Activity Based Budgeting

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

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.

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.Activity based Budgeting
  • 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.

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.


Last updated on : July 13th, 2017
What’s your view on this? Share it in comments below.

Leave a Reply

Traditional Budgeting
  • Limitations of Budgeting
    Limitations of Budgeting
  • Variance Analysis
    Variance Analysis
  • Material Variance
    Material Variance
  • Variance Analysis Types
    Variance Analysis Formula with Example
  • Subscribe to Blog via Email

    Enter your email address to subscribe to this blog and receive notifications of new posts by email.

    Join 122 other subscribers

    Recent Posts

    Find us on Facebook

    Related pages

    asset based loan agreementliquidity ratio formula for banksinventory turn ratio formuladays in receivables formulawhats a current assetwhat is global depository receiptpayback period advantages and disadvantagesequit definitiondifference between financing and leasinghow to calculate stock price with dividendretention rationwhat is preference share capitalroce ratio definitiondividend growth model assumptionscost accountant definitiondecoupling function of inventorystock turnover ratio analysis interpretationfinance lease or operating leasedefinition accountancysources of finance factoringhow to calculate paybackdebits and creditcredit vs debit in accountingcalculate hurdle ratefeatures of retained earningsexamples of fixed expenses and variable expensesddm financecreditworthiness letterrelevance of dividend policydefine debitedadvantages and disadvantages of forward contractscvp analysis break even pointconfirmed documentary creditexample irr calculationweighted average cost of capital calculatoradvantages and disadvantages of credit salesdividend discount model assumptionsimpairment of assets ifrsfactoring arrangementconcept of factoringdefine fixed asset turnoverebit depreciationdefine acid test ratiobank debits and creditsbudgetary slack definitionbudgetary control definition wikipediabond and debenturerelative valuation modelinventory turnover ratio by industryhindi meaning of ascertaincapital rationinglimitation of profit maximizationirr forumladefine weighted average cost of capitalliabilities in hindibanking covenantmirr financeis land a tangible assetliquidity ratio calculation formulainvestment appraisal npvmeaning of scrip dividendbanking covenantshindi meaning of budgetmeaning hypothecationresidual claim on assetscurrents assetsdefinition of transaction exposurethe accounting equation is expressed asshareholders equity calculationtypes of bank guaranteespayback calculationprofitability ratios examplesmaximization of shareholder wealthhow to interpret epsmeaning of external commercial borrowingmarginal costing and decision makingdouble entry system advantages and disadvantages