Zero Based Budgeting (ZBB)

After a budgeting system has been in operation for some time, there is a tendency for next year's budget to be justified by reference to the actual levels being achieved at present. In fact, this is part of the financial analysis discussed so far, but the proper analysis process takes into account all the changes, which should affect the future activities of the company. Despite using such an analytical base, some businesses find that historical comparisons and particularly the current level of constraints on resources can inhibit truly innovative changes in budgets. This can cause a severe handicap for the business because the budget should be for the first year of the long-range plan. Thus, if changes are not initiated in the budget period, it will be difficult for the business to make the essential progress of accomplishing longer-term objectives.

One way of breaking out of this cyclical budgeting problem is to go back to basics and develop the budget from an assumption of 'no existing resources', i.e. a zero base. This means all resources will have to be justified and the chosen way of achieving any specified objectives will have to be compared with the alternatives. For example, in the sales area, the current existing field sales force will be overlooked (for assumption purpose) and the optimum way of achieving the sales objectives in that particular market for the particular goods or services will be developed. This might not include any field sales force or a different-sized team and the company then has to plan how to implement this new strategy.

The obvious problem of this zero-base budgeting process is the massive amount of managerial time needed to carry out the exercise. Hence, some companies carry out the full process every five years. However, the downside is that in that year, the business can almost grind to a halt. Thus, an alternative way is to take an in depth look at one area of the business each year on a rolling basis, so that each sector does a zero base budget every five years or so.

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Study Notes

Assessment

1. What is Zero-based Budgeting?

Discussion

1. Discuss the importance of Zero-based Budgeting in Budgetary control.

4.12 Summary

FINANCIAL ACCOUNTING Financial accounting is the principle source of information for decisions on how to allocate resources among companies; management accounting is the principle source of information for decisions of how to allocate resources within a company.

MANAGEMENT ACCOUNTING Management Accounting provides information that helps managers to control activities within the firm and to decide what products to sell, where to sell them, how to source those products and which managers to entrust with the company’s resources.

198 Accounting for Managers PLANNING A process meant for the purpose of accomplishment; a blueprint of business growth and a road map of development; helps in fixing objectives both in quantitative and qualitative terms.

PERFORMANCE EVALUATION Evaluating the profitability of individual products and product line; determining the relative contribution of different managers and different parts of the organisation; in not-for-profit organisations, evaluating the effectiveness of managers, departments and programs

BUDGETARY CONTROL

• It is a control technique whereby actual results are compared with budgets.

• Any differences (variances) are made the responsibility of key individuals who can either exercise control action or revise the original budgets.

BUDGET

• A formal statement of the financial resources is reserved for carrying out specific activities in a given period of time.

• It helps to co-ordinate the activities of the organisation.

Following are the steps to remember at the time of preparing budget

• Selecting a budget period

• Setting or ascertaining the objectives

• Preparing basic assumptions and forecasts

• Understanding the need to consider any limiting factor

• Finalizing forecasts

• Implementing the budget

• Reviewing forecasts and plans

TYPES OF BUDGET

• Sales budget

• Production budget

• Purchase budget

Accounting for Managers 199

• Labour budget

• Cash budget

• Master Budget

VARIANCE

A difference between the actual cost of an item and its budgeted cost may be due to one or both of these factors. Apparent similarity between budgeted and actual costs may conceal significant compensating variances between price and usage.

ZERO BASED BUDGETING

After a budgeting system has been in operation for some time, there is a tendency for next year's budget to be justified by reference to the actual levels being achieved at present. In fact, this is part of the financial analysis discussed so far, but the proper analysis process takes into account all the changes, which should affect the future activities of the company. Despite using such an analytical base, some businesses find that historical comparisons and particularly the current level of constraints on resources can inhibit truly innovative changes in budgets. This can cause a severe handicap for the business because the budget should be for the first year of the long-range plan. Thus, if changes are not initiated in the budget period, it will be difficult for the business to make the essential progress of accomplishing longer-term objectives.

4.13 Self-Assessment Test

Broad Questions

1. Compare Financial and Management Accounting with examples.

2. What is budgetary control? Explain various types of budgets.

3. What are the steps involved in budgeting?

Short Notes

a. Advantages of budgetary control b. Scope of Management accounting c. Master Budget

d. Zero-based Budgeting e. Variances

200 Accounting for Managers Exercise 4.1 Budgeting I

Draw up a cash budget for D. Shitole showing the balance at the end of each month, from the following information provided by the firm for the six months ended 31 December 19X2.

Cash against sales is received after 3 months following the sales.

• Production in units: 240 270 300 320 350 370 380 340 310 260 250

• Raw materials cost Rs5/unit. Of this, 80% is paid in the month of production and 20%

after production.

• Direct labour costs of Rs.8/unit are payable in the month of production.

• Variable expenses are Rs.2/unit. Of this, 50% is paid in the same month as production and 50% in the month following production.

• Fixed expenses are Rs. 400/month, payable each month.

• Machinery costing Rs. 2,000 to be paid for in October 19X2

• Will receive a legacy of Rs. 2,500 in December 19X2

• Drawings to be Rs.300/month

4.14 Further Reading

1. Contemporary Issues in Management Accounting, Alnoor Bhimani, Oxford University Press, 2006

2. Management Accounting Best Practices: A Guide for the Professional Accountant, Steven M. Bragg, Wiley, 2007