take corrective actions, if necessary. Companies are increasingly preparing rolling (perpetual; continuous; revolving) budgets that always utilize the 12-months period by periodically adding an incremental timeperiod to the end of the budget period, upon completion of month/quarter. By using rolling budgets, management stays in connection with the budgeting process and this provides better control over the operations.

Long-term budgets, on the other hand, are prepared considering the strategic goals and the mission of the company. Long-term budgets cover longer periods such as 5 to 10 years. These budgets include the capital budget, which represents the company’s long-term plans regarding the capacity investments, such as the purchase of property, plant, and equipment, or adding a new product line, to assist the shortterm operations. In other words, capital budgets bring the capabilities of companies in line with their long-term plans.

Classification According to the Scope of Coverage

Similar to the fact that successful implementation of short-term plans constructs the way to reach the long-term objectives, attainment of objectives at narrow scope is the path to follow in order to reach the objectives at a broader sense. Therefore, companies prepare different budgets that reveal objectives at a different scope.

Master budget; is the comprehensive set of schedules and budgets that covers all phases of the company’s operations and describes the company’s overall financial plans for the following period. It represents the short-term objectives of a company in all aspects. A master budget can be divided into two budget categories as operating budgets and financial budgets.

Operating budgets; are the budgets that companies assign objectives for the income generating operations of the company, such as sales, production, operating activities, etc. Preparation of the master budget starts with the preparation of operating budgets and the ultimate outcome of operating budgets is the pro-forma (budgeted) income statement. The number and scope of operating budget depends on the company’s characteristics, such as firm size, the complexity of production, etc.

Financial budgets; are the budgets representing the sources and uses of cash during the budget period, as well as the expected financial position as of the end of the period. They represent the plan of how the company is expected to direct its cash flows in terms of both timing and amount. Additionally, the target financial position of the company as of the end of the budget period is also represented by financial budgets.

Functional Budgets; are the components of the master budget, and they are separately prepared for each process or department. Management prepares department -or process- based plans to lead the company through the plans that the operating budgets based on. Managers use functional budgets to determine the cost and income targets for particular departments and communicate them with subordinates.

Classification According to Capacity Utilization

For most companies, once the target is determined, it stays constant until the year-end and at the end of the year, the target is compared with the actual results to assess whether the targets are met or not. However, it may not help the management in determining the reason for any deviation from the target. Because a deviation may arise because of either the difference between the actual and expected sales in units or unit costs and sales prices may be different than the standards.

Static (Fixed) budgets; are the budgets, in which the predetermined sales levels are used in preparing the budgets. In other words, the static budget remains unchanged irrespective of the actual level of activity. This kind of budget does not consider a possible difference between the actual and budgeted production volumes. Therefore, any deviation from the budget may result because of the difference between either the actual and budgeted volume or different-than-standard unit costs/prices. It mainly aims to coordinate sectional activities to attain company objectives.

Flexible budgets; are prepared to prevent the unexpected effects of uncertainties in activity volumes, as opposed to static budgets. The flexible budgets are prepared for a specific interval, rather than a specific activity level, by considering the cost behavior pattern. These budgets help management with the variance analysis and make it easier to match the variances with the corresponding responsibility centers. For example, if the actual income differs from the budgeted income, which portion of the deviation results from the deviation in sales volume and which portion results from the difference between standard and actual unit costs (and/or sales prices) can be revealed with the help of flexible budgets. The effectiveness of using the flexible budget passes through the understanding of cost structure (cost behavior) for a specific time and/ or interval of activity volume. If there is not a direct relationship between the costs and relevant outputs of a specific activity, that activity cannot be budgeted in accordance with the principles of flexible budget.

As also understood from the information given static (fixed) budget and flexible budgets are the budget types depending on the classification according to capacity utilization, so the correct answer is D.