Why is there increasing interest in ABRP? In part the interest is due to increasing problems with the annual budget process, and not just because individuals are not getting the approval for funding they want. They are disturbed by the budget-
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ing process altogether. Executives and employees are all recognizing that a fixed contractbudget does not transmit the continuously changing and relentless mar- ket pressure, nor competitor actions. There is great cynicism about budgeting as a bureaucratic exercise disconnected from reality. The other reason for discon- tent is that everyone senses that a better way to budget exists, such as with busi- ness modeling and less invasive rolling financial forecasts. The suite of methodologies in performance management (PM) provides better ways to moti- vate people.
132 LEVERAGING FINANCIAL ANALYTICAL FACTS AND TRUTHS
Traditional Budgeting: An Unreliable Compass
Activity-based planning and budgeting is a better approach to forecasting the location and level of resources and budgeted expenditures than traditional budgeting methods. It recognizes that the need for resources originates with a demand-pull triggered by customers or end-users of the organization’s ser- vices and capabilities. In contrast, today’s traditional basis for budgeting tends to extrapolate the level of resource spending from the past, but the past is not a reliable indicator of the future.
Figure 15A contains some sarcasm about traditional budgeting in the form of a check-the-box survey.
is a death march . . . with few benefits.
takes 14 months from start to end.
requires two or more executive tweaks at the end.
is obsolete in two months due to reorganizations.
starves the departments with truly valid needs.
caves in to the loudest voice and political muscle.
rewards veteran sandbaggers who are experts at padding.
is overstated from the prior year’s use-it-or-lose-it spending.
incorporates last year’s inefficiencies into this year’s budget.
Figure 15A Quiz: Check the Boxes Our Budgeting Exercise . . .
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Often when there is a substantial change in a management technique, it stems from a combination of dissatisfaction with the current methods and a vision of what a replacement method would look like. With strategy mapping, scorecards, and ABRP we have both conditions present.
Why are executives, managers, and employees cynical about the annual bud- geting process?
Asexecutivesdiscover how their strategy maps and scorecards can be the link to budgets, typically the financial department’s disconnected exercise, they see the flaws in budgeting as a short-term, focused, “make next year’s numbers” report rather than a guiding instrument to successfully execute their strategy by aligning behavior. The budget gives a false sense of secu- rity. Strategy maps with scorecards make the strategy operational, and linked budgets provide for how to do it.
Managers and employeeshave different gripes. They find the process is too long, too detailed, and excessively burdensome. In addition, they view budgeting as a political game that still usually results in some departments being overfunded while others continue laboring as have-nots. This latter group of workers toils without relief. With organizational downsizing, se- nior management has often removed the bodies but they have not taken out PREDICTIVE COSTING, PREDICTIVE ACCOUNTING, AND BUDGETING 133
Traditional Budgeting: An Unreliable Compass (Continued) Traditional budgeting motivates unintended and wrong behavior. It wastes lots of time, usually hides excessive and unneeded spending, involves gaming to protect self-interests, leads the sales force to attempts to pull a cus- tomer order earlier than needed, and ultimately can result in unethical cook- ing of the books.
Traditional budgeting is backward-oriented and simply takes last year’s ex- penses plus a small amount for inflation. This method implies that the budget process starts with the current level of expenses; however, today many man- agers believe that the budget should flow from the levels of future outputs to determine the needed resources. It should reflect anticipated changes in the marketplace that hopefully the strategy is reacting to. Activity-based budget- ing, in effect, flows in this more appropriate oppositedirection. It logically as- sists in determining what levels of resources are truly required to meet the future market-driven demands placed on an organization.
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the work. Across-the-board percentage cuts in manpower, some of the slash-and-burn variety, are likely to cut into the muscle in some places while still leaving excess capacity in others.
Fortunately there is a vision of what a better way of budgeting looks like.
Rather than as a spending control, the broader purpose for a budget should be to predetermine the level of resources that will be required, such as people, material, supplies, and equipment, to achieve an expected or desired amount of demand for employee services—meaning demands for their work. ABB ad- vocates are interested in the notion of resource requirementsas being the re- sult, not the starting point. They want to be able to first estimate oncoming customer and management demands, and then estimate the supply of re- sources, in terms of cost, that will be needed to match that supply with the work demands.
In short, ABRP advocates want to reverse the traditional budget equation and start with the expected outcomes, not with the existing situation. Effective bud- geting should be a closed loop. It begins with strategic objectives (ideally from a strategy map), considers the projects and plans required to achieve those objec- tives, and finally determines the funding needed to make the plans actionable.
The expected process steps and results of the plan provide metrics (ideally re- ported via a scorecard) to evaluate and monitor the objectives. Too often, plan- ning starts with a budget and ends with it because the tools in the accounting department are limiting and not integrated.
The ABRP approach leads to less detailed yet meaningful continuous, or rolling, financial forecasts that can be periodically refreshed, rather than a year- long committed contract that restricts managers. Rolling financial forecasts al- low for faster reactions to external events, revised strategic objectives, and changes in resource allocations.
ACTIVITY-BASED COSTING AS A FOUNDATION FOR ACTIVITY-BASED PLANNING AND BUDGETING
As activity-based costing (ABC) moved into the early 1990s, some companies began leveraging the activity cost data for more operational purposes, to change and manage the same ABC-calculated activity costs that were accumulating in their product and service line costs. They discovered that their personal computer- based ABC models were useful for modeling their cost behavior. They increas- ingly began using their activity costs and the ABC-calculated unit cost rates for intermediate work outputs and for products and services as a basis for estimating 134 LEVERAGING FINANCIAL ANALYTICAL FACTS AND TRUTHS ccc_cokins_15_131-141.qxd 1/14/04 10:29 AM Page 134
costs. Popular uses of the ABC data for cost estimating have been to calculate customer order quotations, to perform make-versus-buy analysis, and to budget.
The activity-based costing data were being recognized as a predictive planning tool. It is now apparent that the data have a tremendous amount of utility for both examining the as-is, current condition of the organization and achieving a desired to-bestate. (A more robust version of ABM, called resource consumption account- ing [RCA] is based on a German accounting practice for marginal cost analysis and flexible budgeting for operational control. RCA is a comprehensive approach that focuses on resources and capacity management logic with ABM principles.)2
Cost estimating is often referred to as what-if scenarios. Regardless of what one calls the process, the fact remains that decisions are being made about the future, and managers want to gauge the consequences of those decisions. In these situa- tions, the future is basically coming at us, and in some way the quantity and mix of activity drivers will be placing demands on the work that we as an organization will need to do. The resources required to do the work are the expenses. Assump- tions are made about the outputs that are expected. Assumptions should also be made about the intermediate outputs and the labyrinth of interorganizational rela- tionships that will be called on to generate the expected final outcomes.
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Major Clue: Capacity Only Exists as a Resource
As most organizations plan for their next month, quarter, or year, the level of resources supplied is routinely replanned to roughly match the firm customer orders and expected future order demands. In reality, the level of planned re- sources must always exceed customer demand to allow for some protective, surge, and sprint capacity. This also helps improve customer on-time shipping service performance levels.
The broad topic of unused and idle capacity will likely be a thorny issue for absorption costing. A key will be recognizing that capacity can only be as- sociated with resources, not with work activities. Activities have no capac- ity—they draw on it from resource. As management accountants better understand operations, they will be constantly improving their ability to seg- ment and isolate the unused capacity (and the nature of its cost) by individual resource. Managerial accountants will be increasingly able to measure un- used capacity either empirically or by deductive logic based on projected standard cost rates. Furthermore, accountants will be able to segment and as- sign this unused capacity expense to various processes or owners, to the sales function, or to senior management. This will eliminate overcharging (and overstating) product costs resulting from including unused capacity costs that the product did not cause.
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