Activity Based Budgeting In Management Accounting: A Case Study Of Rio Tinto Group Essay.

You are recently employed as a graduate consultant in a management consultancy firm and are assigned to a team. One of your firm's clients is currently evaluating its budgeting system. The CEO of your client had recently attended a seminar on Activity-Based Budgeting (ABB) in private companies and would like to know whether ABB is suitable to the company. Your manager has asked your team to prepare a report for the client.

Your group is required to prepare a report to comment on the suitability of ABB for a company of your group's choice (your firm's client). The report should cover the followings:

a) A description of your firm's client

b) A description of the ABB and its features

c) In what ways ABB in different from traditional budgeting systems

d) A discussion on whether the ABB is suitable to your firm's client

The Importance of Management Accounting

The Management Accounting, for any organisation, is an important aspect in the financial system which helps manage and evaluate the business performance effectively. It facilitates the effective decision making through the collection and reporting of internal financial information. Long and short term strategic decisions can be made by the owner of any corporation timely by the critical evaluation and assessment of the financial performance of his organisation which shall result into improved growth and utmost utilisation of the available resources (Hiebl, 2014). It identifies measures, analyzes, interprets and communicates information to enable an organisation to achieve its objectives. Some of the roles of Management Accounting are identification of future goals, decision making, forecasting cash flows, analyzing the Rate of Return and so on.

The report in question deals with a specialised technique of management accounting which is activity based budgeting. It is an essential tool of management accounting. The Assignment deals with features, advantages, importance of activity based budgeting and its application in Rio Tinto Group which deals with world leaders in terms of production of many important minerals like uranium, coal, aluminium, iron ore, copper and diamonds (Armstrong, 2014). The main purpose of report is to understand the various aspects of the application of ABB (Activity Based Budgeting) in the company and its suitability within Rio Tinto Group. The difference between traditional budgeting system and activity based budgeting method is also the part of report.

Rio Tinto Group, an Anglo-Australian multinational, founded in 1873, after the purchase of a mine complex in the Rio Tinto, Spain by a consortium of multinational investors. It has turned to be one of the world's largest mining and metals corporations with revenue of over $35 B.  The company has had long history of mergers and acquisitions to find a place among the world leaders in the production of many minerals including iron ore, copper, diamonds, uranium, aluminium and coal (Cánovas and et.al. 2014). Its primary focus was on extraction of minerals, but it has diversified its operations in refining for bauxite and iron ore. The company operates on six continents, but its main centres are in Australia and Canada, and own mining operations through a complex web of wholly and partly owned subsidiaries. The joint headquarters of Rio Tinto are in London and Melbourne.

Rio Tinto Group is traded on both the London Stock Exchange, as a component of the FTSE 100 Index, and the Australian Securities Exchange, as a component of the S&P/ASX 200 index. The New York Stock Exchange trades American Depositary Shares of Rio Tinto's British branch which increases its count of listing to 3 main stock exchanges. Rio Tinto Group is listed on London Stock Exchange in the name Rio Tinto Plc. and on Australian Securities Exchange as Rio Tinto Limited.

The dual-listed structure of the company provides the same ownership rights in the Rio Tinto Group and the same proportional economic interests to the shareholders of both the companies in a way which is equivalent to all the shareholders of both companies unified as a single entity (Ghadhab and Hellara, 2016). The purpose of such a structure was to avoid adverse tax conditions and regulatory procedures. The dividends are paid and the company's accounts are kept in US Dollars in order to avoid currency exchange issues.

Activity Based Budgeting: Features and Advantages

Activity based costing is one of the popular technique of management accounting where the budgets are prepared on the basis of Activities to be performed by the organisation. The activities are justified by the cost drivers along with the effective feedback procedures. These measures leads to elimination of unnecessary activities which leads to reduction in the costs and help serve the clients effectively (Haroun, 2015). It also helps in determining the future targets and motivating the employees to work effectively and efficiently.

According to Müller, “Manager can evaluate each step that is required to produce product and services. In addition to this, top management can get greater transparency into the budget process”. In other words Activity based budgeting is a system that researches, records and analyses programs that lead to costs for organisation.

The Activity Based Budgeting has three stages as follows:

• Identification of activities and their cost drivers,
• Forecasting of number of units of cost drivers for that activity
• Calculation of the rate of cost drivers.

Activity based budgeting system control the over budgeting and provide essential information related to projections.  The ABB method identifies the actual cost of activities based on their resources and size and organisation is benefited in relation to costs accuracy and transparency with activities.

ABB is used by Corporations to develop accurate and realistic budgets for business activities and is also concerned with the reduction of cost, and provides useful information in a total quality management environment (Krumwiede and Charles, 2014). It reduces additional expenditure and costs from manufacturing and production department through which quality of services can improve and it increases the productivity and profitability of business unit by elimination of the additional cost of operation. ABB method is largely helpful as it defines each and every cost associated with business as a result management can easily forecast future expenditure and revenue.

The major advantages of ABB system are:

• Helps in viewing the business as a single unit and not in the form of departments.
• Helps in improving the relationship with the customers. 
• Helps the organisation to gain a Competitive edge in the market.
• Evaluation of all the costs associated with the business and elimination of irrelevant activities.
• Research and analysis in this process helps eliminate all the bottlenecks.

For its application in a private company, the organisation should adhere to the two staged process; first, it is the duty of the Manager to determine essential activities and assign overhead cost to each activity in proportion to the enterprise resources. An activity cost pool consists of all overhead costs which are assigned to each activity. Secondly, overhead costs are allocated to each product line from each activity cost pool. Private company can easily measure product costs and take product mix decisions for business. Organisation must be to identify the relative profitability of the commodity and consider cost drivers in effective manner.

However, it has some disadvantages also like its complexity in nature, over consumption of resources and time, training to implement the ABB involves extra cost, its focus on short term goals rather than long term goals.

It can be said on the basis of the inference drawn from the discussion above that ABB method is best suited for its application in the Rio Tinto Group in order to improve customer relationships by providing best quality of products to them. ABB procedures provides the company and its management to have optimum control over the budgeting process and develop it in such a way that it help in realising organisational objectives by aligning all activities of business with its objectives in a very cost effective manner (Ohemeng, 2016). ABB enables the organisation with optimum control over budgeting process by streamlining the budget with the organisational goals.

Rio Tinto Group: An Overview

However, Budgeting system is used by the organisation for Planning to achieve its objectives, coordination of business activities with its goals and enhanced control of internal organisational control. Before 1990s, budgetary system follows traditional methods as management accounting tool but in the late 1990s, a new concept of management accounting tool ABB was developed. CAM-1, which was a US based Advanced Management-International Consortium, had developed “Activity Based Budgeting” to curb the lack of traditional methods used for Budgeting.

There are differences between traditional budgeting and activity based budgeting as the traditional approach has some problems regarding time, strategic focus, cost related etc. The personnel of Rio Tinto Group should take full cognizance of the differences as shown above so that its business can be operated in a smooth and efficient manner.

Some of key differences between ABB and traditional budgeting Approach are as follows:

• In activity based budgeting method, each activity is analysed with a view to realise the organisational objectives. Activities which are not relevant for business entity are eliminated automatically. Departments of the organisation allocate resources only after justification of cost drivers (Nimtrakoon and Tayles, 2015). In this way ABB helps in reducing cost by eliminating unnecessary activities. On the other hand, traditional budgeting approach assumes all the current activities and costs of organisation for every coming year.
• Activity based budgeting is activity oriented approach which streamline the business activities with the organisational goals and considers potential profitability of the entity. On the other hand, Traditional budgeting is function oriented approach which justifies expenditures regarding activities. It does not identify the profitability of the entity and considers resources according to revaluation of the programs.
• Activity based budgeting method focus on the flat structure of the organisation and it gain benefit because of the optimisation of value chain (Swart and Vlok, 2015 ). On the other hand traditional budgeting approach concentrates in the vertical structure of the organisation.
• Activity based budgeting approach is more expensive than traditional budgeting approach as its over consumption of resources and additional cost incur in providing training to its staff for technical understanding of ABB. Further, it also needs more time and details from management to find out budgeting inaccuracies (Pavlatos and Kostakis, 2015). On the other hand, Traditional budgeting approach is quiet simple and easiest way of budgeting.
• In ABB method, allocation of resources is based on the effectiveness and efficiencies of business activities without consideration of budgets of previous years. On the other hand, traditional budgeting approach takes previous years budgets and consumption and adjust these budgets up or down to obtain the reflecting changes for the assumption of a new year.
• In ABB approach, organisation must identify the activities which help it to add value to the organisation (Kenno and Sainty, 2017). Whereas, traditional approach do not consider such kinds of identification of activities and assumes current activities and costs for budgeting without focussing on strategic plans.
• In Activity based budgeting, the departments allocate the resources after justifying the entity’s cost drivers while in traditional budgeting approach, actions of the trade are prioritised on the basis of their vivacity.
• In ABB, analysis of financial index is done by each personnel involved in the activities and also the personnel responsible for the index (CPIM and Dybvig, 2018). Whereas, financial index analysis in the traditional budgeting system is done by corporation structure.

It can be analysed from the above discussion that Activities based budgeting (ABB) and traditional budgeting system have various differences. For any organisation, ABB method is profitable as it concern with the development of future plans by identifying each vital activities that aid value to the organisation and provides the company and its management to have optimum control over the budgeting process and develop it in such a way that it help in realising organisational objectives by aligning all activities of business with its objectives in a very cost effective manner run smoothly (Pathak and Dzigbede, 2016 ).

The process of Activity Based Budgeting starts with “ends” i.e., outputs, which organisation desires or plans to obtain and then identification of “means” which are cost driver activities and also the resources required to create the output. The management personnel of the Rio Tinto company should follow the four steps for the implementation of the ABB approach. Firstly, managerial personnel determine the outputs of the departments and secondly, relevant activities required for the delivery of the output. Thirdly, the demand of each activity is determined and lastly, estimation of the cost of resources of production is to be done.

Importance of Activity based budgeting in Rio Tinto Company as follows -

• Improve relationship- The purpose of ABB is to design the business in such a way that all the irrelevant activities are eliminated and the process becomes highly effective by removing irregularities and serve the customers with high quality of goods and services at competitive prices (Haruna and Vyas-Doorgapersad, 2016). It also helps in building healthy customer relations with that of the organisation.

Rio Tinto Corporation can utilise this tool to improve its relationships with customers by providing high quality of products and services (Smiley and et.al.,2014). It can be said that Activity based budgeting method is best suited and good technique for Rio Tinto company by which not only can it maintain healthy relationship with clients but also can attract new clients towards firm which will result in increasing its market share.

• Evaluation- In the Rio Tinto organisation, business policy planners can critically evaluate every cost driver with help of activity based budgeting method and eliminate ongoing irrelevant practices and activities to make its business more cost friendly and efficient (Herath, Bremser and Birnberg, 2014).

Hence, the use of ABB method can help evaluate and monitor its business operation and remove least required programs and activities from venture.

• Competitive Edge- The use of ABB technique can help organisation in sorting and prioritising its functions and activities with the view of cost effectiveness so that it may eliminate all sorts of irrelevant activities from its chart and develops the operation of business in such a way to gain competitive edge in the market by providing high quality of goods and services to the customers and develops and maintain healthy relationship with its clients (Nielsen, 2018).

By the use of this method, organisation can deliver high quality of products and services at minimum cost than its other competitors in market.

Thus it can be said that Activity based budgeting system is suitable and effective tool for Rio Tinto Group to help it gain competitive edge in the market.

• Elimination of bottlenecks- One of the most important function of activity based budgeting technique is that the personnel of the organisation with the use of this technique conducts deep analysis and research on the processes and activities of the organisation so as to remove various types of bottlenecks associated with functions, operation, business programs and so on (Huang and et.al., 2014). Thus, the use of ABB may help Rio Tinto Corporation to eliminate bottlenecks and carry out all activities in smooth and effective manner.
• Deliver high quality services- The most significant function of the activity based budgeting method is to reduce the cost of operation and improve the quality of functions and provide the customers with quality of services and products and retain the faith of customers for the organisation.
• Focus on strategic planning- Budgeting is associated with Planning to achieve its objectives, coordination of business activities with its goals and enhanced control of organisational internal processes. Activity based budgeting, an innovative approach which can help the Rio Tinto to become competitive by streamlining the budgeting process with the strategic plans and to analysis of core competencies of the organisation (Garousi and Pfahl, 2016). Managerial personnel can design and execute strategic plans according to predetermined objectives of the company and to cater to the needs of its customers.
• Encourage team work- One of the advantages of activity based budgeting approach is to build up team work in the organisation. As ABB align budgeting process with the organisational objectives and strives to attain optimum control and transparency in the organisation so that each department understands their roles, task and responsibility to achieve desired goals of the organisation (Kumar and et.al., 2014). Rio Tinto can use this tool to enhance team work and effective participation of the personnel in the organisation which will create harmonious collaborative cultural environment.
• Customer oriented approach- The activity based budgeting approach concentrate on the actual requirement of business keeping in mind the need of customers. This reduces unnecessary cost and makes it a cost effective approach to provide high quality services to the customers and products at reasonable price (Winterhalter, Zeschky and Gassmann, 2016). So it can be said that ABB is well suited for the implementation in the Rio Tinto company in order to improve relationship with customers and gain potential profitability and competitive advantage in the market.
• Organisation view as a system- Activity based budgeting method helps to view the organisation in question from the start till end instead of hierarchical departments. In this way, responsibilities at each level can be analysed and fixed and further roles can be allocated to each of them in order to improve efficiency (Galea, Houkes and De Rijk, 2014). Each functional department can analyse its own operational responsibilities to meet the business objectives and may act accordingly with the help of ABB method.

Thus, it can be said that ABB method is best suited to Rio Tinto Group for improvement in its performance and profitability.

• Eliminating irrelevant activities and improve efficiency- It is one of the important features of ABB for business enterprises which eliminates irrelevant activities and improves efficiency of the organisation. It provides effective way of forecasting future costs and eliminating irrelevant activities so that it becomes the tool of cost effectiveness. It uses detailed information for allocation of resources for each cost drivers and with the use of this tool, Rio Tinto Group can maintain more control over production and manufacturing unit which will help improve quality of goods and services.
• Increase sales and thereby profitability - It is one of the important benefits of activity based budgeting through which Rio Tinto company quite easily improve sales by elimination of unnecessary activities from business thereby increasing potential profitability and enables the owner to deliver quality services to the customers of the business entity.

Dual-listed Structure of Rio Tinto Group

Conclusion

By encapsulation of the entire report, it can be said that Activity based budgeting method requires to determine the planned activities, cost, size and resources to be required. It requires detailed information and is quite different from traditional approach of budgeting. With an effective ABB, an organisation can have optimum control over budget process, improve customer relationship, enhance its productivity and performance effectively and efficiently and also increase potential profitability and sales as it focuses on alignment of business activities with the realisation of organisational goals and objectives in a very cost effective manner. The tool of management accounting “Activity Based Budgeting (ABB)” is best suited for the Rio Tinto Corporation as this approach eliminates irrelevant activities of the business and also the trouble of incompatibility of the strategic plans with that of market. It is also concluded that, however, ABB does not unravel all the problems associated with the traditional approach and is relatively more expensive but besides all these cons, it has great significance in budgeting as a management accounting tool as it eliminates irrelevant activities and their cost from the business entity.

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