A Study on the interpretation of an article titled

Zero Based Budgeting in the Planning Process

Submitted
To

Dr. Dilip Kumar Sen

School of Business
Independent University, Bangladesh (IUB)
In Partial Fulfillment of the Requirements of MBA
Course- MBA 513
Sec: 02
Management Accounting

Submitted By:
Nawfal Ahmed
ID # 1321719

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Letter of Transmittal
Date: 9th July, 2014
To
Dr. Dilip Kumar Sen
Course Instructor
Management Accounting (MBA- 513, Sec: 02)
Independent University, Bangladesh
Dhaka
Subject: Submission of Management Accounting Report
Sir,
With due respect and humble submission, it is a pleasure to be able to hand
over the report of Management Accounting (MBA 513) on Zero Based
Budgeting in the Planning Process as a partial requirement of this course.
The guidelines, which you provided has been sincerely followed while preparing
this report and it gave me the opportunity to work beyond the text book and
explore the practical work field where my text knowledge provided me with the
theoretical understanding.
I have tried my level best to put meticulous effort for the preparation of this
report. I hope you would be kind enough on any shortcomings or fault that
may arise as my unintentional mistake. I will wholeheartedly welcome any
clarification and suggestion about any view and conception disseminated
through this report. All of my efforts will be successful if the report can serve
its purpose.

Thanking You.
Yours Respectfully

Nawfal Ahmed

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ID: 1321719

Executive Summary
The primary aim of this article is to report preliminary findings from a doctoral
work in process. In this particular, this paper reports the findings of pros and
cons of zero based budgeting in the firms planning process. Zero based
budgeting has emerged in recent years as a controversial approach to planning
and budgeting. The major thrust of this study was to incorporate the budget
development process into an operational planning framework and to empirically
test the relative merits of zero based budgeting as compared to traditional
incremental budgeting. Previous studies have failed to provide an integrative
framework for the application of ZBB which may account for some of the
conflicting

results

obtained

in

previous

ZBB

programmes.

Zero-based

budgeting requires a programs existence to be justified in each financial year,

as opposed to simply basing budgeting decisions on a previous years
allocation. It provides a systematic method of planning company financial
resources.

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Introduction
The article Zero Based Budgeting in the Planning Process written by James C.
Wetherbe and John R. Montanari sourced from Strategic Management Journal,
Vol. 2, No. 1 (Jan-Mar, 1981), pp. 1-14, published by Wiley.
A budget is an important financial plan that adds in the systematic analysis
and explanation of financial forecasts in terms of products, markets and the
application of sources. It requires manager to plan. It needs operational and
financial resources information for decision making. More importantly it sets
the benchmark that can be used for subsequent performance measurement.
Zero-based budgeting is an approach to planning and decision-making which
reverses

the

working

process

of

traditional budgeting.

In

traditional

incremental budgeting (Historic Budgeting), departmental managers justify only

variances versus past years, based on the assumption that the "baseline" is
automatically approved. By contrast, in zero-based budgeting, every line item of
the budget must be approved, rather than only changes. A method of budgeting
in which all expenses must be justified for each new period. Zero-based
budgeting starts from a "zero base" and every function within an organization
is analyzed for its needs and costs. Budgets are then built around what is

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needed for the upcoming period, regardless of whether the budget is higher or
lower than the previous one.

Main Issue
Can zero based budgeting be a part of the planning process?

Theme Of The Study

In this article an effort was made to mix the Zero Based Budgeting in to the
companys planning process. However previous studies had failed to show the
advantages of ZBB.

Analysis
Definition:
According to Sarant, ZBB is a technique which complements and links to
existing planning, budgeting and review processes. It identifies alternative and
efficient methods of utilizing limited resources. It is a flexible management

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approach which provides a credible rationale for reallocating resources by

focusing on a systematic review and justification of the funding and
performance levels of current programs.

Advantage:
1. Efficient allocation of resources, as it is based on needs and benefits
rather than history.
2. Drives managers to find cost effective ways to improve operations.
3. Detects inflated budgets.
4. Increases

staff

motivation

by

providing

greater

initiative

and

responsibility in decision-making.
5. Increases communication and coordination within the organization.
6. Identifies and eliminates wasteful and obsolete operations.
7. Identifies opportunities for outsourcing.
8. Forces cost centers to identify their mission and their relationship to
overall goals.
9. Helps in identifying areas of wasteful expenditure, and if desired, can
also be used for suggesting alternative courses of action.

Disadvantage:
1. More time-consuming than incremental budgeting.

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2. Justifying every line item can be problematic for departments with

intangible outputs.
3. Requires specific training, due to increased complexity vs. incremental
budgeting.
4. In a large organization, the amount of information backing up the
budgeting process may be overwhelming.

Evolution of zero based budgeting:

Planning,
Programming
Line Item

and Performance

Budgeting

Budgeting (PPP)

Zero Base Budgeting

(ZBB)

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Accounting/
Number

Function oriented

oriented

(Objectives)

Function and priority

based

Features

Input budgeting

Input/ Output
budgeting

Dynamic Input/
Output budgeting

Dealing
with

Ongoing schemes

Ongoing

taken

Ongoing schemes
taken for

Schemes

for granted

Granted

Every year old/ new

schemes evaluated
together

Control cost

Resource allocation,
with reference to
results

Resource allocation,
in context of
prioritization

Difference

Objective
Justification
of
expenses

Budget ceiling,
approval,
Appropriation

Achievements in
Cost-benefit,
prioritized activity
performance indicators areas

Traditional incremental budgeting

Traditional budgeting uses the incremental approach. It begins with previous
years budget and adjusts up or down from that budget to reflect changing
assumptions for the New Year. For instance, if previous years budgeted
expenditures for a department were $1.8 million, the department may request a
4 percent increase ($72,000) to maintain the same level of service for next year.
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The justification for increased expenditure is the increased cost of inputs, such
as materials and labor.
This incremental approach may not incorporate a careful evaluation of the level
of services being offered.
Under the incremental approach, government unit managers often strive to
spend the years entire budget, so there is no surplus at the year end. This acts
to maintain the current budgetary level and to help the unit manager apply
additional funds. For example, at a certain government department office in
the New Territories, the officer-in-charge, Wong Kar Ming, was faced with the
possibility of having surplus funds of around $150,000 at the fiscal year end.
Kar Ming found methods to spend the extra money before the year ended. He
posted an internal notice to colleagues saying that those who lived in Kowloon
and Hong Kong Island were welcome to apply for a travel allowance. Brand new
office furniture was acquired for a new section (before office furniture was
centrally dispatched from the government warehouse). The inefficiency and
wastage portrayed in this example is often perpetuated and encouraged by
incremental budgeting.

The following diagrams compare and contrast the Traditional v Zero-Base

approach:

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Implementation of zero-based budgeting

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Zero based budgeting is a method of budgeting whereby all activities are reevaluated each time a budget is set. Discreet levels of each activity are valued
and a combination chosen to match funds available.
Traditionally business unit managers simply justify increases over the previous
years budget. It is often on extrapolation of last years budget by:

Incremental changes for an assumed rate of inflation.

Anticipating increases in wages and salaries.
Recognizing new projects / programs of activity.
Adding incremental business activity as a base for the budget.

Planning

Budget
Review

So zero based budgeting is a part of the planning process.

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Zero-based budgeting aims to justify resource allocation in an individual

budget scheme, regardless of prior period budgets. It is not based on historical
data and begins each budget period afresh. The budget is first allocated as zero
unless the manager responsible makes the case for resource allocation. The
manager must justify the reasons for the financial resource allocation.
Each budget item is queried as if it were new before any financial resources are
allocated to it. Each plan is justified in terms of the total cost involved and the
total benefits. Past performance is not referred to as a building block. Zerobased budgets are set to prevent regular budget creeping behaviour that
emphasizes inflationary adjustments.

New and old work tasks are treated equally. Every managerial activity is
properly identified and then evaluated by analyzing alternative levels of
operation for the same activity. These alternatives are ranked and relative
priorities are set for achieving effectiveness and efficiency.
A zero-based budgeting system demands that the manager justify the entire
budget in detail and explains why the company should spend the money in the
manner proposed. This approach differs from traditional budgeting techniques
as it emphasizes the analysis of alternatives. The implementation steps are:

1. Managers first establish different decision packages associated with

performing each work task, such as forecasting the costs and benefits of
conducting a project or outsourcing it, or centralizing versus decentralizing
operations.
2. The decision packages should be ranked in order of importance. Tradeoffs
between respective packages should be considered. These allow managers to
rank priorities and combine decision packages for old and new projects into

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one, and allow top management to evaluate and compare the needs of
individual units or departments for financial resources allocation.
3. In addition, managers identify different levels for each alternative method of
the proposed activity. A minimum level of spending, usually 75 percent of the
current operating level, is established and then separate decision packages
that consider the costs and benefits of additional levels of expenditure for that
particular activity are developed. The setting of different levels enables
managers to consider and evaluate the level of expenditure lower than the
current operational level. This gives decision-makers the choice of eliminating
the activity or allocating resources for the selected level by including changes in
expenditure level and tradeoffs among departments.
Referring back to the surplus funds of around $150,000 in the earlier example,
there was no justification for spending this amount. Thus this surplus should
not be allocated on a continuing basis.

Results/ Major Achievements of ZBB implementation:

Additional resource mobilization, simplification of procedures

Replacement of legislative enactments

Revision of fees matching the cost of service

Computerization

Identification of surplus manpower

Review staff norms

Review of schemes causing savings.

Improvements to zero-based budgeting

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As a way of dealing with the managerial time required, one possibility is to

conduct a rolling budget every year and perform a zero-based budget every
three to five years, or when a major change occurs in operations. This allows
the company to benefit from the advantages of zero-based budgeting without
an excessive amount of work being required.
The company should not feel that all budgets must be developed in entirely the
same manner. Some departments can use an in-depth study of a zero-based
budget while others can use a rolling budget. This is a way of spreading the
work required over a number of years instead of concentrating on one certain
year. Many companies have implemented the system in some form or another
and found that it did not work. If properly implemented, however, the process
could show a considerable improvement over traditional rolling budgets. The
nature and number of decision packages varies between companies. It is not
uncommon for large companies to identify several thousand packages.
After ranking their own packages, top management could rank the packages of
all the managers that report to them. Another solution is for each level of
management to rank a certain percentage of packages within its own area of
responsibility. For example, the first level of management may rank 30 percent
of the proposed packages; the next level may rank the next 30 percent of
packages, while top management may concentrate on the remaining 40 percent
of the budget.

Generation of Questions
Is the program required?

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 Is the program technically feasible?

Is the program operationally viable?
Is the program sound?
Is the activity or function necessary?
Does the activity add value?
If the activity was not carried out, what would be the
consequences?

What level of activity is required?

Is the activity performed efficiently?
Is it cost effective?

Directions for future research

Zero-Based Budgeting is a broad-reaching cost transformation effort that takes
a blank sheet of paper approach to resource planning. It differs from
traditional budgeting processes by examining all expenses for each new period,
not just incremental expenditures in obvious areas. Zero-Based Budgeting
forces managers to scrutinize all spending and requires justifying every
expense item that should be kept. It allows companies to radically redesign
their cost structures and boost competitiveness. Zero-Based Budgeting
analyzes which activities should be performed at what levels and frequency and
examines

how

they

could

be

better

performedpotentially

through

streamlining, standardization, Outsourcing, off shoring or automation. The

process is helpful for aligning resource allocations with strategic goals,

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although it can be time-consuming and difficult to quantify the returns on

some expenditures, such as basic research.

For future research zero based can be used to:

Confront conventional thinking and resource allocations by challenging
every line item and assumption, including the most sacred of cows.

Help organizations that are overly complex due to mergers or

acquisitions.

Fund key strategic imperatives while removing large non value- adding
costs.

Align resources with the mission of the function and enterprise.

Justify proposed activities and resources.

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Conclusion
Companies at all levels are required to prepare budgets as a plan for spending
money for a given period of time, usually one year. Most companies use some
form of incremental budgeting, wherein, new costs or planned increases are
added to existing budget plans. In times when revenue is scarce or program
costs greatly increase, finance managers will consider starting the process from
"zero" and building a budget from the ground up. The following is a description
of such a process - Zero Based Budgeting.
Zero Based Budgeting is an integration of planning and budgeting into a single
process with the objective of development and redeployment of a budget
through scrutiny of programs. Zero Based Budgeting can be thought of as a
tool for provides a process to evaluate programs. It allows for budget reductions
and permits the re-allocation of resources from low to high priority programs.
Finally, Zero Based Budgeting is a cost-benefit analysis for all decision-making
in an organization.
Budgeting is not accounting. It is accountability. As such it is not the exclusive
responsibility of finance manager or the top executive. Zero Based Budgeting
involves everyone in decision making. Past activities should not exist simply
because they have acquired a history. They should exist if there is a need and
someone takes the responsibility for justifying the need for their existence.
Future activities must fit into the organizational objectives and strategy must
pass the test of necessity and cost-benefit analysis. It is not the expenditure
that should justify the output; it should be the output that must justify the
expenditure. Establish objectives of the program consistent with organizational
objectives and gain agreement on them; each cost center can be a decision

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unit. Decision units should be a particular activity or a group of activities that

can be independent and meaningfully identified and evaluated. Decision units
should not overlap. The decision units should be discrete entities for
management purposes, e.g. sites or programs.
Companies use one of two budgeting methods, or sometimes a blend of the the
two, to create their budgets. The incremental budget method multiplies the
previous year's financial results by a percentage based on industry trends and
inflation to produce a current year's budget. This method tends to produce a
budget that repeats the previous year at a level adjusted by the multiplier. The
other method, zero-based budgeting, provides an alternative method to the
incremental approach. It directs company resources to current needs, not
automatically to where they went last year. Managers creating zero-based
budgets must think in terms of creating efficiency and new opportunities for
the company. Zero-based budgeting requires training managers to think
strategically, and it relies on the ability of managers to honestly assess their
part of the business.
Zero-based budgeting provides an opportunity to implement self-imposed
budgeting, a process that uses individuals at all levels of the company to
produce the budget. This strategy gives employees a sense of ownership in the
goals of the company and the resulting budget. Commitment to meeting
company goals often increases among those who helped formulate those goals.
Also, those closest to the work tend to produce more-accurate budgets;
managers removed from the actual work may have unrealistic expectations. The
self-imposed strategy also reduces complaints about unrealistic or unworkable
budgets imposed from above. Smaller companies and startups in particular can
benefit from this sense of team participation.

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Zero-based budgeting requires a commitment of time and resources that may

exceed the capacity of a small business. Because of this, a company may find it
expedient to create a zero-based budget once every few years and use
incremental budgets in the years in between. A company may establish a
schedule under which each operating unit produces a zero-based budget once
every few years, but at least one unit produces such a budget each year.
Employing one of these strategies helps your small business enjoy the benefits
of zero-based budgeting without going through the process companywide every
year.

References
Strategic Management Journal, Vol. 2, 1-14 (1981).
Michael D. LaFaive, The Pros and Cons of Zero Based Budgeting,
November 4, 2003.

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 http:// en.m.wikipedia.org/wiki/Zero-based_ budgeting

Fong, C.C.S. and Kumar, N.K. 2002, Cost Accounting, 2002 edition,
Hong Kong
Association of Accounting Technicians.

Hilton, R.W. 2005, Managerial Accounting: Creating Value in a Dynamic

Business

Environment. McGraw-Hill.

Warren, C.S., J.M. Reeve, and P.E. Fess. 2005, Accounting. 21st ed.
Thomson

South-Western.

The End

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