Activity based budgeting is the idea that each activity within an organization should record their costs in order to define their expenditures. This can help tie together strategic goals and determine what costs are needed when creating a budget. The basic premise is to streamline costs, improve business practices and meet objectives rather than simply setting a budget based on history, inflation or revenue growth.
Activity Based Budgeting Definition
Activity-based budgeting (ABB) is a budgeting method that allocates resources to specific activities within an organization based on their consumption of those resources. It starts with identifying the activities that consume the most resources and then assigns budgets to each of these activities. ABB provides a more accurate picture of the costs associated with specific products or services, and it helps organizations make better-informed decisions about resource allocation and cost control.
Activity based budgeting is the idea that each activity within an organization should record their costs in order to define their expenditures. This can help tie together strategic goals and determine what costs are needed when creating a budget. The basic premise is to streamline costs, improve business practices and meet objectives rather than simply setting a budget based on history, inflation or revenue growth.
The History of Activity Based Budgeting
In an attempt to control indirect costs and improve the data received from the accounting department, General Electric began using activity based budgeting in the early 1960s. The accounting department noted that many indirect costs could be predicted before the costs were actually incurred. In addition, the different departments were not aware of the effect their expenses had on other departments. In order to resolve this problem they began to look at each specific activity in order to determine its costs to the organization.
When it is Best to Use Activity Based Budgeting
Activity based budgeting has become an extremely popular accounting tool in recent years. However, it is important for companies to understand the best times to apply the assumptions of this budgeting plan. For example, a company that produces several different diverse products might not want to use this program as their core budgeting tool as the cost of consumption, selling and overhead may be different from one product to another and will distort the results of the analysis.
Why Activity Based Budgeting Makes Sense
Activity based budgeting helps companies provide better communication of their objectives to employees. They are also able to allocate resource more effectively and determine which resources are needed for each level of business. The recorded data can help to show which activities are needed, how to perform them and what their final cost is. In addition, it will highlight any waste, fraud or excess and point out any potential alternatives where resources could be redeployed.
The Drawback to Activity Based Budgeting
The problem with activity based budgeting is that when employees assign a cost to certain objects, it is still an estimate. Accountants within the company should work to build a cost/benefit analysis to determine more precise costing for the organization. However, sometimes the cost of gathering the data can be more expensive than the benefit derived from the increased precision. Considering these variables ahead of time can help to determine if this time of budgeting plan is the best fit for an individual company.
Activity based budgeting can be an invaluable tool for managers and can aid in decision making and increase profits. Understanding the basic assumptions of this plan can prevent financial distortions that lead to inaccurate data and poor decisions later. Management should also be aware the complications this type of budget could create. By balancing and evaluating the many variables involved however, it can improve a company’s accounting practices and help to determine where money should be spent.
What are examples of activity-based budgeting?
Activity-based budgeting can be used in any organization that wants to allocate resources more effectively and understand the costs associated with specific products, services, or business processes. Some common examples of activities in an activity-based budget include:
- Manufacturing processes: budgeting for direct and indirect costs associated with producing a product, such as raw materials, labor, overhead, and maintenance costs.
- Sales and marketing: budgeting for customer acquisition and retention efforts, such as advertising, trade shows, and customer service.
- Research and development (R&D): budgeting for the costs associated with designing, testing, and bringing new products or services to market.
- Supply chain management: budgeting for the costs of acquiring raw materials, storing inventory, and shipping products to customers.
- Information technology (IT): budgeting for the costs of software development, hardware maintenance, and network security.
These are just a few examples of how activity-based budgeting can be applied in different industries and organizations. The key is to identify the activities that consume the most resources and allocate budgets based on their specific needs.
