Incremental Budgeting: Session 2 Types of Budgets & Usages of The Budgetary System

Session 2
Types of budgets & Usages of the budgetary system
Incremental Budgeting
Incremental budgeting is a method of budgeting in which next year's budget is prepared by
using the current year's actual results as a starting point, and making adjustments for expected
inflation, sales growth or decline and other known changes.
Relatively straightforward way of preparing a budget.
But is an inefficient form of budgeting, as it encourages slack and wasteful spending to creep
into budgets.
Fixed budgets
A fixed budget is a budget which remains unchanged throughout the budget period, regardless
of differences between the actual and the original planned volume of output or sales.
The budget is prepared on the basis of an estimated volume of production and an estimated
volume of sales, but no plans are made for the event that actual volumes of production and
sales may differ from budgeted volumes.
When actual volumes of production and sales during a control period (month or four weeks or
quarter) are achieved, the budget is not adjusted or revised (in retrospect) to the new levels of
activity.
Flexible budgets
A flexible budget is a budget which, by recognising different cost behaviour patterns, is changed
as the volume of output and sales changes. It recognises cost behaviour patterns such as
changes in salesrevenue and variable costs as sales volumes change, and step changes in fixed
costs as activity levels rise or fall by more than a certain amount.
Flexible budgets may be used in one of two ways.
1. At the planning stage.
2. Retrospectively.
Zero based budgeting

Zero based budgeting involves preparing a budget for each cost centre or activity from a zero
base. Every item of expenditure has then to be justified in its entirety in order to be included in
the next year's budget.
Managers do not have to budget from zero, but can start from their current level of
expenditure and work downwards
The basic approach of ZBB has three steps.
Step 1: Define decision packages (Mutually exclusive packages or Incremental packages)

Step 2: Evaluate and rank each activity (decision package).
Step 3: Allocate resources
The advantages of implementing ZBB
 It is possible to identify and remove inefficient or obsolete operations.

 It forces employees to avoid wasteful expenditure.
 It can increase motivation of staff by promoting a culture of efficiency.
 It responds to changes in the business environment.
 ZBB documentation provides an in-depth appraisal of an organisation's operations.
 It challenges the status quo.
 In summary, ZBB should result in a more efficient allocation of resources.
The limitations of implementing ZBB

 zero based budgeting is the enormous extra volume of paperwork created and the extra
time required to prepare the budget.
 Short-term benefits might be emphasised to the detriment of long-term benefits.
 The organisation's information systems may not be capable of providing suitable
information.
 It may call for management skills both in constructing decision packages and in the
ranking process which the organisation does not possess.
 The ranking process can be difficult. Managers face three common problems.
Reading: Using zero based budgeting.

Activity based budgeting
Activity based budgeting involves defining the activities that underlie the financial figures in
each function and using the level of activity to decide how much resource should be allocated
and how well it is being managed and to explain variances from budget.
ABB is therefore based on the following principles.
1. It is activities which drive costs and the aim is to plan and control the causes (drivers) of
costs rather than the costs themselves, with the result that in the long term costs will be
better managed and better understood.
2. Not all activities add value, so activities must be examined and split up according to their
ability to add value.
3. Most departmental activities are driven by demands and decisions beyond the
immediate control of the manager responsible for the department's budget.
4. Traditional financial measures of performance are unable to fulfil the objective of
continuous improvement. Additional measures which focus on drivers of costs, the
quality of activities undertaken, the responsiveness to change, and so on are needed.
Benefits of ABB
a. Different activity levels will provide a foundation for the 'base' package and incremental
packages of ZBB.
b. It will ensure that the organisation's overall strategy and any actual or likely changes in
that strategy will be taken into account, because it attempts to manage the business as
the sum of its interrelated parts.
c. Critical success factors will be identified and performance measures devised to monitor
progress towards them
d. Because concentration is focused on the whole of an activity, not just its separate parts,
there is more likelihood of getting it right first time.

Incremental Budgeting: Session 2 Types of Budgets & Usages of The Budgetary System

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Incremental Budgeting: Session 2 Types of Budgets & Usages of The Budgetary System

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Session 2

Types of budgets & Usages of the budgetary system

Zero based budgeting

The basic approach of ZBB has three steps.

Step 1: Define decision packages (Mutually exclusive packages or Incremental packages)

The advantages of implementing ZBB

 It is possible to identify and remove inefficient or obsolete operations.

The limitations of implementing ZBB

Reading: Using zero based budgeting.

ABB is therefore based on the following principles.

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