Budgeting Systems in Accounting

Zero Based budgeting

This method of budgeting has a principle that the budget of each cost Centre should be justified from scratch. Every item of expenditure worthwhile must be justified in its entirety. It assumes that this year’s activity will not continue in the same way for next year. Therefore every item of expenditure must be justified before it can be included in next year’s budget.

Advantages of a zero based budgeting system

• Inefficient and obsolete operations, activities or expenditure items can be easily identified for removal.
• It compels workers to avoid wasteful expenditure
• It encourages or enhances motivation
• It provides an in depth assessment (appraisal) of the firm’s operations in all activity areas.
• It challenges the status quo (meaning as it is)
• It returns a more efficient and beneficial allocation of scarce resources
• It responds to changes in any dynamic business environment

Disadvantages of a Zero based budgeting system

• It is time consuming
• It is cumbersome
• The short benefits might be emphasized to the detriment of long term benefits
• It requires perfect information system
• The ranking process might be difficult
• It might be difficult to rank expenditure items with quantitative benefits. Eg sponsoring community college inter house sport, spending on staff welfare, sales promotion etc.

Use of Zero based budgeting

Zero based budgeting is particularly useful for discretionary cost and for rationalization purposes. It is not useful for direct cost because they are budgeted by using standard costing, work study and planning and control techniques. It can also be applied successfully in service industry and not for profit organization.

Rolling Budget

These are budget that are updated continuously by adding a further period (one month, one quarter) and deducting the earliest period. The budget will be prepared for the year but only the first month will be the fully prepared budget while the other months or quarters will be prepared in skeletal manner. Towards the end of implementation of the 1^st month or quarter budget, the subsequent months or quarter budget will be prepared based on the experience of the previous month or quarter.

Incremental Budget: It is a budgeting system whereby the budget for the next period or year is based on the current year’s result plus an extra amount for estimated growth or inflation in the coming year e.g.  if raw materials this year was actually N70 million, the  budget for next year could be prepared to be N70M + (10% X 70m) = N77m.

Advantages of Rolling Budget  

• A quick and easy method of budgeting
• Suitable for organizations that operate in stable environment where historic figures are constant and do not change significantly.
• Ijt is appropriate for admin cost such as sales, entertainment and advert etc.

 

Disadvantages of Rolling Budget

• Encourages slacks and wasteful spending to creep into the budget
• It carries over previous problems and and inefficiency
• Manager may spend for the sale of spending in other to use up their budget allocation.
• Uneconomic activities may be continued next year.

Incremental budgeting in the public sector

The public sector always adopts the traditional approach to budgeting. The public spending establishes an annual cycle of year on year incremental bids rather than justifying from the scratch.

Activity Based Budgeting

Activity Based Budgeting identifies the activities carried out in an organization. It will then establish the cost drivers and prepare the budget based on the activities and the cost drivers.

Advantages of Activity Based Budgeting

• Different activity level will provide the fundamental basis on budget preparation either by incremental approach or Zero based budgeting.
• Overall strategies or any change in strategies can be easily accommodated in the budget
• Critical success factors can be identified and performance measures designed to monitor progress towards them.
• Because cost concentration is focused on whole of an activity. It is possible to get it right at the first trial.
• Cost can be easily controlled since the budget is based on activities and cost drivers
• It responds to changes of the dynamic nature of the business environment.

Disadvantages of Activity Based Budgeting

• It is not all cost drivers that can 100% explain the behavior pattern of the cost of some activities.
• The cost pool of an activity may not be easy to identify especially incidental cost.
• It may not be easy to prepare Activity Based Budgeting on monthly basis because of fluctuations e.g. increase in purchase orders due to increase in sales volume.

Recommended Reading

Ray Garrison., Managerial Accounting, 14th Edition

Mark P. Holtzman., Managerial Accounting For Dummies