Question

Pretorious Manufacturing has just hired a new controller, Diana Metcalf. During her first week on the job, Diana was asked to establish a budget for operating expenses for next year. Since Diana was not yet familiar with the operations of Pretorious Manufacturing, she decided to budget these expenses using the same procedures as the prior controller. Therefore, in order to establish a budget for operating expenses, Diana started with actual operating expenses incurred in this year and added 4.3 percent. Diana based this percentage on inflation as measured by the consumer price index.

Comment on the effectiveness of Diana’s budgeting strategy.

Answer 1

This type od budgeting is called incremental budgeting,which implies that what is already being spent is automatically being sanctioned.

Diana could have alternatively used zero base budgeting,whereby all activities are reevaluated each time the formulation of budgets takes place.All expenditures, not only the increases,need to be justified afresh each time budgets are prepared.

Pros of zero base budgeting:
a)Resources are allocated by need and benefit leading to a more efficient allocation of resources
b)Identification and elimination wastage and redundant activities
c)Questioning of the current practices is encouraged each time a fresh budget is prepared.
d)It leads togreater involvement by the staff in the budgeting exercise,thereby enhancing employee motivation and morale.
e)Communication and coordination within the organization are improved

Cons of zero base budgeting:
a)Costs involved in preparing the decision packages can be very high, specially so for a large firm
b)Time consuming
c)A degree of subjectivity may be involved in ranking of decision packages and allocation of resources
d) Managers might feel insecureby zero based budgeting,and as such may oppose new ideas and changes