Activity-Based Budgeting – Definition

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Activity-Based Budgeting (ABB) Definition

Activity Based Budgeting, or ABB, is a system used to research, record and then analyze the activities leading to costs in a business. This method works by distributing costs according to the activities the company carries out and is used in cost accounting. The basis of ABB is that the company’s activities are the ones consuming resources and originating costs.

A Little More on What is Activity-Based Budgeting

Since the company’s activities consume resources, the ABB model uses physical and monetary indicators. This model has been made possible by the evolution and advancement of computing for carrying out the company’s services. By allowing the monetary and non-monetary measures to be carried out, this system provides the whole view of the company’s costs and ensures better utilization of resources.

This method assumes a split variation of the total cost model that indicates that all the costs in a company have to be distributed among its products. This method, which appeared in the mid-80s, is one of the most reliable models of allocating costs to activities.

Activity Based Budgeting Activities

The first task of the ABB system is to identify all the activities developed in the company and consuming resources.

These activities are classified as:

  • Main activities: These are those activities directly related to the company’s purpose and cannot be eliminated.
  • Secondary activities: These are those generating added value from the customer’s viewpoint. They usually involve too many costs which are sometimes subcontracted.

This way the company knows the resources that each activity consume and analyzes the cost of this in the product.

The ABB method offers:

  • An extension of the management’s conception, control, and the costs’ analysis while paying attention to the planning and design of the product.
  • A measure of quality and delivery times, flexibility, innovation, and after-sales service while also discerning the traditional cost systems which are less developed compared to it.
  • Obtaining a detailed analysis of the resources used in the case of the base of the costs by activities.

Distribution of costs through inducers

After the tasks in the company have been defined, it is essential to determine how to distribute the costs among the activities. In this situation, the inducers are used since they are factors whose purpose is influencing the level of consumption in different activities.

There are three types of inductors:

  • Transaction inductors. The number of activities an activity is repeated has to be taken into account to calculate the average cost per activity.
  • Inductors of duration. This is the time necessary to carry out each activity.
  • Inductors of intensity: These are the resources consumed each time that the activity occurs.

Analysis oriented system

The ABB system is an excellent element of analysis for obtaining the information needed to make decisions and assessing the activities and actions related to the product. It is, however, more complex and difficult to implement compared to others. It emphasizes on the cost of activities unlike other more traditional systems of cost quantification. The ABB model emphasizes on the added value that activities bring to the product.

Steps Applied in Activity-Based Budgeting

There are three steps involved in activity-based budgeting. They are as follows:

  • Identify relevant activities’ cost drivers. These cost drivers account for the revenue or expenses incurred by a company.
  • Determine the cost driver’s number of units needed for each activity level.
  • Compute the rate of the cost drivers (cost per activity unit).

How Activity-Based Budgeting Works (Example)

The following is an example of activity-based budgeting where office sales scenario has been used. Note that the cost driver here is represented by the number of sales’ order.

Now let’s assume that the company’s anticipated sales orders in the coming year are $100,000. Then, the cost for processing one order is $4. In this case, the ABB’s expenses related to processing in the coming year’s sales order will be $40,000 ($100,000 x $4).

Importance of Activity-Based Budgeting

Activity-based budgeting has one importance. It brings about efficiency in an organization’s activities. This is because activities are scrutinized for the purpose of adjusting cost drivers. Budget is prepared based on the identified productive activities. This saves the company from costs related to unnecessary activities.

Advantages and Disadvantages of Using Activity-Based Budgeting

There are several advantages and disadvantages related to the use of activity-based budgeting. They are as follows:

Advantages 

  • The ABB enables the management to avoid wasting resources on irrelevant activities. Using ABB, activities are properly scrutinized and then resources aligned to more efficient activities. These cuts down the activities costs and resources are used to maximize sales which lead to higher profits.
  • The ABB’s is done after intensive research and analysis. This enables the management to do away with bottleneck related activities. It ensures that the business’ operations run smoothly.
  • Also, the ABB budget ensures that operational requirements are balanced. It is able to point our sources of inefficiencies and imbalances. It also highlights areas of improvement which allows the management and the employee to be able to amend the inefficiencies.
  • It increases the management’s agility as far as the following functions are concerned:
    • Decision-making process
    • Activity contingency planning
    • Activity performance measurement
    • Activity evaluation
  • Since it improves the resources and activities’ flow, it becomes easier for the management to evaluate activity performance. The management is able to hold employees’ accountable. This is because, through ABB, it is easier to tell who is responsible for particular activities in various departments.

Disadvantages

  • Activity-based budgeting is expensive in terms of cost. This is so because the budget requires more resource allocation compared to other types of budgets.
  • It is time-consuming. The management will require more time and information in order to develop an activity-based budget.
  • The ABB requires deep knowledge (competence) to be able to develop and implement it in various business functional areas. In this case, if the management is not able to understand it well, it may result in inaccuracy in budget preparation.
  • The ABB has much workload which requires activity tracking. The tracking comes at a cost, meaning that the company will have to allocate funds for this operation. Also, besides costs, setting up activity tracking is, on the other hand, a complex job.
  • The activity-based budgeting is used in business to account for short-term goals. It is not, therefore, applicable to business’ long-term goals. Note that a budget which doesn’t focus on helping the business to achieve its long-term goals is detrimental to the entire organization.

Key Takeaways

  • The activity-based budgeting is a budgeting system whereby cost related activities are researched, recorded, and analyzed.
  • The activity-based budget is mostly used by emerging organizations which are going through material changes.
  • The activity-based budget helps firms to cut down activity related costs and generate more returns from sales.

References for Activity-Based Budgeting

Academic Research for Activity-Based Budgeting

  • Activity-based budgeting–part 1, Cooper, R., & Slagmulder, R. (2000). Strategic Finance, 82(3), 85.  This Paper focuses on the objectives of the ABB model and its advantages over the traditional budgeting.
  • The impact of activity-based costing techniques on firm performance, Kennedy, T., & Affleck-Graves, J. (2001). Journal of management accounting research, 13(1), 19-45. This paper shows how the choice of a management accounting system can significantly impact on a firm’s value. It uses a sample of U.K. firms to show that firms using activity-based costing (ABC) methods do outperform matched non-ABC firms.
  • Management accounting: some comments, Horngren, C. T. (2004). Journal of Management Accounting Research, 16(1), 207-211. This paper the importance of management accounting techniques in forcing managers to focus on the fundamentals of their firms.
  • Management accounting practices in the British food and drinks industry, Abdel-Kader, M., & Luther, R. (2006). British Food Journal, 108(5), 336-357. This paper investigates why direct costing is practiced together with ABC and full absorption costing despite the limitations of conventional budgets.
  • Activity-based budgeting–part 2, Cooper, R., & Slagmulder, R. (2000). Strategic Finance, 82(4), 26. This paper explains how the ABC system takes the costs of existing resources and then drive their costs through various activities to the profit objects.
  • 13 Trends in budgetary control and responsibility accounting, Otley, D. (2006). Contemporary issues in management accounting, 291. This study focuses on the trends present in budgetary control and responsibility accounting and also the contemporary issues that arise in management accounting.
  • Enterprise resource planning systems’ impact on accounting processes, Spathis, C., & Constantinides, S. (2004). Business Process Management Journal, 10(2), 234-247. Using an exploratory survey of 26 companies, the study investigates various reasons that make companies choose to convert from conventional information systems to Enterprise Resource Planning systems, and the changes are brought, mainly in the accounting process.
  • The activity-based costing method: development and applications, Wegmann, G. (2008). This paper performs an analysis of management accounting applications that attempt to improve the ABC method. This paper also performs experiments in the IT supply in the European division of an international group that uses ABC Chain Costing Tool in managing its inter-organizational relations.
  • Effects of accounting and budgeting on capital allocation for infrastructure projects, Wooldridge, S. C., Garvin, M. J., & Miller, J. B. (2001). Journal of Management in Engineering, 17(2), 86-94. This study examines why infrastructure modernization has been depending increasingly on new strategies to manage asset collection during the decline of public funding in the previous 30 years. The study notes that these strategies have a renewed emphasis on condition assessment, alternative financing, and project delivery methods.
  • New developments in budgeting, Wilhelmi, M., & Kleiner, B. H. (1995). Management Research News, 18(3/4/5), 78-87. This paper observes how corporations are getting decreased revenues, and the governments face huge deficits making budgeting very difficult. The paper also investigates how these factors lead these entities to search for better methods they can use to allocate and control the expenditure of funds since the old methods are no longer suitable.
  • A survey of management accounting practices in South Africa, Waweru, N. M., Hoque, Z., & Uliana, E. (2005). International Journal of Accounting, Auditing and Performance Evaluation, 2(3), 226-263. This paper gives an account of a survey on management accounting practices that as conducted in 52 South African firms in 2001 between January and April. It also documents the changes taking place in the field of management accounting and the factors prompting its change.
  • Traditional versus activity-based budgeting in non-manufacturing companies, Pietrzak, Ĺ». (2013). Social Sciences, 82(4), 26-37. This paper determines the utility of ABB and takes into account the advantages, possibilities and the difficulties accompanying the implementation of this approach through the illustration of the budgeting process in a service company. It also shows the results of literature studies that encompass the use of techniques like critical analysis, a generalization of the views of other authors and conclusion formulation.
  • Budgeting in the information age: a fresh approach, Brander Brown, J., & Atkinson, H. (2001). International Journal of Contemporary Hospitality Management, 13(3), 136-143. This paper investigates whether if by adopting flexible, responsive and empowered management structures, hospitality firms can compete successfully in the rising information age which emphasizes on innovation, quality, and speed.
  • A survey of activity-based costing in the UK’s largest companies. Innes, J., & Mitchell, F. (1995). A survey of activity-based costing in the UK’s largest companies. Management accounting research, 6(2), 137-153. This paper contains the results of a 1994 survey of activity-based costing (ABC) in the U.K.’s largest 1000 companies. The survey was designed to ascertain the adoption rate of ABC in these companies, the specific application of ABC, the views of users on the success and importance of ABC, the views of non-ABC users on ABC and the possibilities for future research. The results indicate that although ABC is now used by a significant number of large companies its impact is often restricted in scope and it has also been rejected by a sizeable number. The majority of companies have still to come to a decision on its use. Among users it is applied throughout all of the core areas of management accounting. There is thus potential for considerable growth in its adoption among non-users. It is an on-going development which gives considerable opportunity for researches interested in change to pursue work on this topic in a variety of the sub-areas of management accounting.Traditional versus activity-based budgeting in non-manufacturing companies, Pietrzak, Ĺ». (2013). Traditional versus activity-based budgeting in non-manufacturing companies. Social sciences, 82(4), 26-37. The objective of this paper is to determine the utility of activity-based budgeting (ABB) taking into account advantages, possibilities, and difficulties associated with the implementation of this approach by an illustration of the budgeting process in a service company. This article is the result of literature studies in which techniques, such as critical analysis, generalization of other authors’ views, and conclusion formulation have been used. To illustrate and extend, the case study method has been chosen for the analysis. Literature studies have led to the conclusion that companies do not plan to move away from traditional budgeting altogether; they prefer modifying it and adapting to management needs with the possible use of new techniques, such as activity-based budgeting. The case study has offered the possibility to present advantages and disadvantages of using the method in a service company and has also served as a confirmation of surveys conducted by other researchers. It has added a more holistic and richer contextual understanding of the ABB nature and helped explain how it could change the budgeting procedure, and, further, the management. This paper bears theoretical and practical significance. From a theoretical point of view, it contains critical analysis of the possibilities for implementing new trends in budgeting. From a practical point of view, it could expand managers’ knowledge about a new approach to budgeting.

    Target performance management for an international shipping harbor: An integration activity-based budgeting with a balanced scorecard approach, the case of …, Lin, W. C., & Yahalom, S. (2009). Target performance management for an international shipping harbor: An integration activity-based budgeting with a balanced scorecard approach, the case of Keelung Harbor. African Journal of Business Management, 3(9), 340-349. The economy of Taiwan heavily depends on sea transportation. Port planning and development is related to the trade growth and changes in industrial structure. Keelung Harbor, located in northern Taiwan and built in 1886, is the second largest commercial port in Taiwan. Due to the competitive environment, Keelung Harbor must pay more attention to operational efficiency and devise an overall performance evaluation. Balanced scorecard (BSC) is a system of performance evaluation; activity-based budgeting (ABB) follows the organization’s need to budget. It can help a firm reach the performance target that BSC sets. In order to evaluate the overall performance of Keelung Harbor, we design an evaluation system integrating balanced scorecard with activity-based budgeting to control cost and examine the achievement rate of target performance. The results of this study indicate that organization’s target and resources can be integrated by employing the BSC and ABB systems. The results of the study can be good references measure for operating of Keelung Harbor and others.

    Activity-based budgeting: Creating a nexus between workload and costs, Shane, J. M. (2005). Activity-based budgeting: Creating a nexus between workload and costs. FBI L. Enforcement Bull., 74, 11.

    Activity-based: Costing, management and budgeting, Simpson, W. K., & Williams, M. J. (1996). Activity-based: Costing, management and budgeting. The Journal of Government Financial Management, 45(1), 26.

    Activity-based life-cycle costing in long-range planning, RodrĂ­guez Rivero, E. J., & EmblemsvĂĄg, J. (2007). Activity-based life-cycle costing in long-range planning. Review of Accounting and Finance, 6(4), 370-390.

    Applying activity based costing (ABC) method to calculate cost price in hospital and remedy services, Rajabi, A., & Dabiri, A. (2012). Applying activity based costing (ABC) method to calculate cost price in hospital and remedy services. Iranian journal of public health, 41(4), 100. Activity Based Costing (ABC) is one of the new methods began appearing as a costing methodology in the 1990’s. It calculates cost price by determining the usage of resources. In this study, ABC method was used for calculating cost price of remedial services in hospitals

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