Activity-Based Budgeting (ABB) For Wesfarmers Limited: A Management Accounting Perspective

Background of Wesfarmers Limited

This report is developed on the perspective of management accountant assigned the responsibility of providing recommendation to the CEO of a firm regarding the adoption of budgeting method of Activity-Based Budgeting (ABB). The selected firm in this context is Wesfarmers Limited, a retail company of Australia. In this context, it has specifically examined the suitability of the method to be adopted by the selected firm. The firm selected in this context is Wesfarmers limited, a recognized retail company of Australia. It is done mainly by developing an understanding of the ABB by examining its relevant characteristics. Also, a comparison of the method with the traditional method of budget preparation is also carried out in the report.

Wesfarmers Limited is an Australian retail company, having major interests in the business operations of retail, coal mining, gas processing, chemical, fertilizers, industrial and safety products. It is listed on the Australian securities Exchange (ASX) have major subsidiaries of Coles, Supermarkets and Bunning’s warehouse. The company major focus is to provide higher returns to the shareholders by achieving customer satisfaction. The company is highly committed to promote the development of the local communities and reducing the environmental impact of its operations. The company has achieved strong management capability on account of gaining expertise development and execution of strategy. The strong management of the company has enabled to achieve a control over its diverse business operations. 

Activity-based budgeting (ABB) can be defined as method of budgeting that is developed for increasing the transparency in the process of budget development of business entities. It helps in improving the accountability in the budgeting process of an entity by allocating the revenue realized in proportion to the unit responsible for that activity. It assists the managers in adequate management of resources and expenses by having a direct control over them and largely helps in achieving the overall mission and strategic goals of an entity. The method is largely used by business nowadays for gaining a competitive advantage over their competitors through adequate management of their cost structure and reduction of generation of waste resources. The method of budgeting primarily involves the identification of the activities followed by analyzing the cost drivers that are the factors responsible for driving expenses over that activity. It is followed by forecasting the number of units of cost driver required for completing the activity level. Lastly, the overall cost is calculated by identifying the cost incurred in completing per unit of activity. The method is largely effective for gaining an accurate estimate of the overhead costs to be incurred for completing an activity level. For example, in a scenario of sales office the cost driver for the number of sales orders can be estimated by calculating the forecasted cost of processing of a single sales order. It is followed by forecasting the number of sales orders for a budgeted period and then calculating the overall budget for the total sales. Thus, the method of ABC would be highly helpful for examining the variable costs such as accommodation that is incurred by the sale office.

Understanding Activity-Based Budgeting (ABB)

Therefore, it can be said that the major benefit of the use of this type of budgeting system is that it largely helps the management accountants in gaining a future estimate of the overhead costs. Thus, it can help in having a direct control over the cost structure of an entity by identifying the activities that can be eliminated in order to reduce the variable costs incurred during its overall operational process. The budgeting system enables an entity to forecast the activities that it will engage for production of a specified volume of products or services. This will help the management accountants in organizing the number of activities as per its strategic goals and objectives. The costs of each activity to be incurred is compiled for developing an accurate budget that enables the managers in taking a right decision regarding its future growth and development. The major features of the ABB method of budgeting can be stated as follows:

• The method of activity-based budgeting should be done mainly by the busies entities that adopts the use of activity based costing for allocation of operational costs
• It is highly useful in achieving Total Quality Managements (TQM) in entities by attaining cost-effectiveness through elimination of unnecessary activities
• It assists in making strategic planning by business managers through establishing a connection between operational planning and the financial results
• It helps in accurate forecasting of the resources required to produce a specific output by determination of the activities that are necessary for achieving that output and then allocation of direct resources to each unit of activity
• The method of budgeting system is highly useful for the entities in which overhead costs are a major proportion of the overall cost structure of an entity
• It is known to be an output-based approach which involves recognition of the activities at the initial level that drives the costs and views the overall business operations as a collection of activities and aligns them with the organizational strategy (Zhang and Isa, 2010)

It is important to understand the meaning of traditional budgeting and its importance in management accounting before discussing between traditional budgeting and ABB. In general traditional budgeting is defined as the management process used to project the business revenue and expenses for future years through using the budget of previous year. In this context budget is referred to as management tool that helps to predict and analyze the business earnings and expenditures. In short it helps in decision making process of management in relation to allocation of resources. Traditional budgeting process is mainly used by the businesses that are already established and make use of previous budgets with adjustments to inflation and others changes in business (Stamenova, 2018). The differences arise between ABB and traditional budgeting due to difference of process of drafted the budgets, methods used to prepare the budgets, and their advantages and disadvantages. The budgeting approach used in the preparation of traditional budgets is referred to as an incremental approach. As per incremental approach of budgeting company uses past year data to prepare the current budgets but there is need to make correction in current budgets due to change in output, changes in prices, inflation etc. So it can be said that this method of budget preparation is very easy and simple to understand. 

There are multiple differences in traditional budgeting and activity based budgeting that has led companies to shift towards the activity based budgeting from traditional budgeting. Some of major differences between traditional budgeting and activity based budgeting arises due to manner of preparation, its use, information conveyed, process used, importance, decision making and many other. While preparing the activity based budgets information from the previous year budgets are not taken but in this method resource are allocated on the basis of efficiencies of business operations and available resources with the entity. The role of cost manager in preparing the activity based is very strong as he has to analyze each and every activity before making allocation of resource to each activity. The purpose of analyzing each activity is to achieve maximum output with optimum utilization of resources. In case of traditional budgeting no such factors are being considered while performing the task of preparation of budgets. Only one thing is kept in mind that there is no change in business activities and all activities yield same output as previous year. This method of budget preparation is very old and does not support the decision making process. While it has been noted that activity based budgeting plays a critical role in decision making process. There is orientation difference between both types of budget methods. Traditional budget is accounting oriented i.e. it follows a process simple accounting technique without considering a surrounding environment and other factors while preparing the budgets. ABB is project oriented which means it considers business objectives, business requirements and requirements of various activities before allocating the resources to each activity. This way of preparing budgets is very effective and takes in accounts all the factors that impacts profitability and optimum utilization of resources (Shim, Siegel and Shim, 2011).

Comparison between ABB and Traditional Budgeting

In activity based budgeting it is very easy to identify and measure the effect of the unused capacities while in case of traditional budgeting it is not possible to identify the unused capacities under each activity, only the effect of unused capacities can be seen. Traditional budgeting focuses only on cost of departments and completely ignores the total budgeting cost that is main disadvantage of traditional budgets. On the other hand, activity based budgeting take into account total volume of work delivered through the budgets together with the total cost levied. It helps to make suitable changes in budgets that arise due to uncertainties after the budgets have been prepared. So it can be said that activity based budgets helps in manipulate the budgets after it has been prepared but it is not possible in case of traditional budgeting. In short it can be said that activity based budgeting uses more meaningful approach to allocate the resources while so such approach has been deployed by the traditional budgeting that is its biggest disadvantage (Lalli, 2011). So it clear that all the shortcoming of the traditional budgeting has been removed in the activity based budgeting and all the resources are allocated after evaluating each activity despite of using old budgets. It is important cost manager pay emphasis on the economic factors while preparing the budgets but due to rigidness of traditional budgets it is not possible for managers to consider the factors such as economic conditions. In case of ABB it is important to consider the economic factors before drafting the budgets. 

In preparation of activity based budgets cost manager has to follow the procedure of ranking each activity so that resources can be allocates on optimum basis. Also in case of activity based budgeting goals and important business functions are considered in preparation of budgets but traditional budgeting has no provisions to evaluate the business functions and goals (Drury, 2008).

Wesfarmers is a leading retail company within Australia having a number of subsidiaries such as Coles, supermarkets, Bunning’s Warehouse and any other. The company as such is recognized to have interests in various filed such as retail, chemical, fertilizers, coal mining, industrial and safety products. The company as such is involved in providing various products and services to the customers and therefore marinating a direct control over its overhead costs is essential for it to achieve operational efficiency. This can be achieved by the company through accurate forecasting of cost to be incurred in completing each of its activity by means of budget preparation. In this context, the company is recommended to adopt the use of method of ABB (Activity-based Budgeting) that will help in determining the resources required for completing each unit of activity on the basis of specific output to be achieved.

Benefits of Activity-Based Budgeting

The retail companies such as Wesfarmers may face increasing difficulties in developing budgets for its administrative departments. This is because due to lack of clear input-output relationship as there exists uncertainty on account of labor required as per the volume of production. Therefore, management can face problem in planning and control for future direction by having insufficient data relating to the expected expenses to be incurred in administrative functions. These departments incurs large amount of indirect fixed costs and therefore it is essential for the retail companies to implementation an accurate method of budgeting that helps in minimizing the costs in these areas for enabling a company to achieve operational efficiency.  Wesfarmers carries out its business activities in a highly competitive retail environment of Australia. As such, it is highly essential for the company to utilize an accurate method of budgeting that enables it to reduce its operational costs for maintaining its competitive position (Liu and Pan, 2007).

In this context, the method of activity-based budgeting proves to be highly suitable for assigning the overhead costs as per the volume of products and services. This s can be done by the management accountants by identifying the number of activities involved in their production and assigning the overhead costs to each unit of activity as per their resources consumed by them (Ayers, 2017). As such, the budgets developed with the use of activity-based costing information can enable the management accountants in retail companies to a large extent by determining the relation between the quantities of units produced and the activities involved in production of the specific units. The major benefits that Wesfarmers can realized by the use of ABB method is identification of the physical resources required for delivering a specific amount of products and services and also projecting the future costs. It is done by determining the output to be achieved and the allocating the resources required for completion of that output level. Thus, the development of a budget with help of ABB method will help the company to achieve its vision by converting it into a strategy by identification of the various ways through which it can be realized (Baird, 2007). 

The vision of the company is to create value for the customers through providing them high quality products and services. As such, the development of a forecasted budget predicting the overall cost to be incurred in delivering a specified dumber of product to the customers will help the company to determine various ways of creating value for them. This involves taking important decisions regarding reducing expenses, increasing market share, improving sales rate, increasing profit margins and minimizing the operational costs. For example, the company can develop an accurate sales budget with the use of ABB approach (Dunne, 2007). This involves determination of an estimated demand of goods or services required by carrying out sales forecasts. This can be done by estimating the demand for the output of each business activity on the basis of its cost driver. The use of this rate can be done to estimate their resources required for completing of the activity. As such, it will also enables the management accountants in developing an insight into each of the business activity and thereby eliminating the unnecessary activities and reducing the waste generation leading to improved operational efficiency (Huynh, 2013).

Suitability of ABB for Wesfarmers Limited

As such, Wesfarmers to successfully integrate the method of budget preparation with the use of ABB for a specific department need to primarily determine the output to be delivered from it. This should be followed by developing an estimate of the activities required for delivering the output and identification of the cost drivers. The demand for each activity should be estimated followed by determination of the cost of resources required to produce the identified activities. It can be said from the overall discussion that the use of ABB method of budget preparation will help the management accountants in achieving the determined cost target effectively. It will facilitate the business managers in achieving the organizational goals by assisting in taking accurate decisions (Moustafa, 2005).

In addition to this, the method can be employed by the company in providing an assessment of the performance of a manager. This can be done by comparing the results obtained with the use of ABB method with that actually realized. The effectiveness can be assessed by examining whether the manager has achieved or exceeded the goads described.  However, the company is required to develop an insight into the significant challenges that it can face while the adoption of ABB method. This involves lack of support from employees, lack of relevant knowledge and competency in the manager, significant cost to be incurred in implementation and time required for its successful adoption. As such, the company is required to develop proper plans for gathering relevant resources and providing training to the business managers and employees to involve their participation. Also, the perceived benefits to be realized should be compared with the cost to be incurred in its adoption for taking final decision of its implementation (Oseifuah, 2014). The integration process of ABB within the company can be illustrated as follows:

 

(Source: https://article.sciencepublishinggroup.com/pdf/10.11648.j.ijefm.20130104.11.pdf)

Conclusion

The report has inferred that the use of ABB method of budget development in comparison to that of traditional method of budgeting will enable in improving the transparency in the budget preparation. It also facilitates the managers in taking effective decisions at the time of strategy formulation by gaining an accurate forecast regarding the overall cost structure of an entity. It has been recommended to the CEO of Wesfarmers to integrate the method of budget preparation on the basis of activity costs to gain a realistic view of the firm cost structure and develop possible ways of maximizing the company’s operational efficiency 

References

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Moustafa, E. 2005. An Application of Activity-Based-Budgeting in Shared Service Departments and Its Perceived Benefits and Barriers under Low-IT Environment Conditions. Journal of Economic & Administrative Sciences 21 (1), pp.42-72.

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Shim, J.K., Siegel, J.G. and Shim, A.I. 2011. Budgeting Basics and Beyond. John Wiley & Sons.

Stamenova, S. 2018. Benefits of a budget system. Traditional budgetary Systems versus Rolling budgets, zero-based budgets and activity-based budgets. GRIN Verlag.

The Wesfarmers Way. 2017. [Online]. Available at: https://www.wesfarmers.com.au/who-we-are/the-wesfarmers-way [Accessed on: 28 September 2018].

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