Activity-based costing

OVERVIEW

What is it?

Activity-based costing is a methodology for defining an indicative budget on the basis of an activity schedule or plan (Activity-based budgeting (ABB) is the budget element of the broader activity-based management (ABM) concept and relates mainly to operational activities. In ABM, 'budget, management and reporting are treated as components of one single conceptual framework, based on common performance information' [European Commission, Analytical Fiche Nrº21, 'Activity Based Budgeting (ABB)]).  

What can it be used for?

ABC supports calculation of the budget of an intervention.

When can it be used?

ABC feeds into negotiations with implementing partners (when identified during the design phase) or instructions for the tendering procedure. During implementation, it is a management and monitoring tool.

Who can use it?

• EU staff for management and monitoring
• Implementing partners charged with carrying out planned activities and delivering results

What are its strengths?

• Directly linked to the intervention concept and expected results.
• Relatively precise; if the costs of items are known, there will be little deviation during implementation.

What are its limitations?

• ABC's precision relies on costing all activities in a detailed manner; it may be difficult to have a precise medium-term forecast in a country with a volatile political and economic environment.

PRACTICAL APPLICATION

Key elements

ABC entails defining the list of activities and types of inputs required (e.g. expertise, equipment/material, travel) and their related costs (defined by quantities and costs per unit). The indicative budget needs to be broken down by result and implementation modality; thus, it informs discussions with prospective implementing partners.
ABC can be accomplished using the following step-by-step approach.

Step 1: Set a resource schedule pro forma. For each activity identified, ensure that all resources/inputs required for that activity's accomplishment are provided for; enter these in a schedule/checklist. Do not overlook budgeting for management activities at this stage.

Step 2: Cost activity. Once the activity's components have been entered into the schedule, specify the resources needed to carry them out. Resources should be allocated to agreed cost categories or drivers (e.g. the activity of establishing a planning unit requires three categories/drivers: equipment, salaries and allowances). Estimates can be drawn from similar interventions and refined based on local market conditions, recent tenders, etc.

Step 3: Schedule costs. Costs are next scheduled by planning period (see Figure) using simple formulas to allocate the annual quantity by unit cost. Once total costs have been calculated, it is important to take note of recurring costs linked to maintenance of service provision.

Figure: Example of activity-based costing

Source: European Commission (2004), 'Aid Delivery Methods. Volume 1. Project Cycle Management Guidelines', Figure 38.

Requirements

Data/information. ABC relies on the chosen results chain and the indicative list of activities to be implemented. Information on these elements is a precondition to define what activities are going to be implemented and when.

Time. ABC has to be predefined at the formulation phase but needs to be revised regularly and updated as needed during implementation. The time devoted to these tasks will depend on the scope of the intervention.

Skills. A good knowledge of the intervention and its core components is needed to allocate resources wisely.

Facilities and materials. N/A

Financial costs and sources. N/A

Tips and tricks
Cost estimation translates plans into a financial reality check. Without proper budgeting, there is a risk the intervention may be overly ambitious, and implementation crippled by a lack of sufficient financial resources. For example, if there is no baseline, the budget should include resources to finance it.

RESOURCES

Where to find it

The European Commission, 2004. Aid Delivery Methods. Volume 1. Project Cycle Management Guidelines. Chapter 5.4. Activity, resource and cost schedule (Pages 90-91).

Complementary guides, methodologies and tools

N/A