Activity Based Budgeting

Activity based budgeting is a budgeting method in which budgets are prepared using Activity Based

Costingafter considering the overhead costs. In simple words, activity based budgeting
is management accounting tool which does not consider the past year’s budget to arrive at current
year’s budget. Instead, the activities that incur the cost are deeply analyzed and researched. Based
on the outcome of the study, the resources are allocated to an activity.
Table of Contents
 1 Need of Activity Based Budgeting
 2 Advantages of Activity Based Budgeting
o 2.1 Evaluation
o 2.2 Competitive Edge:
o 2.3 Business as a Unit
o 2.4 Elimination of Bottlenecks
o 2.5 Improves Relationship
 3 Disadvantages of Activity Based Budgeting
o 3.1 Requires Understanding
o 3.2 Complex
o 3.3 Resource Consumption
o 3.4 Cost Involved
o 3.5 Short Term

NEED OF ACTIVITY BASED BUDGETING

Activity based budgeting is carried out to bring efficiency in the activities of an organization. Budgets
are prepared after justifying the cost drivers. Thus, activity based budgeting is activity oriented and
not function oriented.
Let us now have a look at the benefits of activity-based budgeting method.
Course on Budgeting and Forecasting**
ADVANTAGES OF ACTIVITY BASED BUDGETING
EVALUATION
Activity based budgeting method evaluates each and every cost driver. It takes into consideration all
the steps involved in an activity. The irrelevant activities are eliminated and only the necessary
activities form a part of the business.

COMPETITIVE EDGE:
Activity based budgeting system eliminates all sorts of unnecessary activities, which helps the
business to save its costs. The saved cost results in the production of goods and services at lower
cost than that of competitors. It also helps the organization to gain a competitive edge in the market.

BUSINESS AS A UNIT
This budgeting technique helps in viewing the business as a single unit and not in the form of
departments. The managers or the top management prepare the budget for the business unit as a
whole and not keeping in mind any single department as done in the case of other methods of
budgeting.

ELIMINATION OF BOTTLENECKS
Budgets under activity based budgeting are prepared after deep research and analysis. This study
removes all the unnecessary activities of the business. By doing so, the business eliminates all sorts
of bottlenecks associated with an activity and business functions are carried out more smoothly.

IMPROVES RELATIONSHIP
Activity based budgeting system helps in improving the relationship between the organization and its
customers. The main aim of this budgeting method is to eliminate unnecessary activities and serve
the customers with the best quality at best price. This enforces (indirectly) the employees of the
company to serve the customers in the best way possible and ensure customer satisfaction. In turn,
the relationship between the organization and the customers improves.

LEARN HOW TO CREATE BUDGETS FOR A BUSINESS **

Let us have a look at disadvantages of activity based budgeting.

DISADVANTAGES OF ACTIVITY BASED BUDGETING

Activity-based budgeting offers many advantages. However, like every process, this too has its
disadvantages as listed below:

REQUIRES UNDERSTANDING
Activity-based budgeting requires a deep understanding of various functional areas of the business.
If the manager preparing the budget is incapable of understanding and evaluating the areas of
business, it would lead to inaccurate budget preparation.

COMPLEX
 Activity-based budgeting system is complex in nature. It requires research and analysis of various
factors. This budgeting method comprises of estimation of demand and based on that, it does the
estimation of resources to be employed in various activities.

RESOURCE CONSUMPTION
The process of budgeting in this method consumes a lot of resources of an organization. It needs to
employ top officials for conducting numerous analyses. It is a very time-consuming task too. If these
resources are employed in other operational activities, they can give better returns.

COST INVOLVED
Implementation of activity-based budgeting requires trained employees. An employee, who is not
trained enough, cannot handle the budgeting exercise effectively. So business needs to incur extra
costs to train its employees. Moreover, the process requires the involvement of top management, so
proves to be costly too.

SHORT TERM
Activity-based budgeting focuses on short-term goals of the business. It does not take into account
the long-term scenario of the business. Focusing more on short-term goals rather than long-term
goals can prove to be very fatal for the organization.

References:
 http://www.investopedia.com/terms/a/abb.asp
 http://www.cgma.org/resources/tools/essential-tools/activity-based-budgeting.html?
TestCookiesEnabled=redirect
 http://benefitof.net/what-are-the-key-benefits-of-using-activity-based-budgeting-abb-in-
businesses/
 http://www.brighthub.com/office/finance/articles/94622.aspx
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Last updated on : August 14th, 2018
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