What is Activity‑Based Budgeting (ABB)?
– Activity‑Based Budgeting (ABB) is a budgeting method that builds the budget from the bottom up by estimating the planned volume of business activities and then assigning the cost of resources needed to perform those activities. In ABB, an “activity” is any repeatable task or process that consumes resources (for example: processing a sales order, running a production setup, or handling customer support calls). A cost driver is a measurable factor that causes or correlates with the cost of that activity (for example: number of orders, machine hours, or calls handled).
How ABB works — step‑by‑step
1. Map activities. List the major activities that generate costs across the business (order processing, invoicing, maintenance, etc.).
2. Measure resource consumption. For each activity, identify the resources consumed (labor hours, supplies, equipment time) and collect cost data for those resources.
3. Select cost drivers. Choose an appropriate driver for each activity that best explains changes in cost (e.g., orders processed, setup hours).
4. Calculate a driver rate. Compute cost per driver unit = total activity cost / total driver units.
5. Forecast activity volumes. Estimate the business volume for each driver for the budget period (how many orders, setups, machine hours you expect).
6. Build the budget. Multiply expected driver volume by the driver rate to produce the budgeted cost for each activity, then sum across activities to get the total budget.
7. Review and monitor. Compare actuals to the budgeted activity costs; refine driver choices and forecasts as needed.
Core formula
Budget for activity i = (Expected units of activity i) × (Cost per unit of activity i)
Three practical implementation phases (summary)
– Analysis: identify activities and drivers.
– Estimation: measure costs and forecast volumes.
– Consolidation & control: produce the budget, monitor variances, and update assumptions.
Short checklist for implementing ABB
– Obtain management buy‑in and define objectives (cost control, pricing support, process improvement).
– Inventory and map activities across departments.
– Collect historic resource‑cost data and choose plausible cost drivers.
– Calculate driver rates and run pilot calculations for a subset of activities.
– Forecast driver volumes for the budget period using operational plans.
– Build the activity‑based budget and compare it against the traditional budget.
– Implement monitoring: report driver volumes and costs monthly; adjust drivers and forecasts as needed.
– Keep the model manageable — prioritize high‑cost or high‑variance activities rather than every minor task.
Worked numeric example
Assumptions
– Company expects to process 50,000 sales orders next year.
– Historical analysis shows the cost to process one order is $2 (this is the driver rate).
Calculation
– ABB budget for order processing = 50,000 orders × $2/order = $100,000.
Comparison with a simple traditional approach
– Suppose last year’s budgeted order processing cost was $80,000 and management plans for 10% business growth.
– Traditional budgeted amount = $80,000 × (1 + 10%) = $88,000.
– Difference = $100,000 (ABB) − $88,000 (traditional) = $12,000. This highlights that ABB tied the budget to expected activity volume and per‑unit cost rather than simply inflating past numbers.
Advantages of ABB
– Tighter link between resources and operational drivers; budgets reflect expected workload.
– Helps identify inefficient processes and opportunities to reduce activity levels.
– Provides management with more detailed, actionable cost information for decision‑making.
Disadvantages and caveats
– Data‑intensive and more time‑consuming to set up and maintain than simple roll‑forward budgets.
– Requires good choices of cost drivers; poor driver selection can produce misleading budgets.
– Often requires additional assumptions and managerial judgment, which introduces potential errors.
– May be unnecessary in stable businesses with little change in activity patterns.
When ABB is most useful
– Organizations undergoing significant change (new products, locations, customers).
– Firms without reliable historical budgets or where past costs no longer represent future operations.
– Situations where understanding the operational cost drivers leads to better control or pricing decisions.
Assumptions to watch
– Linearity: ABB usually assumes cost changes are proportional to activity volume for a given driver; this may not hold for step costs or capacity constraints.
– Stable driver rates: driver rates can change if resource prices or processes change.
– Forecast accuracy: ABB is only as good as the activity volume forecasts.
Further reading (reputable sources)
– Investopedia — Activity‑Based Budgeting: https://www.investopedia.com/terms/a/abb.asp
– Corporate Finance Institute — What Is Activity‑Based Budgeting (ABB)?: https://corporatefinanceinstitute.com/resources/management/what-is-activity-based-budgeting/
– Harvard Business Review — Activity‑Based Costing That Makes Sense: https://hbr.org/2006/07/activity-based-costing-that-makes-sense
– AccountingTools — What Is Activity‑Based Budgeting?: https://www.accountingtools.com/articles/what-is-activity-based-budgeting.html
Educational disclaimer
This explainer is for educational purposes only and does not constitute individual financial, accounting, or investment advice. Use your organization’s data and professional judgement when applying ABB; consider consulting a qualified accountant or financial manager for implementation.