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Activity-Based Budgeting -- Part 2.

IN THIS COLUMN WE'LL CONTINUE OUR DISCUSSION of the reversal of activity-based costing (ABC) systems for use as activity-based budgeting (ABB) systems. There are two more reasons for inaccuracies in this reversal that we have yet to cover: fungible resources and unavailability of detailed knowledge.

Fungible Resources

The ABC system takes existing resources (or anticipated resources) and drives their costs through activities to the profit objects. If two or more activities consume the same resources, then the first stage or resource driver takes the resource and drives it to the consuming activities depending upon their demand for the resource. Thus, in an ABC system, fungible resources (consumed by more than one activity) present almost no challenge to the design of the system. For example, suppose that supervisors also can perform setups. There are 10 supervisors, and their workload is split evenly between supervision and setup. The ABC takes the cost of the 10 supervisors and drives it 50:50 to the supervision and setup activities. Subsequently, the supervision cost is assigned to the activities performed by the workforce that require supervision and hence to the products that they are producing. The setup activity costs are assigned proportionally to the products that require setup.

But when the ABC system is reversed for ABB purposes, an estimation of resources emerges. If we again assume the 10% increase in demand for profit objects, then the ABB will predict a demand for 5.5 supervisors and 5.5 setup individuals. When we correct these figures for integer people, the system will predict that six supervisors and six setup individuals are required, giving a total of 12 individuals. But only 11 individuals are really required. The problem is that the reversed ABC system cannot cope with the fungible nature of supervision and setup. The ABB system has to be designed to accommodate this property of activities and resources.

Unavailability of Detailed Knowledge

A budget is only as good as the estimates used in its preparation. Even the best ABB will lead to erroneous results if the assumptions about future demand and hence resource consumption are incorrect. One of the biggest differences between traditional budgeting and ABB is the amount of information needed to develop the budgets. ABB requires much more information in two forms. First, the information about the relationship between resource consumption and acquisition is greater because the ABB system is more detailed and, in particular, requires information about the way resources are consumed. Second, there is a need to understand the relationship between secondary output quantities and secondary resource consumption. Increasing demand for more detailed information challenges the practicality of any budgeting approach. ABB users should manage the level of detail to keep the budgetary process timely (the required information can be collected in time), efficient (at a resonable cost), and effective (the final ou tput is accurate).

The information challenge can be illustrated by example. Anybody who has developed a budget (traditional or activity based) knows that accurately predicting the demand for profit objects at the individual item level is virtually impossible. Such a prediction would require the ability of the estimators to predict the number of each SKU that is going to be sold during the upcoming period. In almost all reasonably complex settings such an estimate is impossible to achieve with any accuracy. Consequently, there is not enough information to reverse an ABC system. Instead, implementers must develop an ABB application method that is less demanding of future output information.


In this column and the previous one, we showed that ABB involves more than simply reversing an ABC system as evidenced by the four challenges we presented. Each of these challenges has to be resolved before a cost-effective ABB system can be developed. In the next few columns we'll describe how to overcome each of the four challenges and develop an effective and efficient approach to ABB that reflects the principles of zero-based budgeting (ZBB).

Robin Cooper is professor in the practice of cost management at the Goizueta Business School of Emory University.

Regine Slagmulder is professor of management accounting, Tilburg University (the Netherlands), and visiting professor at the University of Ghent (Belgium).
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Author:Cooper, Robin; Slagmulder, Regine
Publication:Strategic Finance
Article Type:Brief Article
Geographic Code:1USA
Date:Oct 1, 2000
Previous Article:Corporate Reporting.
Next Article:beyond budgeting.

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