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A WELL-DESIGNED ACTIVITY-BASED COSTING (ABC) system has three strategic objectives. The first is to report accurate costs that can be used to identify the source of firm profits. The second is to identify the cost of activities so that more efficient ways to perform them or produce their outputs can be identified. The final one is to identify the future need for resources so that they can be acquired more efficiently. To date we have addressed the first two objectives but not the third. In the next few columns we are going to discuss activity-based budgeting (ABB). ABB uses the principles of ABC to estimate the firm's future demand for resources. ABB has two advantages over traditional budgeting. First, it has the potential of being more accurate, and, second, it provides greater insights into why the demand for resources is not linear with production volume.
At the heart of ABB is a reversal of an ABC system. Instead of driving the cost of resources to activities and then to outputs, we now drive the demand for outputs to activities and then to resources. The classical NorthSouth process of ABC is replaced by the South-North process of ABB (Figure 1). In theory, the ABB process is easy. You tell the ABC system the demand for outputs and run the model backwards to estimate the future demand for resources (see Figure 2, p. 86). What could be simpler?
Unfortunately, a simple reversal approach does not work well at all. Typically, the estimates for resource demand that are obtained this way are hopelessly inaccurate. The source of these errors is not a failure of the central activity-based model but fundamental differences between ABC and ABB. There are at least four reasons why a simple reversal...