Final answer:
Activity-based budgeting focuses on the backward calculation from activities and cost drivers to associated costs, allocating costs to activities rather than traditional line-item approaches. The correct option is C.
Step-by-step explanation:
The correct answer to the question is c. Activity-based budgeting works backward from activities and their drivers to the underlying costs. This method of budgeting differs significantly from traditional budgeting methods, which may involve preparing budgets based on historical expenditure and incremental changes to previous years' figures. Activity-based budgeting starts with identifying the activities that drive costs within an organization and then allocates costs to these activities. For instance, a manufacturer would look at the activities required to produce goods, such as ordering materials, manufacturing products, and delivering them to customers, then allocate costs based on the resources these activities consume.
On the subject of costs, understanding the types of costs is crucial. Fixed costs, such as the example of rent on a factory or a retail space, do not change regardless of the level of production. This is because they are costs of the fixed inputs, such as capital, which do not change in the short run. In contrast, variable costs will vary with the level of production, displaying characteristics such as diminishing marginal returns where the marginal cost of producing higher volumes increases.
It’s important to note that while activity-based budgeting incorporates a deep understanding of cost behavior, option a, which suggests that activity-based budgeting uses knowledge of cost behavior to split line items into fixed and variable components, doesn’t capture the essence of the backward approach that activity-based budgeting employs. Options b and d describe aspects more aligned with traditional budgeting approaches, often centered around line items or a static perspective.