Every business sets out to achieve clearly defined goals and specific objectives. For this to be possible, a business needs to have business plans. Business plans are expressed in qualitative and quantitative forms.
A budget is a quantitative expression of a plan of action prepaid in advance of the period to which it’s associated with.
A budget is the most effective financial tool a business can use to translate its objectives into easy to perform tasks. It’s also a tool for monitoring working capital management, communication channels and to carry out regular performance evaluation.
The fact is, having just any conventional budgeting system does not automatically translate to controlling, monitoring and improving processes that lead to the attainment of set goals.
A budget based on activity analysis methods is steps ahead of conventional budgeting system. One of them is activity based budgeting.
What is activity based budgeting (ABB)?
Activity based budgeting is based on activity based costing which identifies and put activities that cause costs in cost pools. Activities that cause costs are known as cost drivers.
ABB .recognizes the fact that not all activities add value, it therefore separates and treats activities according to their potential to add value to the business.
The ultimate aim of ABB is to directly control cost drivers and not the costs.
ABB can be summarized as a budgeting technique that applies cost driver data to budget setting and variance analysis process.
A variance is the difference between the standard cost and the actual cost.
However, ABB has its limitations.
The apportionment of costs is not completely free of bias and may not be a good regular monitoring system because of short term business instabilities.
A business’s costs and resources divides between cost drivers of vendors and purchase orders. Based on the expected activity for the period, cost driver volumes of 310 suppliers and 2,500 purchase orders have been projected.
The purchasing manager and the purchasing team can use the activity volumes and cost analysis to budget cost driver units and resources for the purchasing department;
Budget for purchasing department:
|Cost drivers||number of customers||number of purchase orders||Cost sustaining department||Total|
|salaries of managers||20,000||1.000||25,000||46,000|
|travelling and accomodation||22,000||2,000||500||24,500|
|B: Activity volumes||310||2,500||–||–|
The Activity Based Costing (ABC) uses the cost driver rates of $181 and $10 to determine the product costs.
Activity based costing is also known as activity cost management (ACM).