What is Activity Based Budgeting
Activity based budgeting takes a similar approach to activity based costing. ABB is defined as a ‘method of budgeting based on an activity framework utilising cost driver data in the budget setting and variance feedback process’.
In its simplest form, ABB is simply about using costs determined via ABC to prepare budgets for each activity. The basic approach of ABB is to budget the costs for each pool as follows.
(1) The cost driver for each activity is identified. A forecast is made of the number of units of the cost driver that will occur in the budget period.
(2) Given the estimate of the activity level for the cost driver, the activity cost is estimated. Where appropriate, a cost of activity, known as the cost driver rate, is calculated.
What are the advantages and disadvantages of Activity Based Budgeting
Advantages
- It draws attention to the costs of ‘overhead activities’. This can be important where overhead costs are a large proportion of total operating costs.
- It provides information for the control of activity costs, by assuming that they are variable, at least in the longer term.
- It provides a useful basis for monitoring and controlling overhead costs, by drawing management attention to the actual costs of activities and comparing actual costs with what the activities were expected to cost.
- It also provides useful control information by emphasising that activity costs might be controllable if the activity volume can be controlled.
- ABB can provide useful information for a total quality management (TQM) programme, by relating the cost of an activity to the level of service provided (for example store requisitions processed) – Do the user departments feel they are getting a cost effective service?
Disadvantages
- It is an expensive system to implement. New information systems are required and managers need to be trained to use it
- It will also rely on the use of activity based costing (ABC) as the standard costing system.
