Question

Budgeting has a number of different purposes including: Planning; Control; Performance evaluation; Motivation. Some managers believe that zero-based budget is more beneficial than other types of the budget for firms.’

Required:

Critically discuss the above statement with reference to academic literature. In your discussion, you should refer to the budgeting systems you learned in this module.

Answer 1

Meaning of Budgeting:

Budgeting is the process of designing, implementing and operating budgets. It is the managerial process of budget planning and preparation, budgetary control and the related procedures. Budgeting is the highest level of accounting in terms of future which indicates a definite course of action and not merely reporting.It is an integral part of such managerial policies as long-range planning, cash flow, capital expenditure and project management. It must be remembered that budgeting is not forecasting. It is true that budgeting does involve some sort of forecasting particularly in the area of sales budget. But the process is physically one of detailed analyses and planning not merely prognosticating future results.

BUDGETING SYSTEM:

The process of preparing and using budgets will differ from organisation to organisation.However, there are a number of key requirements in the design of a budgetary planning and control process.

Co-ordination: Budgets provide a means of co-ordination of the business as a whole. in the process of establishing budgets, the various factors like production capacity, sales possibilities, and procurement of material, labour, etc. are balanced and co-ordinates so that all the activities proceed according to the objective. For this purpose a budget committee is formed which includes all the departmental heads together to solve a common problem.

Participative budgeting: Participative budgeting is known as ‘bottom-up budgeting’. It contrasts with imposed or top-down budgets where the ultimate budget holder does not have the opportunity to participating in the budgeting process.

Identification of the principal budget factor: The principal budget factor is the factor that limits the activities of functional budgets of the organisation. The early identification of this factor is important in the budgetary planning process because it indicates which budget should be prepared first.In general sales volume is the principal budget factor.sales budget must be prepared first, based on the available sales forecasts. All other budgets should then be linked to this.Alternatively, machine capacity may be limited for the forthcoming period and thereforemachine capacity is the principal budget factor. In this case the production budget must be prepared first and all other budgets follow it.Failure to identify the principal budget factor at an early stage could lead to delays later on when managers realize that the targets they have been working with are not feasible.In case of one limiting factor, we shall need to apply the concept of Marginal costing. In this we initially allot the limiting resource on the basis of highest contribution per limiting factor.

How to identify the principle budget factor:

In case of single product organization, Steps to follow:

1. Identify the capacity of the production departments. Generally normal capacity is consider for budget / estimation. Capacity of a department is defined as facility available for work & generally expressed in terms of labour hour, machine hour or unit. There are 4 different expression of capacity.

Maximum Capacity: Maximum No. of Days in a period x No. of Workers x Hrs/Days.

Practical Capacity: Maximum Capacity — Sunday & Statutory holidays & Normal Maintenance & Idle time.

Normal Capacity: It is the average of the last 3-year of normal performance if there is any abnormal is any abnormal data don’t consider in the computing the average.

Actual Capacity: It can be determined only at the end of the period. So it has no importance for preparation of budget.

2. Maximum production in a dept. = Normal Capacity + Time per unit

3. Select the minimum production volume among the above results. The dept. producing that result is known as bottleneck among the production department.

4. Identify the sale or demand of the product.

5. Now by comparing the above 2 steps we can identify the principle budget factor.

In case of multi product organization:

1. Sale / Demand is the Principle Budget Factor

2. Capacity is in short supply or Limiting Factor i.e. capacity requirement according todemand is more than its supply

-Only one limiting factor

-More than one limiting factor- the technique of linear programming is applied.

ZERO BASED BUDGETING:

ZERO BASED BUDGETING is defined as ‘a method of budgeting which requires each cost element to be specifically justified, as though the activities to which the budget relates were being undertaken for the first time. Without approval, the budget allowance is zero’.

Zero — base budgeting is so called because it requires each budget to be prepared and justified from zero, instead of simple using last year's budget as a base. Incremental level of expenditure on each activity is evaluated according to the resulting incremental benefits. Available resources are then allocated where they can be used most effectively. Zero based budgeting is a decision oriented approach .In Zero Based budgeting no referenceis made to previous level expenditure. Zero based budgeting is completely indifferent towhether total budget is increasing or decreasing.

Characteristics of Zero-base budgeting:

• Manager of a decision unit has to completely justify why there should be at all any budget allotment for his decision unit. This justification is to be made a fresh without making reference to previous level of spending in his department.
• Activities are identified in decision packages.
• Decision packages are ranked in order of priority.
• Packages are evaluated by systematic analysis.
• Under this approach there exist a frank relationship between superior and subordinates. Management agrees to fund for a specified service and manager decision of the decision unit clearly accepts to deliver the service.
• Decision packages are linked with corporate objectives, which are clearly laid down.
• Available resources are directed towards alternatives in order of priority to ensure optimum results.

Traditional Budgeting vs Zero- based budgeting:

Following are the points of difference between traditional budgeting and zero based budgeting:

• Traditional budgeting is accounting oriented. Main stress happens to be on previous level of expenditure. Zero-based budgeting makes a decision oriented approach. It is very rational in nature and requires all programmes, old and new, to compete for scarce resources.
• In traditional budgeting, first reference is made to past level of spending and thendemand for inflation and new programmes. In zero based budgeting a decision unit is broken into understandable decision packages, which are ranked according to importance to enable to top management to focus attention to only on decision packages, which enjoy priority to others.
• In tradition budgeting, some managers deliberately inflate their budget request so that after the cuts they still get what they want. In zero-base budgeting, a rationale analysis of budget proposals is attempted. The managers, who unnecessarily try to inflate the budget request, are likely to be caught and exposed. Management accords its approval only to a carefully devised result-oriented package.
• Traditional budgeting is not as clear and as responsive as zero base budgeting is.
• In traditional budgeting. Its for top management to decide why a particular amount should be spent on a particular decision unit. In Zero-base budgeting, this responsibility is shifted from top management to the manager of decision unit.
• Traditional budgeting makes a routine approach. Zero-base budgeting makes a very straightforward approach and immediately spotlights the decision packages enjoying priority over others.

Zero base budgeting s superior to traditional budgeting: Zero base budgeting’s superior to traditional budgeting in the following manner:

• It provides a systematic approach for evaluation of different activities.
• It ensures that the function undertaken is critical for the achievement of the objectives.
• It provides an opportunity for management to allocate resources to various activities after a thorough cost benefit analysis.
• It helps in the identification of wasteful expenditure and then their elimination. If facilitates the close linkage of departmental budgets with corporate objectives.
• It helps in the introduction of a system of Management by Objectives.

Advantages of Zero-base budgeting:

• It provides a systematic approach for the evaluation of different activities and rank them in order of preference for the allocation of scarce resources.
• It ensures that the various functions undertaken by the organization are critical for the achievement of its objectives and are being performed in the best possible way.
• It provides an opportunity to the management to allocate resources for various activities only after having a thorough cost-benefit-analysis. The chances of arbitrary cuts and enhancement are thus avoided.
• The areas of wasteful expenditure can be easily identified and eliminated.
• Departmental budgets are closely linked with corporation objectives.
• The technique can also be used for the introduction and implementation of the system of ‘management by objective.’ Thus, it cannot only be used for fulfillment of the objectives of traditional budgeting but it can also be used for a variety of other purposes.