Definition:
Activity-based budgeting (ABB) is a budgeting method that allocates resources based on the activities that drive costs. It’s a more granular approach than traditional budgeting methods, which often allocate resources based on departments or functions.
Key steps in ABB:
- Identify activities: Identify the key activities that drive costs within the organization.
- Determine cost drivers: Determine the factors that cause costs to change for each activity.
- Allocate costs: Allocate costs to activities based on the cost drivers.
- Develop budgets: Develop budgets for each activity based on the allocated costs and expected activity levels.
Why is ABB used?
- Improved accuracy: ABB provides a more accurate allocation of costs, as it considers the specific activities that drive costs.
- Better decision-making: ABB can help businesses make better decisions about resource allocation and pricing.
- Cost reduction: By identifying and addressing non-value-added activities, ABB can help businesses reduce costs.
Example:
In a manufacturing company, traditional budgeting might allocate costs based on departments like production, sales, and administration. ABB, on the other hand, might allocate costs based on activities such as machine setup, product assembly, and customer service. This more granular approach can help identify areas where costs can be reduced or reallocated.
In essence, ABB is a more sophisticated budgeting method that provides a more accurate and informative view of a company’s costs and resource needs.
