2.4 Features of Zero-base Budgeting
To implement zero-base budgeting, the following processes are involved:
- Activities of a company are to be divided into decision packages. A package contains information describing the activity;
- Each activity is evaluated and ranked on cost benefit basis. The information contained in the decision packages are sufficient to enable a manager to evaluate the activity and to compare and rank it on the cost benefit basis; and
- Resources are then allocated (Das 2001).
2.5 Activity Based Budgeting (ABB)
Activity based budgeting involves analysing the products, identifying the activities required to produce and sell the products and budgeting the resources needed to carry out the activities of making and selling the products. Budgets are prepared for each activity. Activity based budgeting places emphasis on the outputs from the budgeted resources inputs (Das 2001). Das (2001) indicated that activity based budgeting aims to control activities that drive costs, and plan and control activities to meet customer needs.
2.6 Characteristics of Activity Based Budgeting
Activity based budgeting emphasizes on budgeting activities rather than budgeting cost elements and it provides a link between budgeting and corporate strategy (Das 2001). Das (2001) also stated that activity based budgeting justifies budget allocation on the basis of activities required to make and sell the products and it also emphasizes on control of cost drivers. Besides that, it provides allocation to activities and not to departments or cost centres (Das 2001).
2.7 Steps in Activity Based Budgeting
Das (2001) asserted that activity based budgeting involves a number of steps:
- Set corporate objectives. Translate them into strategies.
- Prepare planning guidelines based on corporate objectives.
- Carry out activity analysis. Identify cost drivers (quantitative and qualitative) estimate volume.
- Calculate cost rates for the activities.
- Calculate revenue based on quantity, margin and price.
- Consolidate estimates into budget forecasts and budget proposals.
- Implement the budgets. The budgets are now called the activity-based budgets.
- Monitor, compare and report performance.
2.8 Strengths and Weaknesses of Budget Models
According to ACCA study text, the following table shows the strengths and weaknesses of activity based budgeting and zero base budgeting.
3.0 Differences and Similarities between Zero Base Budgeting and Activity Based Budgeting
3.1 Similarities between Zero Base Budgeting and Activity Based Budgeting
Activity based budgeting - It requires you to establish all activities that incur costs in each function of your business and then define the relationships between those activities. The information you get will guide your decision on how much resource you should allocate to each activity.
By contrast, in zero-based budgeting, every department function is reviewed comprehensively and all expenditures must be approved, rather than only increases. Zero base budgeting requires the budget request justified in complete detail by each division manager starting from the Zero-base. The Zero-base is indifferent to whether the total budget is increasing or decreasing.
Both zero base budgeting and activity based budgeting require managers to perform critical assessment of the various tasks and activities carried out within an organization in order to determine whether or not they should be continued. Both budgets must be justified each new period and not only to justify increases over the previous year budget and what has been already spent is automatically sanctioned.
In activity based budgeting, different activity levels can be used to provide the foundation or base and incremental decision packages (descriptions of specific organizational activities), which are used in ZBB to rank activities on order of priority against other activities.
The reviews of activity based budgeting and zero base budgeting are carried out frequently. Both of the budgets are time consuming and costly to justify on an annual basis.
It is worth nothing that some writers treat activity based as more of a philosophy than a technique attribute to all the good features of a number of new or not so new ideas including zero base budgeting.
3.2 Differences between Zero Base Budgeting and Activity Based Budgeting
Activity based budgeting considers all of an organization’s activities whereas zero base budgeting tends to focus on discretionary costs such as advertising and training.
Zero base budgeting starts the budget with a zero base in a new period and it allows no activities or functions to be included in the budget unless managers can justify their needs while activity based budgeting starts with the budgeted output and segregates costs required for the homogeneous cost pools (Blocher 2008).
Every department function is reviewed comprehensively and all expenditures must be approved, rather than only increases. Zero base budgeting requires the budget request justified in complete detail by each division manager starting from the Zero-base. The Zero-base is indifferent to whether the total budget is increasing or decreasing. Besides that, zero base budgeting allocates resources based on needs and benefits while activity based budgeting allocates resources based on
4.0 Traditional Budgeting vs. Participative Budgeting
4.1 Traditional Budgeting
Figure 1: Traditional Budgeting
Source: http://www.principlesofaccounting.com/chapter%2021.htm
4.1.1 Disadvantages of Traditional Budgeting
According to Budgeting and Costing (Anon 2004), allocation of traditional budgeting appears to be subjective and it assumes the more money invested, the higher the quality it will be and vice versa. It also reviewed that traditional budgeting can be disadvantageous in four aspects - cost pools, allocation base, decision support and implementation as follows:
Cost pools – based on fund accounting systems designed for compliance, accumulates costs into heterogeneous cost pools, costs in each pool are the costs of many major processes and generally not caused by a single factor.
Allocation base - inability to assign overhead type costs and no mechanism to determine actual cost of an output.
Decision support – input driven, cost control is a departmental exercise rather thana cross functional effort, decisions are not based on cost of output.
Implementation – relatively inexpensive to implement and maintain, can produce plethora of reports which can be understood only by accountants.
Traditional forecasting practices are operated on the basis of predetermined maximum spending limits, and are normally characterized by the need to re-write the business plan to fit expenses. The traditional process focuses on what managers are allowed to spend, and not the resources they actually need to add value to their business. Thus, the traditional budget process fails to identify waste, does not identify the incoming workload, does not support continuous improvement, does not identify cost drivers, and appears to have a general lack of ownership and buy-in. Other criticisms of the traditional budgeting process are that it is extremely time-consuming for the benefits achieved, it results in arbitrary cost increases or reductions, and it focuses on resource inputs instead of the outputs generated by those inputs. The true cost of producing a product caused by complex overhead activities such as research, marketing, human resources are simply not captured or measured with traditional methods. Indeed, traditional methods typically under cost low volume but complex products and over cost high-volume products (Anon 2007).
According to Luecke (2004) upper management may be out of touch with the realities of the individual divisions’ production processes or markets. As a result, the goals they set may be inappropriate or unattainable (Luecke 2004). Due to the dictatorship of traditional budgeting, middle managers and employees may feel left out of the decision-making process and consciously or unconsciously, may not fully participate in achieving the budgeted goals (Luecke 2004). According to () traditional budgeting assumes that the activities and methods of working will continue in the same way hence it fails to take into account changing circumstances. It also stated that as it is merely a marking up the previous year budget, it is too simple a method where it does not provide incentive for employees to develop new ideas or to innovate. It also encourages spending up to the budget so that the budget is maintained next year (). The web stated that, with this spend it or lose it mentality, cost cannot be reduced. It reviewed that the budget may become out of date and no longer relate to the level of activity or type of work being carried out and the priority for resources may have changed since the budgets were set originally. The webpage also indicated that there may be budgetary slack built into the budget, which is never reviewed-managers might have overestimated their requirements in the past in order to obtain a budget which is easier to work to, and which will allow them to achieve favorable results.
4.1.2 Advantages of Traditional Budgeting
One disadvantage of the top-down approach is that lower-level managers may view the budget as a dictatorial standard. Resentment can be fostered in such an environment. Further, such budgets can sometimes provide ethical challenges, as lower-level managers may find themselves put in a position of ever-reaching to attain unrealistic targets for their units.
On the positive side, top-down budgets can set a tone for the organization. They signal expected sales and production activity that the organization is supposed to reach. Some of the most efficient and successful organizations have a hallmark strategy of being “lean and mean.” The budget is a most effective communication device in getting employees to hear the message and perform accordingly.
4.2 Participative Budgeting
Figure 2: Participative Budgeting
Source: http://www.principlesofaccounting.com/chapter%2021.htm
4.2.1 Advantages of Participative Budgeting
Participative budgeting is a budgeting system in which all budget holders are given the opportunity to participate in setting their own budgets and it also be referred to as bottom-up budgeting (Scarlett 2007). According toParticipative Budgeting or Self-imposed Budgeting (Anon 2008) managers at all levels participate and coordinate with each other in budgeting. The author indicated that it contrasts with imposed or top-down budgets where the ultimate budget holder does not have the opportunity to participate in the budgeting process. With participatory budgeting, the people responsible for achieving the budget goals are included in goal setting (Luecke 2004). Luecke (2004) indicated that for instance, it would develop the budget for his own division with the active participation of the heads of purchasing, human resources, production, marketing and administration. People who are closest to the line services can make a good budget decision since they are familiar with all the functions and needs (Luecke 2004). He also asserted that participants in participative budgeting are more likely to make extra effort to achieve the budgeted goals. According to Scarlett (2007) the advantages of participative budgeting are as follows:
-
Imposed quality of forecasts to use as the basis for the budget: Managers who are doing a job on a day-to-day basis are likely to have a better idea of what is achievable, what is likely to happen in the forthcoming period, local trading conditions and so on.
-
Imposed motivation: Budget holders are more likely want to work to achieve a budget that they have been involved in setting themselves rather than one that has been imposed on them from above.
According to (), participative budgeting is advantageous as during the transferrals of information from the subordinate to superior it increases the job satisfaction for the subordinate, budgetary responsibility and goal congruence. It also indicated that since transferral of information is from the subordinate to the superior, the information transferred is likely to be more accurate and reliable as the subordinate has direct contact with the activity and there is in the best position to make budget estimates. With participatory budgeting, the people responsible for achieving the budget goals are included in goal setting (Luecke 2004). For instance, it would develop the budget for his own division with the active participation of the heads of purchasing, human resources, production, marketing and administration (Luecke 2004). Moreover, it helps for the setting of realistic goals through a better understanding of how goals can be achieved and it ensures that important issues are considered and employees understand the importance of their roles in meeting organizational goals; provides good opportunity for problem solving and fosters commitment to agreed-upon goals (Tee 2007). According to Luecke (2004) people who are closest to the line services can make a good budget decision since they are familiar with all the functions and needs and participants in participative budgeting are more likely to make extra effort to achieve the budgeted goals.
4.2.2 Disadvantages of Participative Budgeting
According to () on the negative side of the equation, a bottom-up approach is generally more time consuming and expensive to develop and administer. It also reviewed that this occurs because of the iterative process needed for its development and coordination and another potential shortcoming has to do with the fact that some managers may try to pad their budget, giving them more room for mistakes and inefficiency.
5.0 Conclusion
Activity based budgeting and zero base budgeting reverse the techniques of traditional budgeting which emphasizes on increases or make adjustment for the inflation of that new period. Activity based costing and zero base budgeting require managers to perform critical assessment of the various tasks and activities carried out within the organization in order to make a good budget. Although zero base budgeting and activity based budgeting are well accepted by the modern business world, it still has some weaknesses that can not be avoided such as time consuming and costly.
We can see that, activity based budgeting and zero base budgeting is leaning towards participative budget but to make a good budget it still has to depend on many factors such as the size of the organization and etcetera. Tradition budgeting has got a lot criticism from the modern business world but still it is preferred by some of the organization which shows that a good budget may have the combination of traditional budgeting and participative budgeting. The advantages and disadvantages of participative budgeting and traditional budgeting reflect the weaknesses of traditional budgeting can be covered by using participative budgeting and vice versa.
