Activity-Based Budgeting (ABB)

Activity-based budgeting (ABB) is a system that records, researches, and analyzes activities that lead to costs for a business. Activity-based budgets are more than merely adjusting previous budgets to account for inflation or business development. Instead, ABB searches for efficiencies in business operations and develops budgets based on these activities.

Activity-based budgets (ABB) are more likely to be utilized by newer companies without historical budgeting information on which to rely. Also, ABBs are more useful for companies undergoing material changes, such as those with new subsidiaries, significant customers, business locations, or products. Because traditional budgeting processes simply adjust a previous year's budgeted amounts, established firms with minimal change are more likely to use traditional growth budgeting approaches. A flat rate is typically applied to the data from the previous year to reflect business growth and inflation. The activity-based budgeting (ABB) process is broken into a three-step process. 

Identify relevant activities. These cost drivers are the items responsible for incurring revenue or expenses for the company. 

1. Determine the number of units related to each activity. This number is the baseline for calculations.
2. Delineate the cost per unit of activity and multiply that result by the activity level.
3. Example of Activity-Based Budgeting

As an example, a company anticipates receiving 50,000 sales orders in the upcoming year. The cost to process a single order is $2. Therefore, the activity-based budget (ABB) for the expenses relating to processing sales orders for the upcoming year is $100,000 ($50,000 * $2). 

This figure may be compared to a traditional approach to budgeting. If last year’s budget called for $80,000 of sales order processing expenses and sales were expected to grow 10%, only $88,000 ($80,000 + ($80,000 * 10%)) is budgeted.

Activity-based budgeting (ABB) systems allow for more control over the budgeting process. Revenue and expense planning occurs at a precise level that provides useful details regarding projections. ABB allows for management to have increased control over the budgeting process and to align the budget with overall company goals.

Activity-based budgeting is costlier than traditional budgeting techniques. It requires more information and time from management to be developed. ABB systems need additional assumptions and insight from management, which results in potentially numerous opportunities for budgeting inaccuracies. Finally, the ongoing maintenance and analysis of budget variances require more resources than other budgeting techniques.