Zero Based Budgeting (ZBB)
Zero Based Budgeting (ZBB):
Learning Objective of the article:
- Define and explain the term "zero based budgeting" and "incremental budgeting" in managerial accounting.
- Explain the importance and use of zero based budgeting in business.
- What are advantages and disadvantages of zero based budgeting?
- Definition and explanation of zero based budgeting ZBB
- Advantages and disadvantages of zero based budgeting
- An example of zero based budgeting
Zero based budgeting (ZBB) is an alternative approach that is sometimes used particularly in government and not for profit sectors of the economy. Under zero based budgeting managers are required to justify all budgeted expenditures, not just changes in the budget from the previous year. The base line is zero rather than last year's budget.
In traditional approach of budgeting, the managers start with last year's budget and add to it (or subtract from it) according to anticipated needs. This is an incremental approach to budgeting in which the previous year's budget is taken for granted as a baseline. This approach is called incremental budgeting.
Zero based budgeting approach requires considerable documentation. In addition to all of the schedules in the usual master budget, the manager must prepare a series of decision packages in which all of the activities of the department are ranked according to their relative importance and the cost of each activity is identified. Higher level managers can then review the decision packages and cut back in those areas that appear to be less critical or whose costs do not appear to be justified.
Zero based budgeting is a good idea. The only issue is the frequency with which a ZBB review is carried out. Under zero based budgeting (ZBB) ,the review is performed every year. Critics of such type of budgeting charge that properly executed zero based budgeting is too time consuming and too costly to justify on an annual basis. In addition, it is argued that annual reviews soon become mathematical and that the whole purpose of zero based budgeting is then lost. Whether or not a company should use annual reviews is a matter of judgment. In some situations, annual zero based reviews may be justified; in other situations they may not because of the time and cost involved. However, most managers would at least agree that on occasion zero based reviews can be very helpful.
Advantages | benefits of zero based budgeting process:
- Efficient allocation of resources, as it is based on needs and benefits.
- Drives managers to find cost effective ways to improve operations.
- Detects inflated budgets.
- Municipal planning departments are exempt from this budgeting practice.
- Useful for service departments where the output is difficult to identify.
- Increases staff motivation by providing greater initiative and responsibility in decision-making.
- Increases communication and coordination within the organization.
- Identifies and eliminates wasteful and obsolete operations.
- Identifies opportunities for outsourcing.
- Forces cost centers to identify their mission and their relationship to overall goals.
Disadvantages | Limitations of zero based budgeting method.
- Difficult to define decision units and decision packages, as it is time-consuming and exhaustive.
- Forced to justify every detail related to expenditure. The research and development (R&D) department is threatened whereas the production department benefits.
- Necessary to train managers. Zero based budgeting (ZBB) must be clearly understood by managers at various levels to be successfully implemented. Difficult to administer and communicate the budgeting because more managers are involved in the process.
- In a large organization, the volume of forms may be so large that no one person could read it all. Compressing the information down to a usable size might remove critically important details.
- Honesty of the managers must be reliable and uniform. Any manager that exaggerates skews the results.