Definition of Activity-Based Budgeting
Activity Based Budgeting involves documenting organizational operations that incur costs within each functional area and analyzing and defining relationships among them. It is not simply a matter of adjusting prior period budgets for business development or inflation in order to prepare these budgets. Instead, these budgets find efficiencies in the operations of the 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. Additionally, obtaining direct control over resources through activities provides incentives to set priorities and develop new activities that align with organizational mission and strategic goals.
Companies with little historical information are more likely to adopt Activity Based Budgeting. 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 methods only make adjustments to prior-year budgeted amounts, developed organizations with nominal change are more likely to adopt the flat-rate approach to budgeting to reflect inflation and growth in business.
It is possible to simplify the activity-based budgeting process by using a three-step approach. Firstly, identify relevant activities. These activities are the cost drivers responsible for incurring expenses or revenue. Secondly, as a second standard, each activity has a specific number of units. Lastly, we multiply the activity level by the determination of cost per unit of activity.