Question

Define and discuss the uses of the fixed budget and the flexible budget.

What is the difference between an operating budget and a capital budget?

What does it mean to convert volumes into expense requirements?

Answer 1

Ans 1:

(a) Fixed Budget

A fixed budget is a budget that does not change or flex when sales or some other activity increases or decreases. A fixed budget is also referred to as a static budget.

To illustrate a fixed budget, let's assume that a company pays commission on its sales at a rate of 5%. If the company prepares a fixed budget and it is projecting sales of $1 million, its budget for sales commissions will be fixed at $50,000. If the actual sales end up being only $900,000 the budget for commissions will remain unchanged at the fixed amount of $50,000.

(b) Flexible budget:

A flexible budget is a budget that adjusts or flexes for changes in the volume of activity. The flexible budget is more sophisticated and useful than a static budget, which remains at one amount regardless of the volume of activity.

Assume that a manufacturer determines that its cost of electricity and supplies for the factory are approximately $10 per machine hour (MH). It also knows that the factory supervision, depreciation, and other fixed costs are approximately $40,000 per month. Typically, the production equipment operates between 4,000 and 7,000 hours per month. Based on this information, the flexible budget for each month would be $40,000 + $10 per MH

Ans 2

Capital Budgeting

When you budget for capital expenditures, you plan to buy assets. Assets include equipment and property that you expect to last more than one year. The budget for these purchases must come from cash on hand to qualify as capital budget expenditures. You must have a capital budget so you can continue to grow your business by purchasing assets that will produce income.

Operational Budgeting

Your operational budget covers day-to-day expenses. This can include wages, rent, utilities and purchases of items that are intended to last less than a year. If you borrow money for capital expenditures, the expense comes out of your operational budget because you will have to service that loan with monthly payments. The operational budget tells you how much cash you need to take in each month to cover your bills.

Ans 3: Convert Volumes into Expense Requirements
a. Calculation of labor expense with benefits, nonlabor benefits, and overhead expenses.
b. Budget histories indicate labor expense with benefits per production unit.
c. Budget history for nonlabor expense include supplies, travel, and repairs.
d. Senior management determines the benefits packages
e. Department managers can reduce benefits expenses for part-time or contract workers (less expensive sources of labor)
f. Department mangers should reduce non-labor expenses per production unit.
g. Budget committee provides department managers with information regarding cost-of-living raises, merit raises & bonus
i. Cost of living raises= protects employees during inflation and raise is administered to all employees at the same time
ii. Merit raises= expensive for the organization because the raise amount is built into the employee's base pay for future years.; Usually given during performance appraisals.
iii. Bonus= given at end of year and easy for organization