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An Overview of Activity Budget
A budget report compares actual results with budgeted numbers and highlights whether the variance is favorable or unfavorable. Higher revenues usually cause a favorable variance, and higher costs and expenses usually cause unfavorable variance.
To cope with different levels of activity and eliminate variance in budget reports, many companies adopt flexible budgets that provide budgeted data for different levels of activity. A flexible budget is, simply put, a combination of several static budgets, with each static budget incorporating the figures for a specific activity level. The company selects the budget with the relevant activity level at the end. For instance, a restaurant prepares a flexible budget that includes the financials for serving 100, 200, 300 and 500 customers; and, assuming the restaurant serves 300 customers at the end of the day, it chooses the flexible budget for 300 customers, discarding the figures for other activity levels.
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Activity Based Flexible Budget vs. Traditional Flexible Budgets
Activity-based flexible budgets are an improvement on traditional flexible budgets. While traditional flexible budgets center on one cost driver or the dominant variable factor in the budget, this type of budget bases itself on budgeted costs for each activity center and related cost driver. The budget for each activity center within the budget depends on the appropriate cost driver for the activity center. The cost remains fixed relative to units and varies with such cost drivers. Such budgets are appropriate when the basis of cost fluctuation comes from such cost drivers rather than units of output.
The cost driver for an activity is the factor that determines the resources the activity will consume.
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Let's assume specifics of a fictitious courier company to illustrate the concept of an activity-based flexible budget.
One activity of a courier company is transportation of goods by truck. The variable costs for the activity are driver wage, fuel, truck wear and tear or depreciation, and insurance. The underlying factor that determines how much wages, fuel, wear and tear, and insurance are required is the distance covered. Thus, the cost driver for the trucking activity center of the courier company is the distance.
Another activity of the courier company is delivery of packages from the warehouse to the addresses. The variable costs incurred for the activity are delivery agent salary and commission, vehicle cost, and administrative costs such as telephone as well as fixed costs such as warehouse rent. The cost driver for this activity is the number of deliveries.
This kind of budget therefore derives from the courier company incorporating projections that vary with distance for the trucking operations and the number of deliveries for the delivery operations.
An example of an activity-based flexible budget for the above illustration would reflect the following figures:
Distance – Driver Wage – Gas – Other Costs
- 1,000 Miles-$1,000-$50-$275
- 1,500 Miles-$1,250-$75-$325
- 2,000 Miles-$1,500-$100-$360
Delivery Budget for Warehouse X
Number of deliveries-Rent-Wages-Transport-Administrative Costs
- Distance – Driver Wage – Gas – Other Costs
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Many companies prefer flexible budgets, and more so activity-based flexible budgets as such budgets remain more in sync with reality and provide more definite cost management information. The uncertain business environment in today's world means that actual performance may show wide variance from predicted performance; business operations remain complex, with many sub-activities driven by many variables. Such conditions account for the increasing popularity of activity-based flexible budgets.
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- “Review of Key Concepts." Pearson Management Accounting. http://wps.prenhall.com/ca_ph_horn_mgmtacct_5/51/13067/3345321.cw/content/index.html. Retrieved May 08, 2011.
- “Flexible Budgets" from Accounting Principles II, Cliff's Notes. http://www.cliffsnotes.com/study_guide/Flexible-Budgets.topicArticleId-21248,articleId-21241.html. Retrieved May 08, 2011.
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