Activity-Based Budgeting (ABB)

Activity-based budgeting (ABB) is similar in concept to activity–based costing (ABC)

Activity-based costing (ABC) is an alternate method of allocating overhead costs to products.

When activity-based costing is used to allocate overhead costs, the overhead allocations are not based on usage of resources such as direct labor hours or machine hours as in traditional costing.Instead, they are based on activities performed and the cost of those activities. ABC is much more detailed than traditional costing because it uses many more cost pools, and each cost pool has its own cost driver. When activity–based costing is being used for overhead allocations, the overhead allocation rates under ABC are calculated according to the activity based costing cost pools. Activity based budgeting is integral to developing the overhead allocation rates used in activity based costing.

Activity-based budgets are prepared based on the budgeted overhead costs to perform the budgeted activities. Activities that drive the costs are identified and a budgeted level of activity for each of the drivers is determined based on a budgeted level of production. A budgeted cost pool (budgeted overhead costs) is developed for each activity. Budgeted overhead costs per unit of each activity are determined by dividing the total budgeted overhead costs for the activity by the total budgeted units of the activity. Overhead costs are allocated to products based on the budgeted levels of each activity for each product. The company may have several different overhead cost pools, each with a different cost driver and a different cost allocation to the units produced. Thus, several different overhead allocations may be made to each product.

An activity-based budget system makes clear the relationship between activities performed and output. The advantage of this clear relationship is that when changes are made to products, product design, product mix, manufacturing processes, and so forth, managers are able to examine the effects of the changes on budgeted activities and on the costs of those activities.

If activity–based costing is used as the costing system, then the budget should also be activitybased to enable continuous improvement and also to make comparisons between actual results and budgeted results meaningful. Activity–based budgeting is an extension of the company’s activitybased costing system and uses the same activity cost pools to group budgeted costs as the activity based costing system uses to group actual costs.

However, before using the current year’s activity cost pools to develop the next period’s budget, a firm needs to review its activity pools and the costs going into each pool for their continued appropriateness and accuracy. Some of the factors may change before the future budget period begins, and data from the current ABC system may need to be updated. Updating of the current ABC system will be needed especially if variances during the current or previous periods have been significant.

For example, new equipment may have been acquired that has decreased setup time per batch or has reduced supervisory time during setup or production. Cost per setup will change as a result.

Benefits of Activity–Based Budgeting

1. The process of preparing an activity–based budget brings out information about opportunities for cost
   reductions and the elimination of wasteful activities. Thus, activity–based budgeting makes it possible
   to identify and enhance high value added activities and to eliminate low value added activities, which
   promotes continuous improvement.
2. It helps managers to identify resources needed and changes that will be needed in resources if changes are made in products offered, product design, product mix, manufacturing processes, and so forth.
3. Budgeted costs are based on the costs for the resources required to perform the budgeted activities, which defines a clear relationship between resource consumption, costs, and output.
4. Activity–based budgeting can help to identify budgetary slack.
5. An activity–based budget system makes clear the relationship between activities performed and output. When changes are made to products, product design, product mix, manufacturing processes, and so forth, managers are able to examine the effects of the changes on budgeted activities and on the costs of those activities.

Limitations of Activity–Based Budgeting

1. Activity–based budgeting must be used in conjunction with activity–based costing.
2. Both ABC and ABB require more work than a traditional costing and budgeting system and so are costlier to implement. Costs include the research needed to do the cost allocations and the time required to educate managers about the cost allocations. The more complex the cost allocations are, the higher the costs to educate.