Question Tag: Activity Based Budgeting

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  • 6 Marks

MA – May 2018 – L2 – Q2b – Budgetary Control

Explain and provide examples of Activity Based Budgeting, Zero Based Budgeting, and Rolling Budgeting in a memorandum format.

The Sales Director has recently attended a course entitled ‘Finance for Non-Accounting Managers’. He wants to understand more about a number of management accounting terms that he feels may be relevant to him.

Required:
Prepare a memorandum explaining and providing examples of the following:
i) Activity Based Budgeting
ii) Zero Based Budgeting
iii) Rolling Budgeting

MEMORANDUM
To: Sales Director
From: Technician Student
Re: Accounting Terminology
Date: X/X/XX

Management accounting can provide information for managers to support decision making, planning and control within an organisation. You have been introduced to a number of management accounting theories and related terminology. This paper aims to provide further information and explanation of a number of key terms.

Activity Based Budgeting
Is a method of budgeting in which the activities that incur costs in every functional area of an organisation are recorded and their relationships are defined and analysed. Activity based budgeting stands in contrast to traditional, cost-based budgeting practices in which a prior period’s budget is simply adjusted to account for inflation or revenue growth. As such, ABB provides opportunities to align activities with objectives, streamline costs and improve business practices.

Zero Based Budgeting
Traditional budgeting approaches are not always clearly linked to strategy and are focused on financial aspects only. In this scenario, the annual budget uses an incremental approach whereby increases and decreases are applied to previous outturn positions. In contrast, Zero based budgeting supports a more innovative approach, requiring managers to justify all costs as if the proposals were being considered for the first time. This approach is focused on opportunity costing and can eliminate inefficiencies, however, it can be quite complex and time-consuming to administer.
A definition of zero based budgeting provided by CIMA is ‘a method of budgeting whereby all activities are re-evaluated each time a budget is formulated. Each functional budget starts with the assumption that the function does not exist and is at zero cost. Increments of cost are compared with increments of benefit, culminating in the planning of maximum benefit for a given budget cost’.
An example of zero based budgeting:
It is proposed to increase the maintenance budget by 20% to take account of the age of some equipment and other inflationary factors. Due to zero based budgeting analysis, it is identified that a particular machine, which costs €/£8000 to maintain is only used once per quarter. An alternative outsourcing option has been identified and the budget adjusted accordingly.

Rolling Budgeting
Is one that is revised at regular intervals by adding a new budget period to the full budget as each budget period expires. A budget for one year, for example, could have a new quarter added to it as each quarter expires. In this way, the budget will continue to look one year forward. Cash budgets are often prepared on a continuous basis.

 

  • 10 Marks

MA – May 2018 – L2 – Q2a – Performance analysis

Analyze a survey comparing attitudes towards Japanese and German cars based on service, economy, reliability, and comfort.

Diligence Research Ltd, a research and advocacy company, has undertaken an attitude survey of recent buyers of particular brands of cars in Ghana. As part of this study, recent buyers of Japanese cars and recent buyers of German cars were asked to agree or disagree with a number of statements. They were asked to choose only one out of the four options and indicate whether they agree or disagree. One of the summary tables from the survey is shown below.

Agree Disagree
Japan cars are:
Easy to get serviced 65 35
Economical 81 19
Reliable 76 24
Comfortable 69 31
German cars are:
Easy to get serviced 32 68
Economical 61 39
Reliable 74 26
Comfortable 85 15

Required:
Analyse the above data highlighting the most significant features of these data. Illustrate your analysis with tables.

Agree Disagree Agree % Disagree %
Japan cars are:
Easy to get serviced 65 35 22% 32%
Economical 81 19 28% 17%
Reliable 76 24 26% 22%
Comfortable 69 31 24% 28%
Total 291 109 100% 100%
German cars are:
Easy to get serviced 32 68 13% 46%
Economical 61 39 24% 26%
Reliable 74 26 29% 18%
Comfortable 85 15 34% 10%
Total 252 148 100% 100%
  • For buyers of Japanese cars, they view them as economical and reliable. For German cars, buyers appreciate their comfort and reliability.
  • Japanese cars are seen as not easy to service and less comfortable compared to German cars.
  • Buyers who prioritize reliability and comfort might prefer German cars, while those valuing economy and reliability might lean towards Japanese cars.
  • Buyers focused on ease of servicing should choose Japanese cars.
  • German cars show significant disparity in comfort and servicing compared to Japanese cars, with comfort being a notable strength and serviceability a significant weakness.
  • 10 Marks

MA – April 2022 – L2 – Q3b – Activity-based costing

Differentiate between Activity-Based Budgeting and Incremental Budgeting, explain ABB processes, and discuss arguments for and against ABB.

Kankum Industries is considering switching from Incremental Budgeting to Activity-Based Budgeting (ABB) because of the argued pricing specificity of the ABB approach. The Chairman of the Finance Sub-Committee of the board, who does not have an accounting background, has contacted you for clarification on some key issues relating to ABB in order to assist in his explanation to the board.

Required:

i) Differentiate between Activity-Based Budgeting and Incremental Budgeting. (3 marks)

ii) Explain the process in ABB. (3 marks)

iii) State TWO (2) arguments in favour and TWO (2) arguments against ABB. (4 marks)

i) Differentiation between Activity-Based Budgeting and Incremental Budgeting:

  • Activity-Based Budgeting (ABB): ABB is a method of budgeting that is based on identifying activities that incur costs within an organization and then determining the cost drivers of those activities. Budgets are prepared based on the expected activity levels, making the budgeting process more accurate and aligned with operational realities.
  • Incremental Budgeting (IB): IB is a traditional approach where the previous period’s budget is used as a base, and adjustments (usually increments) are made to create the current period’s budget. This method is less detailed and relies heavily on historical data without necessarily considering the actual activities or changes in the organization.

ii) The Process in ABB:

  1. Identify Activities: The organization must identify the key activities that incur costs within its operations.
  2. Accumulate Costs into Cost Pools: Similar activities are grouped into cost pools to better track and manage expenses.
  3. Determine Cost Drivers: The organization then identifies the factors that drive the costs of each activity, known as cost drivers.
  4. Assign Costs Based on Activities: Costs are then assigned to each activity based on the identified cost drivers, leading to a more accurate and activity-focused budget.
  5. Prepare the Budget: The budget is prepared using the costs and activities identified, ensuring that it reflects the operational needs and cost drivers.

iii) Arguments in Favour of and Against ABB:

Arguments in Favour:

  1. Improved Cost Control: ABB allows for more accurate budgeting and cost control by focusing on the activities that drive costs, enabling organizations to allocate resources more efficiently.
  2. Aligns Budget with Operational Activities: ABB ensures that budgets are closely tied to the actual activities of the organization, making the budgeting process more realistic and aligned with business needs.

Arguments Against:

  1. Complexity and Cost: ABB is more complex and time-consuming to implement than Incremental Budgeting, requiring detailed analysis and identification of activities and cost drivers.
  2. Resource Intensive: The implementation of ABB requires significant resources, both in terms of time and personnel, to identify, measure, and manage activities and their associated costs, which can be burdensome for some organizations.
  • 12 Marks

PSAF – Nov 2017 – L2 – Q3a – Public Sector Fiscal Planning and Budgeting

Distinguishing between Activity-Based Budgeting and Programme-Based Budgeting and explaining the advantages of Programme-Based Budgeting.

The Minister of Finance is mandated by law to develop a budgetary system throughout the public sector. Recently, the government has moved away from Activity-Based Budgeting to Programme-Based Budgeting system for many reasons.

Required: i) Distinguish between Activity-Based Budgeting and Programme-Based Budgeting. (4 marks)

ii) Explain FOUR advantages that Programme-Based Budgeting has over the Activity-Based Budgeting. (8 marks)

a)
i) Activity Based Budgeting Vs Programme Based Budgeting
The following are the differences between ABB and PBB:

  • ABB links resource allocation to the activities required to be undertaken in order to achieve a desired output, but PBB assigns resources to measurable results to be achieved.
  • ABB emphasizes the relationship between activities and cost, thereby producing much detail on overheads, whereas PBB focuses on the linkage between programme funding level and expected results of the programme.
  • ABB produces detailed information on cost on each activity, thereby making control cumbersome, but PBB aggregates cost information at the programme level rather than activity level.
  • ABB provides full costs of programmes and services which are more transparent and available for planning, budgeting, and decision-making, whereas PBB consolidates the cost information, thereby limiting transparency and availability of full cost information for planning, budgeting, and decision-making.

(2 marks each for any 2 differences explained = 4 marks)

ii) Advantages of PBB over ABB

  • It provides a framework for measuring the performance of the MDA expenditure programmes.
  • It enables effective management of resources to achieve government outcomes or objectives since the emphasis is on programmes attainment rather than a mere performance of activities.
  • It promotes process accountability and transparency that enables the public to judge the fiscal stewardship of the managers.
  • It provides a specific linkage between resources allocation and strategic policy objectives of the MDAs. That is, it establishes a closer link between resources allocated and what has been done with it.
  • It makes budget evaluation and control much more focused and conclusive. It becomes very easy to measure which programme outcomes are achieved and those that are not.

(2 marks each for any 4 points explained = 8 marks)

  • 20 Marks

IMAC – JULY 2023 – L1 – Q2 – Budgeting | Marginal Costing and Absorption Costing

Explain types of budgeting and prepare a flexible budget for cost control, including variance analysis.

a) Explain the following:
i) Incremental Budgeting (2 marks)
ii) Zero-Based Budgeting (2 marks)
iii) Activity-Based Budgeting (2 marks)

b) Cox Ltd is a manufacturing company that produces a body shaping drink for the African market. The company employs a marginal costing system as an integral part of its reporting systems. During the reporting period, there was no opening or closing inventory. The company produces its budgeted and actual results for December 31, 2022, as follows:

Budget Actual
Production/sales (units) 2,000 1,400
Sales (GH¢) 60,000 42,400
Variable Costs:
Direct material (GH¢) (20,000) (13,200)
Direct labour (GH¢) (10,000) (7,600)
Variable overhead (GH¢) (6,000) (4,400)
Contribution (GH¢) 24,000 17,200
Fixed cost (GH¢) (20,000) (20,800)
Net profit/loss (GH¢) 4,000 (3,600)

Required:
Prepare a budget that will be useful for management cost control purposes and briefly comment on the company’s performance in December 2022. (14 marks)

a)
i) Incremental Budgeting:
This is the system of budgeting where the previous period’s or year’s budget is used as a basis for preparing the current period’s budget by making incremental adjustments influenced by factors such as inflation, expansion needs, and growth. It is simple to apply in practice because you need not develop a decision package or justify the inclusion of the cost of an item into the budget. However, this method perpetuates past inefficiencies and does not lead to optimal and efficient allocation of budgetary resources. (2 marks)

ii) Zero-Based Budgeting:
This is a process of budgeting whereby all activities contained in the budget are re-evaluated each time the budget is prepared. Every item of expenditure must be justified in its entirety to be included in the next year’s budget. This approach adds a psychological impetus to employees to avoid wasteful expenditure, but it creates extra paperwork as the process of preparing the decision packages under Zero-Based Budgeting can be repetitive and cumbersome. (2 marks)

iii) Activity-Based Budgeting:
This is a method of budgeting based on an activity framework and the utilization of cost driver data in the budget-setting and variance feedback process. It involves defining activities that drive costs and using the level of activity to decide how much resource should be allocated and to determine how well an activity is being managed and to explain variances from the budget. While it helps managers to identify the cost of an activity and facilitate cost reduction, it can sometimes be difficult to trace objectively the cost of an activity to a product. (2 marks)

b)
Cox Limited – Cost Card

Cost Element Calculation GH¢
Selling price (GH¢60,000 / 2,000 units) 30
Direct material (GH¢20,000 / 2,000 units) 10
Direct labour (GH¢10,000 / 2,000 units) 5
Variable overhead (GH¢6,000 / 2,000 units) 3
Budgeted production cost 18
(2 marks)

Flexible Budget for the Month, 31 December 2022

Performance Area Fixed Budget Flexible Budget Actual Result Variance
Production/Sales 2,000 units 1,400 units 1,400 units
Sales (GH¢) 60,000 42,000 42,400 400F
Variable Costs:
Direct material (GH¢) 20,000 14,000 13,200 800F
Direct labour (GH¢) 10,000 7,000 7,600 600A
Variable overhead (GH¢) 6,000 4,200 4,400 200A
Total variable cost (GH¢) (36,000) (25,200) (25,200) 0.00
Contribution (GH¢) 24,000 16,800 17,200 400F
Fixed cost (GH¢) (20,000) (20,000) (20,800) 800A
Net profit/loss (GH¢) 4,000 (3,200) (3,600) 400A
(Marks are evenly spread for flexible budget and variance = 10 marks)

Commentary:
Sales variance was GH¢400F. This means that budgeted selling price is
(GH¢60,000/2,000units) GH¢30 and actual selling price is (GH¢42,400/1,400 units)
GH¢30.285. The overall performance is GH¢400 worse than budgeted. That is, the
flexible budget is GH¢3,200 compared with actual loss of GH¢3,600. Control of
direct material cost has been very good as this has been GH¢800 better than
expected. Direct labor cost is overspent as does fixed overhead by GH¢600 and
GH¢200 respectively.
(2 marks)

  • 20 Marks

IMAC – MAY 2021 – L1 – Q2 – Budgeting | Cost and Cost Behaviour | Relevant Cost and Revenue

QR activity-based budgeting system for products Q and R, and working capital calculation for a company.

a) QR uses an activity based budgeting (ABB) system to budget product cost. It manufactures two products, product Q and product R. The budget details for these two products for the forthcoming period are as follows:

Product Q Product R
Budgeted production (units) 80,000 120,000
Number of machine setups per batch 4 3
Batch size (Units) 5,000 4,000

The total budget cost of setting up the machine is GH¢74,400.

Required: i) State and explain THREE (3) objectives of budgeting. (6 marks)

ii) Calculate the budgeted machine setup cost per unit of product Q and R. (5 marks)

iii) State THREE (3) benefits and TWO (2) limitations of using an activity-based budgeting system. (5 marks)

b) A company has annual sales revenues of GH¢30 million and the following working capital periods:

Period Months
Inventory conversion period 2.5
Accounts receivable collection period 2.0
Accounts payable payment period 1.5

Production costs represent 70% of sales revenue.

Required: Calculate the total amount held in working capital excluding cash and cash equivalents. (4 marks)

a) i) Objectives of a budgetary control system:

  1. To compel planning: Budgeting ensures that managers plan for the future by producing detailed plans to implement the company’s long-term goals.
  2. To coordinate activities: Budgeting aligns the activities of different departments into a common plan, ensuring efficient resource allocation and scaling production based on anticipated changes.
  3. To communicate activities: Budgets formalize management expectations and facilitate communication between different departments.

ii) Calculation of budgeted machine setup cost per unit:

  • Number of batches for Product Q = 80,000 / 5,000 = 16
  • Number of batches for Product R = 120,000 / 4,000 = 30
  • Machine setups per batch: Product Q = 4, Product R = 3
  • Total number of setups: Product Q = 64, Product R = 90, Total = 154
  • Budgeted cost per setup = GH¢74,400 / 154 = GH¢483.12Budgeted cost per unit:
    • Product Q: (64 setups x GH¢483.12) / 80,000 units = GH¢0.39 per unit
    • Product R: (90 setups x GH¢483.12) / 120,000 units = GH¢0.36 per unit

    iii) Benefits of Activity-Based Budgeting:

    1. Clear cost-activity linkage.
    2. Better resource allocation.
    3. Enhanced capacity utilization review.

    Limitations:

    1. Time-consuming and resource-intensive.
    2. Requires expert team and sophisticated software.

    b) Working Capital Calculation:

    • Inventory: (GH¢30m x 0.7 x 2.5) / 12 = GH¢4.375m
    • Accounts receivable: (GH¢30m x 2) / 12 = GH¢5m
    • Accounts payable: (GH¢30m x 0.7 x 1.5) / 12 = GH¢2.625m
    • Total working capital = GH¢4.375m + GH¢5m – GH¢2.625m = GH¢6.75m

     

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