Activity-Based Budgeting: An Essay On Its Suitability For A Company.

You are recently employed as a graduate consultant in a management consultancy firm and are assigned to a team. One of your firm’s clients is currently evaluating its budgeting system. The CEO of your client had recently attended a seminar on
Activity-Based Budgeting (ABB) in private companies and would like to know whether ABB is suitable to the company. Your manager has asked your team to prepare a report for the client.

Required:

Your group is required to prepare a report to comment on the suitability of ABB for a company of your group’s choice (your firm’s client). The report should cover the followings:
a) A description of your firm’s client
b) A description of the ABB and its features
c) In what ways ABB is different from traditional budgeting systems
d) A discussion on whether the ABB is suitable to your firm’s client

Description of Pental

Activity-based budgeting is a budgeting framework that is designed to manage the company’s overheads and create greater transparency in the budget processes. This report brings out the practical implication of Activity-based budgeting in the organisations. The organisations have been experiencing elimination of wasteful resources by using this method. Moreover, the companies have abandoned following the traditional method of budgeting.

The report has strived to use the Pental (a soap manufacturer in Australia) that uses Activity based budgeting in its operations. Pental has managed to achieve growth since last the three years where the overall industry was facing declined demand due to increased input cost (ANNUAL REPORT, 2017).

The method identifies three major stages such as identify the business activities and their cost drivers, estimate the sales volume, and finally calculate the cost driver rate. Activity-based budgeting pulls the concern towards the overhead activities and the cost associated with these activities. In recent times, the organisations tries to provide high quality products with low cost to attract the customers. For marinating the quality, the company uses TQM (Total Quality Management) accomplished with Activity-based budgeting.

Pental (PTL) is the largest manufacturer of soaps in Australia. PTL has built a portfolio of fourteen brands in the field of household care, personal care and fabric care. The CEO (Chief executive officer) of the company who joined the company as chief operating officer earlier. To maintain the customer transparency, the company estimates all its cost only after it has reviewed and analysed the activity based budgeting on each of its product. Recently, the company implemented its new supply chain which resulted in 15% cost reduction in soaps due to implementation of activity based budgeting (ANNUAL REPORT, 2017).

After reviewing the cost of doing business with each customer, the company has released the inefficiency in route and food service channels. By the time of existence of the organisation in the market, the company has developed and enhanced the range of country life liquid soaps.

After reviewing the commercial sector, the CEO agreed to continue its long-term objective of expanding and diversifying its commercial channels with its numerous brands. However, to expand the sales of these newly introduced liquid soaps, the company has to conduct its operations transparently. Pental makes a separate cost statement of a product, which also includes its factory overheads such as the process cost of saponification, bleaching, soap cutting cost, and overwrapping. Initially, the company does not combine and cumulate its overall cost. To win the trust that the company is not at all charging more prices from its clients, it has to create transparency by providing them Activity-based budgeting on each product (Annual report, 2016).     

Understanding of ABB and its features

An activity-based budgeting is a system, which records and analyses the activities, which lead to incurring of cost for a business. This budgeting activity not only manages and adjusts the previous budgets due to inflation but also lead to develop efficiencies in business operation. Activity based budgeting is the method of budgeting, which is designed to provide transparency in the budget-making process (Hansen, 2011).

ABB enables guide to organisations to generate revenue from the research activities and allocate to the unit that is responsible for the activity. Moreover, it is a planning system, which ascertains the cost, which is associated with the activities. Further these budgeted expenditure activities are compiled to the expected activity level. Activity-based budgeting system allows a high degree of modification in planning the cost statement and focus on volume and type of activities that are occurring in business (Noreen, Brewer, and Garrison, 2014).

The most likely outcome of using activity-based budgeting is the management plan, which reduces the level of activity required for revenue generation that lead to improve profits. In order to achieve a successful management plan, the manager of the company is forced to attain a detailed knowledge of the operational processes if they contribute to enhance the cost structure. For example- if a company manufactures four watches, the cost of each is calculated based on its operation on each product. Despite this, the company do not form cumulative cost statement rather it drafts different cost statement for each product (Ekholm, and Wallin, 2011).   

Activity based budgeting is a method in which the budgets are prepared by using Activity based Costing after the consideration of overhead costs.

Activity-based budgeting is an management accounting tool which do not consider the cost incurred in the past years to reach current year`s budget (Yalcin, 2012).

The method evaluates and analyses each one of the cost driver. It considers all the steps involved in an activity of manufacturing a product. The irrelevant activities are all eliminated from the activity (Gurcanli, Bilir, and Sevim, 2015).

The method “Activity based budgeting” eliminates all categories of unnecessary activities, which can help the business reduce and save costs. Activity based budgeting is a cost reducing strategy which leads the saved cost to enhance production of goods and services at an competitive cost, which helps the company to gain competitive edge in the market.

Activity-based budgeting technique helps to interpret the business in different departments but as a single unit. The top-level cost manager prepare the budget for all the business activities as a whole without focusing on any one department.

Features

The most important feature of budget is elimination of bottlenecks. This budgeting method removes all the unnecessary cost of the business. By doing so, the organisation is able to eliminate all sorts’ bottlenecks.

Activity based budgeting estimates the total cost which is divided into fixed cost and variable cost. It provides the necessary information that helps in designing a suitable cost system.

The method provides a proper distinction between cost behaviour patterns. Different cost behaviour patterns are diversity related, volume related, event related and time related.   

The method of costing is used in business, which can relate to their accounting strategies. These accounting strategies provide a way to determine the cost of manufacturing products in context of what revenue can be generated by the particular product. Several costing systems determine the overhead cost of production and allocate this cost to the business product (Talib, and Rahman, 2015).

The approach of ABB (Activity-based Budgeting) is different from the traditional budgeting system because in other budgeting methods the cost levels are adjusted based on inflation and revenue changes, which is used to derive annual budget. There are two most common method of allocating indirect cost to products. Both the traditional method and the activity-based budgeting method assess overhead costs then associate this overhead cost to the product (Hayden, 2018).   

The company produces numerous products at the same time and has a complex network of customer-supplier relationship. Allocation of cost of all the direct and indirect activities directs to addition of cost to the final product and ignores the importance of internal value chain. Activity-based budgeting can be a powerful method of costing that helps in building a customer-focused, accountable and a team-oriented organisation. To make a customer-focused organisation, a company has to make accountable to everyone for their products. Sensible resource governance processes also affect association of cost with the products or services. Direct cost is easily assigned to products and services (Tse, and Gong, 2009).

Whereas, indirect cost in each particular product line is amortised from unique services, which must have made value addition to the product. The cost of internal product is transferred to the internal customers and is allocated to the group of product. Further, the cost flows from the internal network of support relationships to the ultimate external product, which is ultimately consumed by the customer (Accounting tools, 2018).

This method is suitable for the company operations. The companies has no longer following the traditional method because of its association with basic concepts such as cost variability, flexibility budget, responsibility accounting, and cost hierarchy. The business processes of modern businesses are moving away from the vertical integration and focus more on customer satisfaction. Business processes that generate value to the customers deserves more attention. Activity-based budgeting is the tangible explicit expression of associating the short-term plans to strategic objectives because it is based on core processes that work for customer satisfaction. On the basis of cost statements, the company could only decide whether the business is profitable. If the cost structure of the organisation has high weightage of indirect cost in the total cost incurred. Proper allocation of cost for specific cost and customers may have significant difference in assessing profitability and ultimately lead to changes in management decision (Mahal, and Hossain, 2015).

In what ways ABB is different from traditional budgeting systems

Companies use ABB (activity-based budgeting) to assign overhead cost to all individual departments. It starts with planning and forecasting the sales volume of each product line. Historical data is derived from traditional budgeting system such as direct material cost and direct labour cost. Activity-based budgeting is used to estimate the required activities to produce the decided sales volume. These activities require certain resources that support to execute the planning process (Angelakis, Theriou, and Floropoulos, 2010).

Activity-based budgeting is regulated to bring out efficiency in the activities of the business. Budgets are approved after justifying the cost drivers because it is the main factor that has cause and effect relationship with the total cost of the business. It strives to evaluate every cost driver that would result in low and competitive cost to the organisation (Oseifuah, 2018).

This method is suitable only for those companies that have implemented and are already using ABC (activity-based costing) in their operations. It provides useful information in total quality management (TQM) environment by relating the cost of the activity to the service level provided. A TQM is a management philosophy that focuses on increasing profitability by improving the quality of the goods and satisfaction of the customers. A company who uses only Activity-based budgeting to manage its overheads cannot get success in the minds of the customers. It has to combine TQM (Total quality management) with the Activity-based budgeting and Activity-based costing to provide high quality with low cost (Capusneanu et al., 2013).

For example- the seatjoy, inc., the company who produces high quality leather desk chairs. Earlier, the company use to follow traditional approach to manage its manufacturing overhead to products based on direct labour hours. Further, the company realised that it would be more profitable if they start using Activity-based budgeting instead of traditional method. It adopted new method because it realised inefficient reengineer process, management procedure, and the information system. In order to improve the situation, it managed to follow product line activity to manufacture the huge airplanes.

(Source: Getty Images, 2003)

The above diagram describes that how seatjoy, inc. managed to drop the traditional method of budgeting. Further strived to apply Activity-based budgeting and activity-based costing for its cost structure sheets to manage its overheads.

Conclusion

From the above discussion on Activity-based budgeting and its implication on organisations, it can be concluded that activity-based budgeting requires the determination of cost of planned activities in a business. The usage of this method depends on the expected size of organisation`s operation and consumption of resources. It is used by the organisation that operate in repetitive activities. Activity- based budgeting is more detailed than the traditional method of budgeting. Activity-based budgeting helps the organisation to eliminate the wasteful expenses.

Activity-based budgeting method has brought radical changes in the cost management systems. It has been noticed that activity-based budgeting is more adopted by forward looking companies because they implement TQM (Total quality management) to maintain and manage the overhead cost with the quality of the product. The report has been more elaborate and tried to be clearer through the example of seatjoy, inc. The company highlights the difference and benefit, which it start experiencing in its cost structure by adopting Activity-based budgeting method. 

References

Accounting tools, (2018) Activity-based budgeting. [online] Available at: https://www.accountingtools.com/articles/activity-based-budgeting.html [Accessed on: 17/09/18]

Angelakis, G., Theriou, N., and Floropoulos, I. (2010) Adoption and benefits of management accounting practices: Evidence from Greece and Finland. Advances in Accounting. Incorporating Advances in International Accounting, 26, pp. 87-96

Annual report, (2016) Pental Limited (PTL) Stable Small Industrial with Earning Upside in Medium Term. [online] Available at: https://www.asx.com.au/documents/research/ptl-20160107-full.pdf [Accessed on: 17/09/18]

ANNUAL REPORT, (2017) Pental: TRUSTED BY FAMILIES FOR GENERATIONS. [online] Available at: https://www.pental.com.au/images/site/pental/15823_Pental_AnnualReport_LR1.pdf [Accessed on 17/09/18]

Capusneanu, S., Boca, I., Barbu, C.-M., Rof, L.-M., and Topor, D. (2013) Implementation of Activity-Based Budgeting method in the economic entities from mining industry of Romania. International Journal of Academic Research in Accounting, Finance and Management Sciences, 3(1), pp. 26-34.

E-finance management, (2018) Activity Based Budgeting. [online] Available at: https://efinancemanagement.com/budgeting/activity-based-budgeting [Accessed on: 17/09/18]

Ekholm, B., and Wallin, J. (2011) the Impact of Uncertainty and Strategy on the Perceived Usefulness of Fixed and Flexible Budgets. Journal of Business Finance & Accounting, 38(1), (2), pp. 145–164.

Getty Images, (2003) Activity-Based Costing and Quality Management. [online] Available at: https://www.swlearning.com/ibc/albrecht9e/pdf/67604_c08_450-512.pdf [Accessed on: 17/09/18]

Gurcanli, G. E., Bilir, S. and Sevim, M. (2015) Activity based risk assessment and safety cost estimation for residential building construction projects. Safety science, 80, pp.1-12.

Hansen, S.C. (2011) A Theoretical Analysis of the Impact of Adopting Rolling Budgets, Activity-Based Budgeting and Beyond Budgeting. European Accounting Review, 20(2), pp. 289-319.

Hayden, A. (2018) Activity-Based vs. Traditional Costing. [online] Available at: https://quickbooks.intuit.com/r/pricing-strategy/activity-based-vs-traditional-costing/ [Accessed on 17/09/10]

Mahal, I. and Hossain, A. (2015) Activity-Based Costing (ABC)–An Effective Tool for Better Management. Research Journal of Finance and Accounting, 6(4), pp.66-74.

Noreen, E.W., Brewer, P. C. and Garrison, R. H. (2014) Managerial accounting for managers. New York: McGraw-Hill/Irwin.

Obeidat, B.Y., Hashem, L., Alansari, I., Tarhini, A. and Al-Salti, Z. (2016) the effect of knowledge management uses on total quality management practices: A theoretical perspective. Journal of Management and strategy, 7(4), p. 18.

Oseifuah, E. K. (2018) Activity based costing (ABC) in the public sector: benefits and challenges. Management, 12, pp. 4-2.

Pietrzak, Z. (2013) Traditional versus Activity-based Budgeting in Non-manufacturing Companies. Social Sciences, 4 (82), pp. 26-37.

Shishini, E. H. M., (2017) the Use of Management Accounting Techniques at Hotels in Bahrain. Review of Integrative Business and Economics Research, 6(2), p.78.

Talib, F. and Rahman, Z. (2015) Identification and prioritization of barriers to total quality management implementation in service industry: an analytic hierarchy process approach. The TQM Journal, 27(5), pp. 591-615.

Tse, M.S.C., and Gong, M.Z. (2009) Recognition of Idle Resources in Time-Driven Activity-Based Costing and Resource Consumption Accounting Models. Journal of Applied Management Accounting Research, 7(2), pp. 41-54

Yalcin, S. (2012) Adoption and Benefits of Management Accounting Practices: An Inter-country Comparison. Accounting in Europe, 9, pp. 95-110