Question

Explain the step in constructing an incremental budget and why one should be employed. Explain the strengths and weaknesses of an incremental budget and how a manager can unnecessarily increase or pad his or her budget?

Answer 1

An incremental budget prepared using a previous period's budget or actual performance taken as baseline with incremental amounts subsequently added for the new period.

• The allocation of resources is based upon allocations done in the previous period.

• In this budgeting approach, we have to utilize the budget for the current period to project the future budget amounts.

• With no standard formula prevalent to determine the applicable marginal changes, the changes are determined using assumptions for the incremental changes.

This budgeting method is simplistic and easy to apply with consistency over period of time requiring less assumptions and may be appealing to few companies being a conservative approach.

STRENGTHS OF INCREMENTAL BUDGETING

• This method of budgeting is very easy to implement and does not entail any complex calculations.
• Incremental budgeting ensures continuity of funding for the departments without much detailed analysis of funding requirement.
• With this type of budgeting, a company is likely to have stable budgets year on year.
• Incremental budgeting is been used by companies to build the value of equality among departments providing similar amount of increase over previous year.
• This method is suitable for companies with relatively fixed funding requirements.

LIMITATIONS OF INCREMENTAL BUDGETING

• In practicality, there may be structural changes with respect to the company or industry which may necessiate much more significant budget changes which is difficult to factor in this method.
• This managers may tend to spend more as budgets may be easily available and may lead to unnecessary spending of funds which may not be warranted.
• This method suffers from lack of innovation and there is not much incentive for managers to reduce the cost.
• Incremental budgeting subconsciously encourages higher spending so that the budget is maintained next year.
• Incremental budgeting may lead to budgetary slack, whereby managers tend to build lower revenue growth and higher expense growth so as to have favorable variances