Feasibility Report on Activity Based Budgeting for Pethe Industrial Marketing Company

This report analyzes the applicability of activity based budgeting in Pethe Industrial Marketing Company and suggests its adoption. It discusses the features of ABB, differences between ABB and traditional budgeting, and its suitability for the company.

PHILLIPS CONSULTING LIMITED
4TH FLOOR, UBA HOUSE, MARINA , LAGOS
Phone : [phone]
A FEASIBILITY REPORT
ON THE IMPLEMENTATION OF THE
ACTIVITY BASED BUDGETING
PREPARED FOR
PETHE INDUSTRIAL MARKETING COMPANY PRIVATE LIMITED
PREPARED BY
STUDENT
STUDENT ID
STUDENT
STUDENT ID
STUDENT
STUDENT ID
CLIENT’S CONTACT: NAME
DESIGNATION: CHIEF EXECUTIVE OFFICER
PHONE ; 022-24223976,FAX : [phone]
ADDRESS : 69, S.K. BOLE ROAD, DAGDIWADI, NEAR PORTEGUESE CHURCH
XXXX (W), XXXXXX- 900028
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EXECUTIVE SUMMARY
In the given assignment we have analyzed the applicability of the activity based budgeting in a
manufacturing concern, Pethe Industrial Marketing Company Limited, and after the overall
analysis we suggested that it would be viable for the company to adopt the ABB as it budgeting
system within the company.
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TABLE OF CONTENTS
Introduction.............................................................................................................................................................................. 4
Key Points.................................................................................................................................................................................. 4
a). A brief description of the Client Company......................................................................................................... 4
b). Description of ABB and its features...................................................................................................................... 5
Features of Activity Based Budgeting........................................................................................................................ 7
c). Difference between ABB and Traditional Budgeting system......................................................................8
Difference between traditional budget and Activity based budgeting.......................................................11
d). Discussion on the Suitability of ABB................................................................................................................. 13
Conclusion............................................................................................................................................................................... 13
References............................................................................................................................................................................... 14
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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 budgeting process. For the purpose of implementation of a
better budgeting practice the chief executive officer of the company has been looking for
prospects (Bennuona, et al., 2010). 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.
(Bromwich & Scapens, 2016). 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
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affected the growth of the company like slow decision making process, which is very important,
etc. (Choy, 2018).
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
(Dichev, 2017).
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:
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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 (Werner, 2017). 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:
i) 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?
ii) 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 (Timothy, 2004).
iii) 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 (Alexander, 2016).
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.
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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:
i) There should be formed proper connection between the organization’s strategy and
its activities.
ii) For the formation of the connection as stated above, proper gap analysis should be
conducted.
iii) Ascertaining the management of the capacity and proper estimation of the
organization’s revenue (Linden & Freeman, 2017).
iv) 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 (Erik & Jan, 2017).
FEATURES OF ACTIVITY BASED BUDGETING
The main features of Activity Based Budgeting have been discussed in brief hereunder:
i) Activity based budgeting is a process of planning which is connected to the strategic
objectives of the organization
ii) It makes the use of a well proven technique of activity analysis, which is being
considered as the heart of all activity based system
iii) It involves the identification of those opportunities which improves the cost
iv) It identifies the existence of interdependencies amongst the various departments of
the organization
v) It enables the various departments of the organization in the proper management of
various resources and related cost more efficiently
vi) It focuses on the achievement of the organizational goals and objectives
vii) It enables the management of the organization to have proper control over the
budgeting processes
viii) It makes use of those assumptions which are more realistic and ensures involvement
various employees of the organization in its preparation
ix) It involves identification of various cost drivers and activities along with cost pools,
which makes it a very complex process (Dumay & Baard, 2017)
x) Activity based budgeting is oriented more towards the achievement of short term
organizational goals rather than long term goals.
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C). DIFFERENCE BETWEEN ABB AND TRADITIONAL BUDGETING SYSTEM
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 (Raiborn, et al., 2016).
Traditional Budgeting has the following features:
i) 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.
ii) Justification is done in this budget of only those items which are in excessive of the
previous year’s budget.
iii) 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. (Jones, 2017).
iv) 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:
i) 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.
ii) 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.
iii) 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.
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The key limitations of the traditional budgeting system are as follows:
i) 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.
ii) The preparation of traditional budget involves great amount of modifications
being done by the management due to which the traditional budget fails to
reflect the goals and objectives of the organization (Mun & Shin, 2018).
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
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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:
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i) The traditional budgeting makes the management of activities with stability and
ease, it thus provides a framework of control
ii) Decentralization within an organization becomes easier with the help of traditional
budgeting, there are many organizations which recognizes the advantages of
decentralization like banks, etc. (Messinger, et al., 2017)
iii) Traditional budgets are easy to understand and control. The preparation of
traditional budget is also not difficult.
iv) 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:
i) 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
ii) The preparation of traditional budget requires analyzing the past year’s
budgets, which tends to be very time consuming process
iii) It fails to increase the employee morale and in providing incentives to them.
iv) The traditional budgets only take into consideration the quantitative aspects
while it ignores the qualitative aspects.
v) The traditional budgeting does not provide any alignment between the
organizational spending and strategy.
vi) 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
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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
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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:
i) The impact that the activity based budgeting will have on the performance and
profit of Pethe Industrial Marketing Company Limited?
ii) Will the implementation of this system of budgeting bring about any improvement
in the cost allocation system of the organization?
iii) The steps which are required to be followed by our client company for an effective
implementation of the activity based budgeting?
iv) 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 (Marques, 2018). 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 (Goldmann, 2016).
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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