Definition: Activity-based budgeting is most often found in cost accounting. Managers prepare budgets and spending propositions based on past production activities. In other words, management examines the costs of performing certain activities, like bending a fender for a car, to budget the overall costs of producing a product.
This might be a little hard to think about without an example. Let’s assume there are two different setup stages to make a cell phone: machining and assembling. A managerial accountant would look at the total amount of cell phones that need to be produced, the number of cell phones in each batch, the setup time for both machining and assembling, as well as the hourly rate of each machinists and assemblers.
By looking at all of these different activities, the managerial accountant could come up with efficiencies in the production process that would save the company money.
What Does Activity Based Budgeting Mean?
Depending on the two activities, the company might be able to save money by increasing the batch production, reducing the production time, or even combining these two activities. As you can see, activity-based budgeting not only helps the company save money, it also forces management to examine every activity. By doing this, management can become extremely familiar with the production process as a whole. This kind of knowledge can lead to much more than cost savings.
Manufacturing and product innovations often result from knowing and understanding the production process. It only takes one person to look at the process differently. As you can see, activity-based budgeting should be important to any manufacturer.