FULL DETAILED NOTES ABOUT ACTIVITY BASED BUDGETING & BUDGETING CYCLE

1. BUDGETING CYCLE
Budgeting Cycle or budget cycle refers to the steps or phases that a company or an
individual or a government organization needs to go through to come up with a
budget. The budget is the estimation of the expenses that a company expects to
incur in the future. We can also say that the budget cycle is the life of the budget,
starting from developing a budget to assessing it.
The traditional budgeting process can range from the informal simple processes
small firms use to elaborate, lengthy procedures large firms or governments employ.
Indeed, the budgeting process for large organizations may span months from start to
final approval. The process usually includes the formation of a budget committee;
determination of the budget period; specification of budget guidelines (including the
preparation of initial budget proposals); budget negotiation, review, and approval;
and budget revision.
BUDGETING CYCLE

2. PHASES:-
1ST PHASE:- PREPARATION
The first step of the budget cycle, it may seem redundant to say, is to prepare a
budget. Depending on the size of your business, the challenges may vary in size and
difficulty. Too often, it seems, communication between departments during budget
planning falls short, resulting in frustration and arguments which end up delaying the
budgetary process. We call this fragmentation, and find that it is often the result of
not sharing individual information between departments in a timely manner.
One solution we’ve discovered is to create and maintain “one version of the truth.”
That is, a centrally located set of tools or software that contain all of the information
for every department. This file contains all the necessary reports, forecasts, and
audits, and can be found, commented on, and discussed by anyone who is granted
access to it. This allows your business to maintain a much more real-time
conversation about the budget, the needs of each section of the business, and come
to a cohesive budgetary vision more quickly.
Naturally, this becomes even more important for larger businesses with more
departments and individual budgets to consider. Smaller businesses operating on
one budget would still benefit from maintaining a central location for all of their
information, year-to-year, especially in the digital age, for ease of access and review.
A business must use its leadership vision to decide on what to include and exclude
from the budget. Also, the management should take the suggestions and
recommendations of the ground-level employees. A budget must include targeted
revenue and the estimates of expenses that a business needs to incur to meet the
revenue targets. Also, the budget should consist of any improvements that a
company expects to go for in the near-term.Once you have a budget that you think
you’re happy with, next up is getting it approved.
2ND PHASE: GETTING THE BUDGET APPROVED
Unless you’re the sole decider of your budget – and then even sometimes if you are
– even the most perfectly prepared budget can be a challenge to approve. Balancing
out every tiny little piece and making everyone as happy as possible while staying
within the means of your company can be a real challenge.

3. Once again, we find that many of the problems – at least internally – with approving
a budget stem from poor communication. From the perspective of a department
head requesting a new copier, it is easier to understand being told no if you can see
the budget as a whole inside the central software and see that there just isn’t room
for it. Approving the budget is not just a simple yes or no. Instead, it may involve
extensive debates before a budget gets final approval. A budget may move back and
forth for edits and corrections until all parties approve the document.
If possible, the business must do an extensive discussion on the budget involving all
the stakeholders In the case of a small company or sole proprietorship, the owner
must discuss the budget with the accountant or have an independent authority to
review it. The budget should get the approval only after the review, discussion, edit,
and corrections (if any).

4. 3RD PHASE: EXECUTING THE BUDGET
Once you get the approval for the budget, the next step is to start executing
it.Execution, for the most part, is the easiest of all the steps of the budget cycle. It
can also be one of the most trying, as the company begins spending money and the
theoretical funds discussed as numbers become dollars, cents, and check after
check signed and delivered. Was enough budgeted for this? Were costs predicted
correctly? Was there enough money set aside for miscellaneous and unexpected
expenses? Will this budget turn a profit?
More than any other step in the process, executing a budget can bring about
questions on the length of a budget cycle. Sticking a company into a budget for too
long a term can hinder its capability to change and react to more current problems
and situations, while creating a short budget cycle may be unnecessary or create a
lot of work that isn’t needed, wasting man hours and more valuable resources. One
way or the other, once a budget is executed, the only thing left to do is determine if it
was successful or not.However, you should not let the budget impede or limit your
business decisions.
A business must create and maintain spending records. Such records help in
ensuring internal and external accountability. They also serve as useful data points
for the next budget cycle. Such records also help to identify trouble spots or
opportunities to save some funds or earn more revenues.
4TH PHASE: EVALUATING/MONITORING/AUDITING THE BUDGET
Arguably the most important part of the budget cycle is the aftermath: auditing what
was done and evaluating whether or not it was successful. Not only do data tools
make analysis of budget cycles smoother and easier, they allow a far simpler
transition between lengths of budget cycles. That means a company can realistically
adjust the timing of their budget in a more practical manner, moving from shorter to
longer or vice versa as their income and analysis demands. Data software and
analysis tools can make or break the budgeting process for a business of any size,
and can define their success in an age of continual technological advancement.
Thus, A company or an individual should regularly evaluate the budget. Regular
evaluation helps to make timely revisions to the budget based on internal and
external factors. These changes could be revising revenue targets, adjusting costs,
or making an adjustment to the budget with any newly available information.

5. Regular evaluation is also necessary to identify variance if any. Variation is the
deviation of the actual spending from budget spending. Even when evaluating the
budget, the focus should be on boosting the profits.
A final evaluation of the budget is done after the end of the accounting period. This
evaluation provides the overall feedback on the budget, including how accurate it
was, cash flow management, and more. Such feedback helps in the preparation of
the next budget and assists management in making better financial decisions.

6. ACTIVITY-BASED BUDGETING
Activity based budgeting is a budgeting method in which budgets are prepared using
Activity based costing after considering the overhead costs. In simple words, activity
based budgeting is a management accounting tool which does not consider the past
year’s budget to arrive at current year’s budget. Instead, the activities that incur the
cost are deeply analyzed and researched. Based on the outcome of the study, the
resources are allocated to an activity. It is more rigorous than traditional budgeting
processes, which tend to merely adjust previous budgets to account for inflation or
business development.
It is defined as the process of planning and controlling the expected activities of the
organization to derive a cost- effective budget that meets forecast workload and
agreed strategic goals. The Activity based budgeting is a quantitative expression of
the expected activities of the firm, reflecting management's forecast of workload and
financial and non-financial requirements to meet agreed strategic goals and planned
changes to improve performance.
KEY TAKEAWAYS
● Activity-based budgeting (ABB) is a method of budgeting where
activities that incur costs are recorded, analyzed and researched.
● It is more rigorous than traditional budgeting processes, which tend to
merely adjust previous budgets to account for inflation or business
development.
● Using activity-based budgeting (ABB) can help companies to reduce
costs and, as a result, squeeze more profits from sales.
● This method is particularly useful for newer companies and firms
undergoing material changes.

7. KEY ELEMENTS OF ABB
Following are the three key elements in activity based budgeting:
1] Type of work/activity to be performed,
2] Quantity of work/activity to be performed,
3] Cost of work/activity to be performed.
Activity based budgeting mainly focuses on the activities or business processes.
Resources required are determined on the expected activities and workload. The
objective is to bring in efficiency into the system. So, in the process of budget
preparation, many key questions, such as the following need to be addressed and
properly answered: Is the activity necessary? Is it possible to club a few activities to
bring in efficiency? Does the activity in question add value to the customer or

8. increase profit to the firm? How much resources are to be allocated? Is this the best
way of performing the activity?
ABB analyzes the products or services to be produced, what activities are required
to produce those products or services, and finally what resources need to be
budgeted to perform those activities. Simply said, ABB is the reversing of the ABC
process to produce financial plans and budgets.
Traditional, functional- based budgeting is concerned with budgeting the costs of
resources associated with organizational units, such as departments and plants.
Firms that have implemented an activity-based costing system may also wish to
install an activity-based budgeting system.
A budgetary system at the activity level can be a useful approach to support
continuous improvement and process management. Furthermore, because
activities are what consume resources and, thus, are the causes of costs, activity-
based budgeting may prove to be a much more powerful planning and control
tool than the traditional, functional-based budgeting approach.

9. An activity-based budgetary approach can be used to emphasize cost reduction
through the elimination of wasteful activities and improving the efficiency of
necessary activities.
As with traditional, functional-based budgeting, ABB begins with sales and
production budgets. Direct materials and direct labor budgets also are compatible
with an ABC framework because these production inputs are directly traceable
to the individual products. The major differences between functional and activity-
based budgeting are found within the overhead and selling and administration
categories. In a functional- based approach, budgets within these categories
typically are detailed by cost elements. These cost elements are classified as
variable or fixed, using production or sales output measures as the basis for
determining cost behavior. ABB, on the other hand, identifies the overhead,
selling, and administrative activities and then builds a budget for each activity,
based on the resources needed to provide the required activity output levels.
Costs are classified as variable or fixed with respect to the activity output
measure.
Activity Flexible Budgeting
The ability to identify changes in activity costs as activity output changes allows
managers to more carefully plan and monitor activity improvements. Activity
flexible budgeting is the prediction of what activity costs will be as activity
output changes. Variance analysis within an activity framework makes it
possible to improve traditional budgetary performance reporting. It also enhances
the ability to manage activities. Activity flexible budgets differ from traditional
flexible budgets because the cost formulas are based on the activity drivers for
the respective activities rather than being based only on a single unit-based
driver, such as direct labor hours.

10. EXAMPLE FOR BETTER UNDERSTANDING OF ABB
ABB Formula = Cost Pool in the Designated Driver /Cost Driver in
Units
SOLUTION:
The company has shifted from traditional based to activity budgeted way, and
hence here we can see that there are two activities which are driving the cost
Using the ABC formula: Cost Pool total / Cost driver, we can calculate the
overhead cost

11. We have = Machine setup cost / Number of Machine setups & Inspection
cost / Inspection hours
1. CALCULATION OF MACHINE SET-UP PER UNIT:
= 4,00,000/700 = 571.43
2. Calculation of Inspection Cost Per Unit
= 2,80,000/15500 = 18.06

12. Hence, in ABB, the cost is determined
at the activity level and not an ad-hoc rate, which was done in a
traditional method where only inflation was accounted for.
IMPORTANT POINTS
Most simply, Activity Based Budgeting shall follow below three stages:
● Identify the activities by conducting detailed research, and along with that also
one needs to identify their cost driver, which again requires proper knowledge
of the process.
● Now, either forecast the number of units which shall be produced for the next
period or there could be new order coming up and also at this stage compute
the overhead per driver.
● In the final stage, one needs to Calculate the cost driver rate and multiply the
same for the new order or the new production units, and that shall give one
the total estimated or budgeted cost.
● But before the above, one needs to determine whether the required time and
cost are adequately available with the management or the company.
● Does the company have required resources and software and workforce to
capture the same daily?
● Cost-benefit analysis needs to be done before implementation of the same,
as the management should be that benefits shall outweigh the cost.
● Can operational managers be recruited at reasonable remuneration?
Advantages
The various different advantages related to the Activity-Based budgeting are as
follows:
1. Activity-Based Budgeting takes up a forward-looking view rather than looking
at previous activities which are a common feature under traditionally based
budgeting i.e. it asks questions like what needs to be performed and where
can we make improvement rather than what was done earlier and sort of just
allocation of costs according to that.
2. Activity-Based Budgeting sources its budgets based on activities and
resources allowing better insight on inefficiencies in processes and sources of

13. imbalances which will help the managers find areas of improvements making
them more efficient in their jobs.
3. Activity-Based Budget has a more practical approach in a dynamic
environment and makes it easier for the employees and managers to
communicate and execute the activities in a time-bound manner as well as to
evaluate performances of the same by fixing accountability of specific
activities.
4. Activity-Based Budget leaves scope for making changes as per the changes
in the climate and current situation as opposed to what was initially planned
as it allows tools to trace resource consumption which allows identifying
capacity issues so they can adjust in a timely manner.
Disadvantages
The various disadvantages related to the Activity-Based budgeting are as follows:
1. Activity-Based Budgeting is a lengthy and comprehensive process that
requires a considerable amount of time and resources on an entity and
spending too much on analyzing may prove to be counterproductive.
2. It requires a well-groomed talented team of individuals who are experts in
finding gaps and are equally competent in reporting and use of the necessary
software as it is a complex process on which the direction of the company is
dependent.
3. While preparing an Activity Based Budget it is possible that the axis of focus
may shift to immediate and short term results and the bigger picture may be
ignored causing damage in the long term.
4. It is based on forecasting with the use of historical data and future
expectations which may sometimes prove to be unreliable if the situations or
scenarios planned do not come out to be what was expected to lead to
problems that can hamper the entity and its resources.
5. Activity-Based Budgeting provides only supplemental information.

14. Conclusion
The traditional way of assigning cost or budget was to take the overhead cost of last
period and adjust the same for inflation and compute the total cost for the new order
and hence it was ignoring the activities cost wherein one could lead to no
involvement in the process, and still it was charged.
Hence, by implementing activity-based budgeting, the management can identify
activities that are indeed involved in the production process and accordingly price the
product and save cost and hence increase the revenue of the firm.