How Activity-Based Budgeting (ABB) Works

Activity-based budgeting (ABB) is a more rigorous process than traditional budgeting, which involves adjusting the budget for developments or inflation. Organizations develop activity-based budgets by scrutinizing every activity in the company and justify why a company should include something in the budget. Using ABB helps you reduce expenditures, which ultimately squeezes more profit from sales. It also can show you how to keep costs at a minimum if your enterprise is undergoing operational changes.

A new enterprise, one without historical budgeting data, can use ABB, and so should those undergoing material change. Previous budget information may not be useful as a basis for forecasting if a company is:

  • Expanding
  • Relocating the business
  • Taking on new subsidiaries
  • Launching new products or services

The ABB process has three main steps:

  1. Identify Relevant Activities: Activities are items and cost drivers responsible for incurring either expenses or revenue.
  2. Determine Activities with their Related Units: The number of units forms the baseline for calculations during the ABB process.
  3. Delineation: Taking the cost per unit of each activity and multiplying the results by the activity level.

While an effective method of budgetary control, not all firms will necessarily use activity-based budgeting. An established company experiencing minimal change can apply the previous year's data at a flat rate to reflect inflation and business growth. In many cases, this is sufficient.

ABB is of significant help if there's a TQM or Total Quality Management environment in place, as it'll help identify cost-effective activities. A company should complete the implementation of ABB once the firm has adopted activity-based costing (ABC). The operational managers are fully supportive and engaged in the success of the process. If management at the operational level of an enterprise struggle with the concept of activity-based budgeting, it can delay or derail the process.

The activity-based budgeting (ABB) method will allow for more control over the business's finances. Projections and expenses or revenue planning can occur with a preciseness that results in useful budgetary allocations. With more budgeting process control, management can align the budgetary process with an ABB system with the overall business goals.

Real-World Example of Activity Based Budgeting

Company Z expects to be the recipient of 50,000 sales orders next year, and management anticipates processing each order at the cost of $2. The ABB for the activity relating to that order's sales processing as an expense for the coming year is 50,000 x $2 = $100,000.

This is a figure easily comparable to making a traditional budgeting approach, where sales should grow from last year's budget. If, for example, the previous budget had $80,000 sale order processing costs, and sales forecast should be about 10% more under activity-based budgeting, implying you'll budget $8,000 more sales for next year.

That works out simply as last year's $80,000 x 10% sales growth = $8,000 + $80,000 = $88,000.

Significance of Activity-Based Budgeting

Activity overheads are brought to the attention of accountants and management through activity-based budgeting. ABB emphasizes that activity volume control is equivalent to bringing down activity costs instead of traditional budgeting, which considers input costs. ABB takes the perspective of viewing the business as a collection of cost-driving activities with the outputs-based approach. This recognition is one that augurs well with overall organizational strategy.

Before the implementation of an activity-based budgeting system, considerations should include;

  • Time and support as ABB require a significant duration for implementation.
  • Availability of ABB software and pertinent resources.
  • Costs of implementation and whether they outweigh ABBs benefits.
  • Ease, or the lack thereof, of identifying all the businesses function costs and activities.

Once you remove bottlenecks and streamline functions, an organization will also benefit from better relationships with its customers. An enterprise can serve its target consumer with the best quality products or services at a lower premium, which guarantees customer satisfaction.

One downside of activity-based budgeting (ABB) is the cost of implementing and maintaining this budget will be more expensive and time-consuming. Additional insights and assumptions that can result in potential inaccuracies in budgeting are also needed to manage ABB systems.

The activity-based budgeting (ABB) system allows management to view the business as a unit instead of several departments. You can prepare budgets with the organization as a whole instead of as separate activities, as is the case with traditional budgeting methods. The business can save costs by eliminating unnecessary activities brought to light through the use of ABB. These saved costs can result in the company producing services or products at a lower price than other industry players, helping it gain a competitive edge in the market.