# Activity Based Budget (ABB)

The activity based budget is the method which management prepares annual budget base on next year’s activity. It is depended on the activities based costing, which analyzes all variable and overhead costs associate with activities, the non-value added cost will not be included.

It is the management accounting tool that does not consider the history data in prior years. The budget needs to build from scratch, the cost will be changed base on the activities.

It includes the usage of activities level to determine the appropriate amount of resource need, how the resource is managed, and the proper explanation of any different from the budget.

## Example of Activity Based Budget

Company A produces product X which involves setup and assembling process. The detailed cost can see as below:

• Direct material \$ 5 per unit
• Direct Labor \$ 10 per unit.

Based on the activity based costing, the cost driver of setup and assembling process can identify as follows:

The setup drive by the number of setup time, base on experience the one setup cost \$ 2,000, and it requires one setup after 5,000 units of production. The assembling process will depend on the number of batches. It cost \$ 3,000 per batch that consists of 1,000 units.

The company plan to produce 500,000 units of products next year, please use the activity base budget to prepare the budget.

First, we need to calculate the overhead cost which requires to produce a unit of product X.

• Setup cost = \$ 2,000/5,000 units = \$ 0.4 per unit
• Assembling cost = \$3,000 /1,000 units = \$ 3 per unit

The budget for both variable and overhead cost:

Description Cost per unit Production units Total cost
Direct Material \$ 5 500,000 units 2,500,000
Direct Labor \$ 10 5,000,000
Setup Cost \$ 0.4 2,000,000
Assembling \$ 3 1,500,000

Note: sometimes, the cost driver cannot separate into the individual unit as it needs to complete as one-time work. So we can calculate the number of cost drivers require to achieve the target. Then we can multiply the number of cost drivers with its cost.

Principle of Activity Based Budget
Control cost driver, not cost ABB tries to control the cost driver rather than the cost itself. A cost driver is a factor that limits the cost, so if we can manage it mean we can manage the total cost. It helps the company to understand deeply in each cost category and be able to reduce. The manager also aware of the impact when each cost driver change.
Reduce non-value-added activities Not all activities have the same value to the company and customer. We need to rank them based on their value, non-value-added activities should be decreased.
Beyond control of each department The activities will be driven by the need of a whole company, so it is not under the control of each department.
Flexible Each activity and cost driver will analyze every year in order to respond to any change which aims to reduce cost without impact on quality.