Activity Based Budgeting

Activity Based Budgeting

1. ABB is defined as: ‘a method of budgeting based on an activity framework and utilising cost driver data in the budgetsetting and variance feedback processes’.

   • At its essence, activity-based budgeting begins by looking at results and the activities that created them, as opposed to cost-based budgeting, which often begins with raw input and material and works outward. ABB can also help firms create more accurate financial forecasts.

2. Advantages

   • It draws attention to the costs of ‘overhead activities’ which can be a large proportion of total operating costs.
   • It recognises that it is activities which drive costs. If we can control the causes (drivers) of costs, then costs should be better managed and understood.
   • ABB can provide useful information in a total quality management (TQM) environment, by relating the cost of an activity to the level of service provided.
   • If an organisation produces many different types of output using different combinations of activities then ABB can provide more meaningful information for budgetary control.

3. Disadvantages

   • A considerable amount of time and effort might be needed to establish the key activities and their cost drivers.
   • It may be difficult to identify clear individual responsibilities for activities.
   • It could be argued that in the shortterm many overhead costs are not controllable and do not vary directly with changes in the volume of activity for the cost driver. The only cost variances to report would be fixed overhead expenditure variances for each activity.