Implementation of Activity-Based Budgeting Assignment

Implementation of Activity-Based Budgeting Assignment

Implementation of Activity-Based Budgeting Assignment

Introduction

At present, Pethe Industrial Marketing Company Private Limited has been analyzing and reviewing the viability of the system of budgeting being practiced by the company in order to bring about improvement in the capital budgeting process. For the purpose of implementation of a better budgeting practice the chief executive officer of the company has been looking for prospects[ CITATION Ben10 \l 1033 ]. Through various seminars, the officer came across the benefits of the activity based budgeting and after proper evaluation of this system of budgeting, the company has proposed to adopt this system of budgeting in front of Phillips Consulting. For the purpose of the adoption of this system of budgeting Phillips Consulting is required to submit a report on the feasibility of adopting the activity based budgeting system in the current scenario of the company.

Key Points

A). A brief description of the Client Company

Pethe Industries marketing is a leading manufacturing company since 1965 of electromagnetic brakes, clutches, crane controls and motors of high quality. Pethe industries is also an exporter and supplier of various kinds of material handling equipment’s, industrial brakes industrial clutches, gear boxes, reduction gears, gear cuttings, couplings and electric engine and motors, etc. These involves variety of activities like storage, transmission, transformation, fabrication, etc. for the performance of such activities there are various other activities which are involved like, recruitment of staff and labor, training process, engineering services, documentation, building rent or factory rent, machine on hire, travelling and conveyance and many more. The cost drivers which are related to these activities are machine hours, labor hours, number of machine set up, number of production runs, batch total, number of units produced, etc.[ CITATION Bro16 \l 1033 ]. There are various non value added activities with respect of the manufacturing process like waiting time or idle time, transportation, handling (moving things), excess inventory buildup or useless inventory, defects and many other types of non value added activities. For the purpose of carrying out the operations smoothly, our client company has implemented high tech machinery and various amenities, the company has also incurred cost in relation to the recruitment of a team having dexterous professionals. We have observed that during the past few years the profit of the company has remained at edge due to incurrence of cost in various improvements in the production system. Other than the cost incurred by the company as mentioned above there are various other factors which has affected the growth of the company like slow decision making process, which is very important, etc.[ CITATION Cho18 \l 1033 ].

With the increasing development in the manufacturing industry and constantly growing competition, the company has also appointed a special team of professionals who are skillful and experts in this field. This is expected to increase the clientele of the company far and wide.

b). Description of ABB and its features

Activity based budgeting is amongst one of the varied types of budgeting. As the name suggests it involves the activity based costing in its approach, that is to say, under this method of budgeting the costs are allocated to those activities with which they are associated and then the budgeted expenses are grouped together on the basis of estimated level of the activity[ CITATION Dic17 \l 1033 ].

Since the activity based budgeting involves activity based costing, their concept is also quite similar to each other. For a better understanding of this we have presented an example, which is as follows:

Activity-based budget:
Research:
Salaries $ 40,000
Internet connection 4,860 $ 44,860

Shipping:
Salaries $ 34,800
Telephone 4,400
Ship sleepeze 940,000
Ship plushette 800,000
Ship ultima 562,000 2,341,200

Jobbers:
Salaries $ 28,600
Telephone 5,000
Commissions 420,000 453,600

Basic ads:
Salaries $ 22,000
Advertising 32,000 54,000
Digital ads:
Salaries $ 40,450
Advertising 860,000 900,450

Office management:
Salaries $ 52,000
Depreciation 32,000
Supplies and Internet 18,900 102,900
Total $3,897,010

2. From the above data we can clearly see that the activity which is adding most amounts to the cost is shipping. The second most cost intensive activity is the digital advertisements, which is followed by jobbers’ activity[ CITATION Wer17 \l 1033 ]. The management should look into this matter to identify the reasons behind such high costs and evaluate different ways to reduce the same. For instance, instead of digital advertisement which is quite expensive, they can use broadcasting on radios, written advertisements like pamphlets, print media, etc. however, during the year of initial startup the company has to use advertisement media which reaches to wide range of people. Hence cost reduction in advertisements could be very difficult.

There are several points that need to be identified while the development of an activity based budgeting system. These points are as follows:

What is the relation between the various activity drivers or cost driver and the main source of the activity driver or cost driver in respective cases?

The ways in which the source of the activity driver can be changed and the effect it will have on the requirement of the resources for the activity[ CITATION Tim04 \l 1033 ].

Analysis of the activities being performed by the organization in order to ensure that the activities are being performed thoroughly and the required quality standards have been met.

There are numerous things that are viewed while carrying on the process of activity based budgeting. This involves the identification of the outputs being produced by the organization along with the various resources which are required to perform the activity of production of the output. Since the activity based budgeting is about allocating the cost to the respective activity in relation to a particular goods or services, these allocation of costs to products is determined on the basis of the characteristics of the products or services[ CITATION Ale16 \l 1033 ].

As we know the implementation of the activity based budget involves activity based costing, it is highly important for the organization adopting the activity based budget to follow the approach of activity based costing as the system of cost accounting in order to have an effective budgeting base within the organization.

Before implementing the activity based budgeting, an organization is required to make note of several fundamental principles in relation to the activity based budgeting. These principles are:

1. There should be formed proper connection between the organization’s strategy and its activities.
2. For the formation of the connection as stated above, proper gap analysis should be conducted.
3. Ascertaining the management of the capacity and proper estimation of the organization’s revenue[ CITATION Lin17/l 1033 ].
4. The connection between the organizational strategy and its business.

The implementation of the activity based budgeting should be considered where the overheads cost forms significant part of the total operational cost. Since the activity based budgeting is based on allocating the cost to the specific activities, it is most favorable in those undertakings where there are numerous activities involved and not where there is only activity which have highest proportion in total operational cost[ CITATION HEr17 \l 1033 ].

Features of Activity Based Budgeting

The main features of Activity Based Budgeting have been discussed in brief hereunder:

1. Activity based budgeting is a process of planning which is connected to the strategic objectives of the organization
2. 
It makes the use of a well proven technique of activity analysis, which is being considered as the heart of all activity based system
3. It involves the identification of those opportunities which improves the cost
4. It identifies the existence of interdependencies amongst the various departments of the organization
5. It enables the various departments of the organization in the proper management of various resources and related cost more efficiently
6. It focuses on the achievement of the organizational goals and objectives
7. It enables the management of the organization to have proper control over the budgeting processes
8. It makes use of those assumptions which are more realistic and ensures involvement, various employees of the organization in its preparation,
9. It involves identification of various cost drivers and activities along with cost pools, which makes it a very complex process[ CITATION Dum17 \l 1033 ]
10. 
Activity based budgeting is oriented more towards the achievement of short term organizational goals rather than long term goals.

c). Difference between ABB and Traditional Budgeting system

The traditional system of Budgeting

Traditional budgeting is the conventional method of budgeting which involves preparing of the budget on the basis of the budgets of previous year. Under this method of budgeting the budget of the current year is prepared by making appropriate changes in budget of the last year by making required adjustment to the expenditures on the basis of the rate of inflation, demand of consumers, circumstances prevailing in the market, etc. the budget of the current year includes the revenues and costs of previous year as well. The traditional budget involves justification of only those items in the current year budget which are over and above the budget of the previous year[ CITATION Rai16 \l 1033 ].

Traditional Budgeting has the following features:

1. Traditional budget is prepared on the basis of the budgets being prepared in the previous year. It takes the last year’s budget as base.
2. Justification is done in this budget of only those items which are in excessive of the previous year’s budget.
3. This budget is not totally revised, rather only appropriate changes and adjustment are done to the items of expenses on the basis of current year’s market condition, like inflation, etc.[ CITATION Jon171 \l 1033 ].
4. The issues relating to the different departments within the organization are totally ignored by this method of budgeting.

The following points are required to be kept in mind while preparing the traditional budget:

For the hassle free application of the traditional budgets the management of the organization is required to collect all the detail relating to the input to be used in the preparation of the budget. Determining the target for a budget is very important. In order to do so, the management of the organization should make comparisons with the associate organizations.  After the preparation of the budget, the same should be reviewed by the managers and their response on the same, if any should also be considered in the budget.

The key limitations of the traditional budgeting system are as follows:

As discussed above, the traditional budget takes the past year’s budgetary data into consideration, it requires analyzing the figures of the last year with great accuracy in order to prepare current year’s budget. The preparation of traditional budget involves great amount of modifications being done by the project management due to which the traditional budget fails to reflect the goals and objectives of the organization[ CITATION Mun18 \l 1033 ]. We have taken help of the following example in order to understand the concept of traditional budget with more ease:

 Classification

Last Fiscal Year

Current Budget

Next Fiscal Year

Personnel Services

     

1110 Salaries

$622,454

$730,500

$895,625

1120 Wages

$95,000

$155,000

$245,000

1130 Overtime Payments

$46,800

$50,555

$58,400

Subtotal: Personnel Services

$764,254

$936,055

$1,199,025

Contractual Services

     

1210 General Repairs

$498

$520

$625

1220 Utility Services

$1,006

$2,200

$3,320

1230 Motor Vehicle Repairs

$3,250

$4,740

$5,605

1240 Travel

$2,000

$3,200

$4,800

1250 Professional Services

$6,200

$7,800

$7,920

1260 Communications

$845

$980

$1,060

1270 Printing

$2,000

$2,400

$3,950

1280 Computing Services

$6,623

$7,900

$9,000

1290 Other Contractual Services

$3,000

$4,010

$5,540

Subtotal: Contractual Services

$25,422

$33,750

$41,820

Supplies and Materials

     

1310 Office Supplies

$5,607

$6,200

$7,840

1320 Fuel Supplies

$7,440

$8,790

$9,905

1330 Operating Supplies

$3,367

$4,950

$5,990

1340 Maintenance Supplies

$2,890

$3,670

$4,640

1350 Drugs & Chemicals

$8,996

$9,995

$10,675

1360 Food Supplies

$4,565

$5,800

$7,010

1370 Clothing & Linens

$9,506

$10,600

$11,800

1380 Education & Recreation Supplies

$5,006

$6,200

$7,500

1390 Other Supplies

$3,000

$4,450

$5,850

Subtotal: Supplies & Materials

$50,377

$60,655

$71,210

1410 Office Equipment

$54,550

$61,500

$71,000

1420 Electrical Equipment

$20,500

$26,500

$34,480

1430 Motor Vehicles

$40,000

$55,000

$54,000

1440 Highway Equipment

0

0

0

1450 Medical & Lab Equipment

0

$200

$400

1480 Data Processing Equipment

0

$4,000

$6,500

1490 Other Equipment

0

0

0

Subtotal: Equipment

$165,427

$147,200

$166,380

Current Obligations

     

1530 Rental Charges

0

0

0

1540 Insurance

$5,800

$6,800

$7,500

1550 Dues & Subscriptions

$60

$85

$105

1560 Electrostatic Reproduction

$450

$7,30

$850

1590 Other Obligations

$100

$150

$210

Subtotal: Current Obligations

$6,410

$7,035

$8,665

Employee Benefits

     

1610 Retirement & Pension Benefits

$83,200

$98,300

$110,450

1620 Social Security Contributions

$60,000

$75,005

$87,500

1640 Group Insurance

$24,270

$36,000

$48,400

1650 Medical/Hospital Insurance

$200,520

$314,250

$417,290

Subtotal: Employee Benefits

$367,990

$523,555

$663,640

       

TOTALS

$1,379,880

$1,708,250

$2,150,240

The various advantages of the traditional budgeting have been discussed below:

The traditional budgeting makes the management of activities with stability and ease, it thus provides a framework of control Decentralization within an organization becomes easier with the help of traditional budgeting, there are many organizations which recognize the advantages of decentralization like banks, etc.[ CITATION Mes17 \l 1033 ] Traditional budgets are easy to understand and control. The preparation of a traditional budget is also not difficult. Traditional budgeting has become a part of the organizational culture of many organizations which makes its abolition quite difficult as a fundamental method of operating.

Although traditional budgeting has several advantages, it also has the following disadvantages as well:

In the preparation of traditional budget, the chances of human error are very high, since it involves study of a lot of spreadsheets, so mistakes are bound to be committed. The preparation of traditional budget requires analyzing the past year’s budgets, which tends to be very time consuming process. It fails to increase the employee morale and in providing incentives to them. The traditional budgets only take into consideration the quantitative aspects while it ignores the qualitative aspects. The traditional budgeting does not provide any alignment between the organizational spending and strategy. The assumptions on which it is based are not scientific and more or less are guess work.

Witnessing the various limitations and drawbacks of the traditional budgeting, two approaches have been introduced. These are beyond budgeting and better budgeting. While the former focuses on the solutions of various problems, the latter is concerned about the evaluation of performance.

Difference between traditional budget and Activity based budgeting

We have summarized the major differences between the activity based budgeting and traditional budgeting in the statement being presented below.

Sl No.

Basis

ABB

Traditional Budgeting System

1.

Orientation

The orientation of this system of budgeting is towards activity and process

The orientation of this system of budgeting is towards outcome.

2

Nature

It is of dynamic nature

It is of static nature

3

Goal

The main focus of this system of budgeting is short term goals

The focus of this budgeting system is on long term goals

4

Approach

The approach adopted by this budgeting system is participative approach.

This system of budgeting does not follow participative approach.

5

Control

The level of control over the system is more

The level of control over the system is less

6

Complexity

This system of budgeting is more complex

This system of budgeting is quite simple

7

Accuracy

This system of budgeting provides a more accurate result

The level of accuracy in this budgeting system is less

8

Support

The support of the lower management is more in this case

The support of the higher management is more in this case

9

Implementation

The implementation process is quite difficult

No such difficulty is involved

10

Wasteful Expenditure

Under this budgeting system it is easy to identify the wasteful expenditure

It does not help in identifying wasteful expenditure

11

Time

This budgeting system is more time consuming

This is less time consuming

12

Volume of overhead

This should be adopted where the overhead costs are high

This should be adopted where the overhead costs are low

d). Discussion on the Suitability of ABB

From the above-detailed discussion there are various points we need to discuss before deciding the adoption of activity based budgeting in our client company, these are:

The impact that the activity based budgeting will have on the performance and profit of Pethe Industrial Marketing Company Limited?
Will the implementation of this system of budgeting bring about any improvement in the cost allocation system of the organization?

The steps which are required to be followed by our client company for an effective implementation of the activity based budgeting?
The availability of ample amount of resources as well as time with the client company for the implementation of activity based budgeting.

As we know, that our client is a manufacturing concern, which involves various types of activities in the manufacturing process[ CITATION Mar18 \l 1033 ]. The operational cost is high and the company is keen in knowing the activities which consumes the maximum portion of cost. The activity based budgeting involves identifying the cost drivers and allocating the cost associated with each activity. This might help the company in getting the desired results.

In our opinion and from the analysis of various aspects of the activity based budgeting being done above, we could advice Pethe Industrial Marketing Company Limited to adopt activity based budgeting practice within its organization. However, the company must be able to implement the budgeting practices properly without any compromise. Once implemented in an organization the activity based budgeting tends to bring about various improvements in the business processes[ CITATION Gol16 \l 1033 ].

Conclusion

On the basis of the overall analysis of the activity based budgeting in this report, we would like to suggest Pethe Industrial Marketing Company Limited to implement the activity based budgeting in its company in order to bring about improvements in its cost allocation system and identification of various cost activities.

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