Activity Based Budgeting Concept, Rational, issues, Limitations
Activity based budgeting is a budgeting process in which budgets are created using Activity Based Costing after accounting for overhead expenses. Activity-based budgeting (ABB) is a budgeting technique in which activities are extensively examined in order to estimate expenditures. ABB does not use previous expenditures in its budgeting process. Simply put, activity-based budgeting is a management accounting method that does not include the previous year’s budget when calculating the current year’s budget. Instead, the actions that incur costs are thoroughly evaluated and investigated. The resources are assigned to a certain activity based on the findings of the investigation. Activity-based budgeting (ABB) is more stringent than standard budgeting methods, which often just alter past budgets to allow for inflation or corporate growth.
- Components
- The components and process of activity-based budgeting are as follows:
- It begins with identifying activities that revolve around resource consumption, which are divided into two categories: main activities and secondary activities. The degree of involvement and importance of an activity to the organization is determined by its priority; thus, main activities are activities that are directly related to the objectives and are essential.
- Secondary activities are those that add value to the customer’s experience and shift their preference in favor of the business, which may require a large amount of resources.
- After establishing the activities, the next step is to determine how to allocate expenditures or resources appropriately among the activities, which is accomplished with the assistance of inducers, which are elements that define the amount of consumption in various activities.
- The three main inducers that impact such choices are time, which shows the length of the activities, the quantity of resources needed by each activity, and the number of times an activity is performed. After obtaining all of these data, the appropriate costs may be computed.
- Importance: Improves Relationship.
- The activity-based budgeting approach helps to improve the organization’s engagement with its consumers. The primary goal of this budgeting strategy is to remove needless operations while providing clients with the highest quality at the best price. This (indirectly) drives the company’s personnel to service clients as best they can and assure customer pleasure. In turn, the organization’s connection with its clients improves.
- Evaluation
- The activity-based budgeting strategy assesses each and every cost driver. It takes into account all of the stages of an activity. The extraneous operations are removed, leaving just the required activities as part of the company.
- Elimination of bottlenecks
- Budgets for activity-based budgeting are created after extensive study and analysis. This analysis eliminates all of the business’s superfluous tasks. This removes any bottlenecks connected with an action, allowing business activities to run more easily.
- Business as a Unit
- This budgeting approach allows you to see the firm as a whole, rather than as a collection of divisions. Managers or senior management construct the budget for the whole company unit rather than just one department, as is the case with other budgeting techniques.
- Competitive Edge:
- An activity-based budgeting system removes all needless tasks, allowing the firm to save money. The decreased costs enable the production of products and services at a cheaper cost than rivals. It also allows the company to get a competitive advantage in the market.
- Issues and Limitations
- It is based on forecasting using past data and future expectations, which might be incorrect if the conditions or scenarios anticipated do not turn out to be as predicted, causing issues for the institution and its resources.
- It requires a well-groomed skilled team of persons who are specialists in identifying gaps and are equally proficient in reporting and using the essential tools since it is a complicated process on which the company’s orientation is based.
- Activity-Based Budgeting is a long and extensive process that involves a significant amount of time and resources from an institution, and focusing too much on analysis may be detrimental.
- Activity-Based Budgeting gives just supplementary information.
- While preparing an Activity Based Budget, the attention may shift to immediate and short-term outcomes, and the wider picture may be overlooked, resulting in long-term harm.
- Process
- The activity-based budgeting (ABB) approach is divided into three parts.
- Identify related activity. These cost drivers are the elements that generate income or costs for the firm.
- Determine the amount of units for each action. This number serves as the starting point for all computations.
- Determine the cost per unit of activity and multiply that figure by the activity level.