Definition of Activity Based Budgeting
Activity Based Budgeting is a budgeting method in which organizational operations through which costs are incurred in every functional area of that organization are documented and relationships among them are analyzed and defined. These budgets are not prepared by simply making adjustments in prior period budgets to incorporate impact of business development or inflation. Instead, these budgets find efficiencies in operations of business and prepare budgets on the basis of these activities. Activity Based Budgeting empowers accountability and greater local planning and provides incentives to all units to efficiently manage expenditures and resources. Moreover, acquisition of direct control over resources which was acquired through activities provides incentives to develop new activities and set priorities which are consistent with the strategic goals and overall mission of the organization.
Brief Explanation of Activity Based Budgeting
Activity Based Budgeting is more likely to be adopted by newer companies which do not have historical information to rely on. Further, these budgets are highly useful for organizations undergoing significant changes, such as with major customers, new subsidiaries, business products or locations. Since traditional budgeting processes only make adjustments in prior year budgeted amounts, developed organizations with nominal change are more willing to adopt traditional approach of budgeting where only a flat rate is used to apply to prior year data to obtain reflection of inflation and business growth.
A three-step process can be used to simplify activity-based budgeting process. Firstly, identify relevant activities. These activities are the cost drivers responsible for incurring expenses or revenue. Secondly, the number of units associated to each activity is used as the standard for the calculation. Lastly, the activity level is multiplied against the determined cost per unit of activity.