Activity-Based Costing for Manufacturing

This assignment delves into the advantages and applications of activity-based costing (ABC) within a manufacturing company context. It critically examines the shortcomings of traditional cost accounting methods and highlights how ABC provides a more accurate and insightful understanding of product costs. The analysis emphasizes the role of ABC in improving efficiency, productivity, and profitability for manufacturing organizations.

Business Finance

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
1.1 Purpose and process of preparing budget..............................................................................1
1.2 Cost drivers of business and traditional budgeting approach................................................2
1.3 Whether traditional Budgetary system is appropriate or not there are basically three major
problems with traditional budgeting which are as follows:........................................................3
PART 2............................................................................................................................................4
2.1 Alternative Budget methods..................................................................................................4
2.2 Application of Alternative budget methods with example...................................................5
2.3 Which method is more efficient ...........................................................................................5
CONCLUSION................................................................................................................................6
REFERENCES................................................................................................................................7

INTRODUCTION
A plan which outlines the financial or operational goals of the organization is known as
budget. It helps in allocating resources, evaluating the performance and for formulating plans.
For successful financial planning budgeting is the first step in this process. In this report there is
a brief understanding about the purpose of preparing budget and the process for budgeting which
company should follow for developing business model. The important cost drivers has been
identified and in what areas cost budgeting will be important. Application of traditional
budgeting approaches has been classified. Various alternative budget methods like Rolling
budgets, zero based budgets and activity based budget has been explained with its application,
merits and demerits.
1.1 Purpose and process of preparing budget
There are three aspects for preparing budget i.e. forecasting of income and expenditure, a
tool for decision making and to monitor the business performance. Budgeting is an important
part while planning of business process. Managers and owners of the business should be able to
predict that it will make profit or not. The main purpose is to create a model that how business
should be performed or to decide strategies, plans and events which are being carried out. It is a
tool for decision making as it gives financial framework of the action which is planned or not.
Expenditure should be tightly controlled for managing business. It helps in enabling t business
performance that should be measured against performance of business which is forecasted. The
steps to be followed while preparing budget are as follows:
 All the assumptions about company's business environment should be reviewed and on
the basis of last budget, it should be updated as soon as possible.
 The capacity level of business should be determined and the constraints of the company
while generating sales should be classified and their impact on company's revenue
growth. They should be able to determine available fund during the budget period and
step cost which can occur in business activity is also been determined.
 Budget package should be created from the preceding year and it should be issued
personally wherever it is possible(Zeller and Metzger, 2013).
 Revenue forecast should be obtained from the sales manager for validation with help of
CEO. Budget from all departments should be obtained and tries to rectify the error.
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 All capital budget should be obtained for validation with the help of senior management
team for suggestions and recommendations. Budget model should be updated in a master
budget model. Budget should be reviewed along with senior management and all the last
alterations should be done.
 Finally, the budget will be issued to all authorized recipients and it will be loaded in
financial software.
If budget is developed properly then it allows business to track the financial position of
their own. It gives long term planning for everything such as operating costs to expansion. It
benefits the business by identifying potential for attracting new investors, goal setting ability,
line of credit, decision making about salaries, bonus and easy tax preparation(Hansen, 2011).
1.2 Cost drivers of business and traditional budgeting approach
Cost driver can be classified in two categories i.e. internal and external forces . It cause
change in cost of any activity. Overhead cost should be assigned properly to the number of units
which are produced. In external, it includes government regulations,weather, access to resources,
location and most important is the workforce. In internal, it includes indirect costs, overheads,
personnel and capital. If business is registered l with specific regulations which are governing
day to day operations. Workforce leads that the business operation is being performed by the
workers properly or not. The cost driver in manufacturing sector may be number of steps or
processing time for producing a product. The cost driver of service sector can be compensation
package of cost for labor.
Traditional budgeting is used for projecting business expenses and revenues for the
coming year on basis of previous year budget. It also helps in predicting profits. Previous year's
budget can be used for adjusting changes which are caused due to inflation. Past budget's
revenue can be used for traditional budgeting process(Myers, 2018). It also helps in decision
making and budget always makes easy in sorting out issues and according to that issues can be
resolved as soon as possible. If the budgeted expenses are exceeding then business expenses can
be reduced or alternative vendors can be checked out for different prices. Traditional budget
provides a plan that how business can be operated. If there is requirement of finance, then too,
traditional budgeting can be used. All investors and lenders always give priority before investing
or giving loan to keep track on financial plans of that particular company. So, traditional
budgeting helps in forecasting the projections related to revenue, expenses and all as well as
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proper reasoning with the specific preference to previous year’s budget. Traditional budgeting is
a part of organizational culture for most of the companies. Practicing fundamental method of
operating can be a risky decision.
1.3 Whether traditional Budgetary system is appropriate or not there are basically three major
problems with traditional budgeting which are as follows:
Time consuming and expensive: Traditional budgeting consumes too much time and many
management resources. Only some people have the mentality that this is worthwhile. Many
companies take six to eight months, . Mostly, budgets require input and very detailed and even
negotiation of many people is throughout the company, which only sums up the number of
resources which are used by traditional budgeting.
The main reason for consuming too much time is use of spreadsheet which contains
inherent shortcomings like issues related to version control, data entry errors and difficulty in
accurate formulations.
Unrealistic objectives: Usually, the senior executives set goals which have specific
guidelines in context of expenditure and specific revenue growth target. Specific goals like
increasing revenues by 20% and cutting cost by 10%. The department managers who have the
responsibility for getting these results are not asking or trying to this then it is next to impossible.
The objectives cannot be achieved by lower level if top level is not giving top solicit input.
Fixed, flexible and easily irrelevant – Traditional management quickly becomes
irrelevant i.e. once the budget has been made then it is fixed that no changes can happen. In the
initial stage, it is top down but afterwards it becomes bottom up to meet fixed goals which are set
by management(Oseifuah, 2018). If market conditions, economy or industry changes, new
entrants may emerge. Innovations, partnerships or any other internal factor with the
repercussions may occur. But budget cannot be changed in the traditional approach.
Executive and Employee compensation against budget: Many companies negotiate
over achieved benchmark of budget so that they can easily accomplish their goal. Most of the
companies tries to execute and employee compensation which are directly related to performance
against the budget. Traditional budgeting process usually focuses on reduction of cost more than
creating value. So, there is a disconnection from strategic plan or the strategic initiatives are
given with low priority(Østergren and Stensaker, 2011).
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Fails to motivate: The desirable behavior of people has not been encouraged in
traditional budgeting system. It always gives unprofessional attitude in budget center mangers,
bureaucracy and vertical control has been strengthened in this approach and it undervalues the
employees. Reinforcement of departmental barriers instead of sharing knowledge.
PART 2
2.1 Alternative Budget methods
Rolling Budget methods – It is a plan which is updated in which time frame remains
same and it is not static. It renews the budget for next period and information is incorporated
from the experience which is to be build (No and Park, 2018). Rolling budget are up to date than
static budget. They do not require huge investment of money and time for planning. All the
alterations are incorporated from previous period. This is more responsive to all unexpected
changes. Performance can be assessed against rationalized and realistic targets. On the other side
it is similar to form new budget again. It regularly requires facts and to gather them from
previous period or robust information system is required for extracting specific information for
sub categories. Constant revision distracts or disturbs the employees. Rolling budget is not
recommended when conditions are not changing constantly. For unvarying environment it is
waste of time.
Zero based Budgeting – It is a reverse approach of traditional budgeting. Managers
review the budget of previous year in traditional budgeting but in zero base budgeting managers
justify all expenses which are budgeted, not only of previous year. The baseline of ZBB is zero
not last year's budget. There is a proper allocation of resources and it helps managers to improve
activities by cost effective ways. Criteria are not always easily identified so this is an advantage
for service departments. It is time consuming as sometimes the expenditures are very difficult to
define for managers. Every expenditure needs to be defined in zero based budgeting so this
requires huge manpower and even knowledge is required so proper training has to be given to
managers. Risk has been faced by managers in zero based budgeting because the volume of data
is very large and no one has that much ability to know every detail of everything. Consistency of
manager must be uniform and reliable.
Activity Based Budgets : This method is designed to give transparency in the budget
process. It records, analyses and researchers activities which increases the cost to the business.
The major disadvantage is the consumption of resources of organization. If there is a too much
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spending then activity base budgeting becomes counterproductive. It does not substitute any of
the process but sums up to the administrative activities of the company. It focuses on immediate
and short term and avoids long term.
2.2 Application of Alternative budget methods with example
Rolling Budget methods : Rollings budget reduces uncertainty in budgeting as they give
proper concentration on the short term especially when the degree of uncertainty is less. Budget
can always be extended into future normally for twelve months. Accurate budget leads to
specific planning and control. Reassessment of the budget is always be forced to the
management in Rolling based budgets. It saves cost and time as compared to traditional budget
which helps for timely adjustments of income and expenses.
Zero based Budgeting : Staff involvement has been increased at all the levels in zero
based budgeting because in this method lots of information, facts and work is required for
completing the budget. Allocation of resources should be more economical and efficient.
Organization's knowledge and understanding of cost behavior pattern will be enhanced. It is
more responsive to business environment. The operations which are not efficient and obsolete
cab be discontinued. It also helps in identifying the opportunities for outsourcing. It increases the
coordination and communication about some important decisions about the company.
Activity Based Budgets : It focuses on cost of overheads which is huge proportion of
aggregate of operating costs. It identifies the activities which increases the cost and if cost is
been controlled then it should be properly managed and understood. The most essential one is
that it gives information in total quality environment, by relating level of service provided and
cost of an activity.
2.3 Which method is more efficient
Companies of some industries always incorporate different variety of inputs for the
creation of services and goods which are sold by them. There is the presence of wide range of
expenses. As these companies can directly allocate costs to one of the most appropriate activity,
cost management and budgeting of these firm to improvise there financial position. Assignment
of cost is on the basis of activity Based costing. It allocates fixed administrative and overhead
costs to the activities which also incur cost. Factors which are related to cost for activity based
costing have a direct relationship with the particular cost of overhead. Activity based costing
provides cost to all those products that actually is in need of activities. This approach has been
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originated from manufacturing sector because it is the best method of allocating overhead costs
as compared to traditional method which was using direct labor. When labor intensive was
transformed to automation and capital intensive facilities and processes, these firms are in need
of that method which suits new operating environment. Whenever, the product lines are
produced by manufacturers in various quantity there is huge requirement of different service
support levels.
It is most important for this company because it gives customized products and services
and customized production environment is always in need of allocation of indirect costs to a
product which gives identification of true cost. It helps in improving the processes of business
such as allocation of indirect costs which is based on cost driver of product and many more
factors which increases the cost. Activity based method is also used to identify all the non value
added activities and for efficiently allocating resources and activities which are profitable. These
methods lead to add value to continuous improvement of any organization's processes. Activity
based method also identifies the wasteful products which are increasing the cost of the company.
This method helps in fixing the price of the products and services that are in large quantity or
incorrect. It gives transparency in budget process and it records the activities which are
increasing the cost of company. It does not substitute any of the process but sums up to the
administrative activities of the company. It focuses on immediate and short term and avoids long
term. Hence, activity based costing improves the productivity, efficiency and it resolves the
issues which are giving impact to the cost of the organization.
CONCLUSION
From the above report, it has been concluded that traditional method of budgeting is not
appropriate because it is time consuming and it has many more limitations which are been
discussed in this case. It can be seen in the report that Alternative budgeting method are more
flexible and easy for interpret the financial position and for comparison. Along with this, it has
been articulated that while choosing Activity based budgeting method for manufacturing
company is very essential. It can be summarized that budgeting improves efficiency, productivity
and more margin to the company if it is well managed. Thus, company should go with alternative
budget method in which activity based is most appropriate.
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REFERENCES
Books and Journals
No, W. and Park, C.H., 2018. Social Media Use from the Citizen Engagement Perspective: The
Case of Twitter in New York and Chicago Participatory Budgeting. In Sub-National
Democracy and Politics Through Social Media (pp. 129-146). Springer, Cham.
Oseifuah, E. K., 2018. Activity based costing (ABC) in the public sector: benefits and
challenges. Management. 12. pp.4-2.
Myers, G. M., 2018. Responsibility Center Budgeting as a Mechanism to Deal with Academic
Moral Hazard (No. dp18-01).
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.
Zeller, T. L. and Metzger, L. M., 2013. Good Bye Traditional Budgeting, Hello Rolling
Forecast: Has The Time Come?. American Journal of Business Education (Online). 6(3).
p.299.
Østergren, K. and Stensaker, I., 2011. Management control without budgets: a field study of
‘beyond budgeting’in practice. European Accounting Review. 20(1). pp.149-181.
Online
Budgeting, 2018. [Online]. Available through:<https://www.cpdwise.com/tutorial/Budgeting-
An-Introduction.html>
Activity Based Budgeting, 2016. [Online]. Available
through:<https://efinancemanagement.com/budgeting/activity-based-budgeting>
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