activity based budgeting

GSAM 7233

ACCOUNTING FOR

DECISION MAKING Graded Assignment

Literature on Activity-Based Budgeting

Name: ONG MAY LING ST1409MD0020

Section: 20

GSAM 7233 ACCOUNTING FOR DECISION

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Table of Contents Introduction ............................................................................................................................................ 2

Literature Review .................................................................................................................................... 3

Conclusion ............................................................................................................................................... 6

Bibliography ............................................................................................................................................ 7


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Introduction

Budgeting plays a role in planning and controlling. In the planning stage, the

objectives and the actions to achieve are identified. The physical or financial terms of

budget are the quantitative expression of planning. When used for planning a budget is a

method for translating the goals and strategies of an organization into operation term.

Control is the process of setting standard, receiving feedback on actual performance, and

taking corrective action whenever actual performance deviates significantly from planned

performance. (Huynh, Gong, & Huynh, 2013). Hence, budgets are used to compare actual

outcome with planned outcomes, and they can monitor and steer the operations back on

course, if necessary.

Budget is developed from the long-run objectives of the firm based on their

operation basis; follow by the actual result is compared with the planned budgeted amount

to be control. The feedback of comparison provides information for the operation

performance as well as for future budget planning.

Budgets are prepared for areas within an organization and for activities based. It

serves as the comprehensive financial plan for the organization as a whole and provides the

organization several advantages. Budget forces the managers to plan on their department

or activities they which to conduct. It provides resource information that can be used to

improve decision making such as whether is it worth to spend on advertising or the other

ways of publicity available. The use of resource and employees are aided by setting

benchmark that can be used for the subsequent evaluation of performance, indirectly

improves the communication and coordination within the organizations.

Budget highlights potential problem and advantages early, allowing manager to take

steps to avoid those problems or use the advantages wisely. Today’s business environment,

organization no longer applied the traditional budgeting process, thus applying a recent

approach to budgeting, which is activity-based budgeting (ABB) that is based on activity-

based costing (ABC).


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Literature Review

What is Activity-Based Budgeting?

Activity-Based Budgeting (ABB) is described as a method of budgeting based on an activity

framework, using cost driver data in the budget setting and variance feedback processes

(Associated of International Certified Professional Accountant, 2013). In ABB, the budgeted

sales of product or service are determined and the activities to achieve the budgeted sales

are then identified. Budget for each of the various activities necessary are prepared by

multiplying the budgeted usage of the cost driver for a particular activity by the budgeted

usage of the cost driver for a particular activity by the budgeted rate for the relevant cost

driver. The activity-based approach to budgeting is more sophisticated version of traditional

absorption costing.

Features

Most business organization uses ABB to focus attention on company operation and finance

beside just control the limit of spending. It is a tool to help managers in both their planning

and controlling functions. As mention, budget helps manager to plan for the future as

evaluated based on what happen at the past. It is one of the most widely used and highest

rate cost-management tools for cost reduction and control.

Budgets are prepared according to their cost-driving activity rather than function, as is the

case with the traditional approach to budgeting. There will be as separated budget for each

cost pool. In ABB, it begins with output and then determines the resources necessary to

create the output. The organization’s definable objectives are translated by the vision into a

strategy in order to create value which include growing market share, improving sales rate,

reducing expenses, increasing profit margins, increasing productivity, and reducing the cost

of capital.

The ABB works backward from activities and their drivers to the underlying cost. ABB

process gives manager guidance in the way to achieve the desired results. The root causes

can be identified and the knowledge can be used to effect process and cost efficiencies by


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using the ABB (Hansen & Mowen, 2003). ABB process is a reverse process of ABC approach.

ABB begins with the forecasted demand of goods (sales budget) and estimates the demand

of each of the activities output as measure by its cost driver. Then using the rate at which

activities consumer resource to estimate or budget the resource needed. To create the ABB,

the following three stages consist:

1. Identity activities and their cost drivers

2. Forecast the number of units of cost driver for the required activity level

3. Calculate the cost driver rate (cost per unit of activity)

Advantages and Disadvantages

In the activity-based budgeting, it draws the attention to overhead activities and their

associated costs. It identifies situation when production plan require new capacity either

both physical capacity or capacity in people resource to deliver much of support and service

activities in organization. When activity volume is controlled, hence the activity cost maybe

controllable. ABB focus on the output –based approach, recognizing that activities drive cost.

ABB views the business as collective of activities, a perspective that link well with

organizational strategy.

ABB provides a more accurate way to project future cost (Kaplan & Atkinson, 1998). It

provides a better understanding of future resource needs and more accurate budgets. It

also provide a better understanding of the effect on budgeted cost of changes in the usage

of the cost driver because of the explicit relationship between cost drivers, activities and

costs.

However, ABB lacks of in how to manage organization operation to achieve what ABB drawn.

It helps to drawn the target and encourages managers to works towards achieving the

organization’s goal but the process to run the organization’s operation to reach the goal is

not proposed. Thus, the organization will then need the Activity-Based Management (ABM)

help to manage the actual judgment in order to get the best way in achieving the goals as

serves as an effective model for decision making.


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On the other hand, ABB also provide the disadvantage where a considerable amount of time

and effort might be needed to establish the key activities and their cost drivers. It might be

difficult to identify managers’ responsibilities for the activities. In short term, many

overhead cost are not controllable and does not vary directly with changes in the volume of

activities for the cost driver. The fixed cost overhead expenditure variance are the only cost

variance to be report.

Applicability

ABB should ensure that costs are closely linked to responsibilities. Managers who have

control over particular cost drivers will become accountable for the costs that are caused.

And important principle of effective budgeting is that those responsible for meeting a

particular budget should have control over the events that affect performance in their area.

The organization uses ABB to measure their effectiveness and efficiency. Some managers

believe that ABB is more useful for controlling waste and improves efficiency which

emphasis on activities and their consumption of resources. Efficiency is achieved when the

business process is performed in the best possible ways with minimum or no waste. The

assessment of the efficiency of a manager is evaluated through the ABB as the actual result

can be compare with the result-based budgeting activities. While effectiveness is describe as

the measure on managers achievement or exceed the goal described.

Examples

PLOC Enterprise produces two products, the Alpha and the Beta. The sales budget for next

year shows that 80,000 units of Alpha and 100,000 units of Beta are expected to be sold.

Each type of product spends time in the finished goods stores. Both products are of roughly

similar size and have very similar storage needs. It is felt, therefore, that the period spent in

the stores (product week) is the cost driver and so a budget for this cost –driving activity is

created. It is estimated that Product Alpha will spend an average of two weeks in the store

before being sold and for Product Beta; the average period is 3 weeks.


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To calculate the activity budget for the finished goods stores, the estimated total usage of

the cost driver must be calculated. This will be the total number of ‘product weeks’ that the

products will be in store.

Based on the previous years’ data, the budgeted rate for the cost driver has been set at

RM2.50 per product week.

Product Product Weeks

Alpha 80,0000 x 2 weeks = 160,000

Beta 100,000 x 3 weeks = 300,000

460,000

The number of product weeks will then be multiplied by the budget rate for the cost driver

to derive the activity budget figure. That is:

460,000 x RM2.50 = RM 1,150,000

The same process will be carried out for the other activities identified.

Conclusion

The ABB is an objective way to link workload cost. Each division manager can create an ABB

to monitor their efficiency of their operation performance. The organization can link

respective departments’ budget and thus has a comprehensive picture of the organization

operating position.

Many investment associate prefer to review on the organization’s ABB in order for them to

see where their money is being spent and how efficiently the investor can administer the

investment. In addition, ABB can be use as a performance-based budget by attaching

performance standard and set as a benchmark to identified best performance.

It is important to take note that ABB is based on expected output. ABB plans backward from

next year’s output while traditional budgeting often plan forward from last year’s

experience. In contrast, the ABB approach uses resources and activities to create output, to

prove more information and identifies the non-value-added activities to be eliminated.


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Bibliography 1. Associated of International Certified Professional Accountant. (2013). Essential Tool for

Management Accounting . United Stated: The Chartered Insituted Management Accounting.

2. Atrill, P., & McLaney, E. (2012). Management Accounting for Decision Makers. Pearson.

3. Hansen, D., & Mowen, M. (2003). Cost Magement: Accounting and Control . Peking : Peking

University Press.

4. Huynh, T., Gong, G., & Huynh, H. (2013). Intergation of activity-based budgeting and activity-

based management. International Journal of Economics, Finance and Management Science ,

181-187.

5. Kaplan, R., & Atkinson, A. (1998). Advance Management Accounting . Prentice Hall

International, Inc .

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