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Subject COMMERCE
Paper No and 06: ACCOUNTING FOR MANAGERIAL DECISIONS
Title
Module No and 12: ZERO BASED BUDGETING
Title
Module Tag COM_P6_M12
COMMERCE PAPER No.06 : ACCOUNTING FOR MANAGERIAL
DECISIONS
MODULE No.12 : ZERO BASED BUDGETING
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TABLE OF CONTENTS
1. Learning outcomes
2. Introduction
3. Meaning of Zero Based Budgeting
4. Salient Features of Zero Base Budgeting
5. Steps for Preparation of Zero Base Budgeting
6. Merits of Zero Base Budgeting
7. Demerits of Zero Base Budgeting
8. Rolling Budget
9. Summary
COMMERCE PAPER No.06 : ACCOUNTING FOR MANAGERIAL
DECISIONS
MODULE No.12 : ZERO BASED BUDGETING
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1. LEARNING OUTCOMES
After studying this module, you shall be able to:
Understand meaning of Zero Based Budgeting (ZBB)
Learn salient features of ZBB
Know the various steps involved in ZBB
Understand merits & demerits of ZBB
Elaborate the concept of Rolling Budget
COMMERCE PAPER No.06 : ACCOUNTING FOR MANAGERIAL
DECISIONS
MODULE No.12 : ZERO BASED BUDGETING
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2. INTRODUCTION
The budgeting process classically begins with a strategy planning session by senior management. The
management team then put on the agreed strategic direction to a sequence of plans that roll up into a
master budget. The plans contain a sales budget, production budget, and direct materials budget, direct
labour budget, manufacturing overhead budget, sales and administrative budget, and fixed assets budget.
All of these strategies roll up into the master budget, which comprises a budgeted income statement,
balance sheet, and cash forecast. There may also be a financing budget in which is enumerated the debt
and equity arrangement needed to confirm that the cash necessities of the budget can be met. Budgeting
has come to be established as well-organized method of short-term planning and control. It is employed,
no doubt, in large business houses, but even the small businesses are using it at least in some informal
way. Through the budgets, a business wants to know obviously as to what it proposes to do during an
accounting period or a part thereof. The method of budgeting is an important presentation of Management
Accounting. Probably, the ultimate aid to good administration that has ever been devised is the use of
budgets and budgetary control. It is a multipurpose tool and has helped directors cope with many problems
including inflation. Zero based budgeting is one of the methods of budgeting which is discussed in details,
in the part of this text.
3. Meaning of Zero Based Budgeting
Zero Base Budgeting is a new technique of budgeting. It is designed to meet the needs of the
Management in order to ensure the operational efficiency and effective utilization of the allocated
resources of a concern. This technique was formerly developed by Peter A. Phyhrr, Manager of Taxas
Instrument during 1969. This concept is extensively used in USA for controlling their state expenditure
when Mr. Jimmy Carter was the president of the USA. At present the technique has for its global
recognition for many countries have implemented in real terms. According to Peter A. Phyhrr ZBB is
defined as an "Operative Planning and Budgeting Process “Which requires each Manager to justify his
COMMERCE PAPER No.06 : ACCOUNTING FOR MANAGERIAL
DECISIONS
MODULE No.12 : ZERO BASED BUDGETING
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entire budget in detail from Scratch (hence zero base) and shifts the burden of proof to each Manager to
justify why we should spend any money at all."
Zero Base Budgeting is the latest modus operandi of budgeting. A budget is a representation of
quantification of the firm’s objectives. An accurate budget can be framed, when a relationship between
the inputs and outputs can be established. In all the activities, such relationship cannot be established. In
such areas, it is difficult to develop standard costs. Where it is difficult to compare the resources allocation
with the output, ZBB is more appropriate in controlling. The term ‘Zero Base Budgeting’ means starting
from the scratch.
In Zero Base budgeting, justification of expenditure is to be made for the past as well as new projects. In
the traditional budgeting, the figures of the previous years are taken as base and additions are made for
the current year. But, in Zero Base Budgeting, even the running projects are to be justified for
continuation. If the past projects were allowed to continue, without justification, the past inefficiencies
would continue, automatically. So, the manager has to justify, why he wants to continue to spend.
In ZBB, the manager has to justify the essentiality of the new projects for their starting and continuation
of previous projects, every year. Equally, the concerned manager has to justify the amount of spending,
thereon, is reasonable
4. Salient Features of Zero Base Budgeting:
1. 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.
2. Activities are identified in decision packages.
3. Decision packages are ranked in order of priority.
4. Packages are evaluated by systematic analysis.
5. Under this approach there exists a frank relationship between superior and
subordinates. Management agrees to fund for a specified service and manager of the decision unit
clearly accepts to deliver the service.
COMMERCE PAPER No.06 : ACCOUNTING FOR MANAGERIAL
DECISIONS
MODULE No.12 : ZERO BASED BUDGETING
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6. Decision packages are linked with corporate objectives, which are clearly laid down.
7. Available resources are directed towards alternatives in order of priority to ensure optimum results.
5. STEPS FOR PREPARATION OF ZERO BASE BUDGETING
1. Determining the Objectives: Determination of the objectives is the first step. The objective can
be cost reduction in staff overheads or dropping those projects that do not fit in the organizational
objectives or focus.
2. Extent of Coverage: It relates to the decision whether Zero-Base Budgeting is to be introduced
in all areas or certain select areas on trial basis.
3. Developing Decision Units: Decision Unit can be a functional department, a programme, a
product-line or sub-line. Each decision unit must be independent. Then only, they come under
consideration. Cost benefit analysis is to be done to the decision units. Decision is to be taken,
whether the units are to be continued or dropped. If the cost benefit analysis is favourable, the
decision unit can be implemented, otherwise can be dropped. Benefit should be more compared to
the cost. Cost benefit analysis is the foundation of ZBB, which helps in ranking the projects. If the
decision unit is dropped, no further thinking is needed about those activities.
4. Developing Decision Packages: This is the most important step involved in the ZBB process.
After decision for selection of the units, the concerned manager of the activity is given the freedom
to come out with the alternatives to achieve. He does the cost-benefit analysis and selects the best
course of alternative. He summarizes the plans and resources required to achieve.
5. Preparation of Budgets: This is the last stage involved in ZBB process. Once the top management
has ranked the various decision packages keeping in view of the cost benefit analysis and
availability of funds, a cut-off point is established. All packages (programmers, products etc.),
which come within the cut-off point are accepted and others rejected. The resources are then
allocated to the different decision units and budgets relating to units are approved. Zero Base
Budgeting is an extension of the cost benefit analysis method to the area of corporate budgeting
COMMERCE PAPER No.06 : ACCOUNTING FOR MANAGERIAL
DECISIONS
MODULE No.12 : ZERO BASED BUDGETING
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6. MERITS OF ZERO BASE BUDGETING:-
ZBB is a revolutionary concept. The benefits are as under:
1. Proper Allocation of Funds: Funds are scarce. Priority in allocation of funds is made on cost-
benefit analysis.
2. Systematic Evaluation: Manager has to justify the demand for resources, every year. So, it
provides the organization a systematic way to evaluate different programmes and operations
undertaken. So, for the ongoing projects too, review is made, every year. Funds allocation for the
ongoing projects is made, if there is justification to continue, further. In other words, there is no
difference between the new projects and ongoing projects from the view-point of allocation of
funds.
3. Links Budgets with Goals of Enterprise: Those projects that do not fit within the overall goals
of the enterprise are not continued, even if they were commenced. Goal oriented approach of the
enterprise would be developed.
4. Zero Base Approach: Zero is taken as the base, every time. Only those activities and programmes
that are essential are undertaken, which improves the overall efficiency of the enterprise.
Alternative courses of action are always studied. Economies are achieved, eliminating wastage.
The focus of the management is on analysis and decision-making
5. Optimum use of Resources: As cost-benefit analysis is the guiding principle in fixing priorities,
resources are used to the optimum advantage of the organization.
6. No Incremental Approach: Normally, budgets are based on incremental approach. The usual
feature of functional heads is to seek information from the accounts department for the previous
year’s expenditure, add ‘something’ for the current year and try to justify the increase. This
incremental approach is not possible with Zero-Base Budgeting. Manager has to justify their
activities and the funds requested.
7. Most Appropriate for Non-Manufacturing Areas: Zero-Base Budgeting is very appropriate for
the staff and support areas (Non-Manufacturing Areas). In these areas, the output of these areas is
COMMERCE PAPER No.06 : ACCOUNTING FOR MANAGERIAL
DECISIONS
MODULE No.12 : ZERO BASED BUDGETING
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not, directly, related with the final output of the organization. Within the business world, ZBB can
be applied to research and development, data processing, quality control, marketing and
transportation, legal staff and personnel office.
Example: A separate training department may remain in an organization. The utility of the continuation
of the department may be studied, in comparison to conducting training outside the organization. Training
is a non-manufacturing area and its discontinuation within the organization and providing diverse types
of training to staff, outside the firm, may be more ideally suitable, while reducing the costs to the
enterprise.
7. DEMERITS OF ZERO BASE BUDGETING
Computation of cost-benefit analysis is essential for ZBB. This is not possible in respect of non-
financial matters.
The system of ZBB has no scope to adjust for changes. So, ZBB has no scope in flexible budgeting.
ZBB involves lot of time and cost of operating is also high.
Formulation of decision package is a difficult process and all the managers may not have the necessary
expertise.
Forced to justify every detail related to expenditure. The R&D department is threatened whereas the
production department benefits.
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.
Necessary to train managers. Zero-based budgeting must be clearly understood by managers at various
levels to be successfully implemented.
COMMERCE PAPER No.06 : ACCOUNTING FOR MANAGERIAL
DECISIONS
MODULE No.12 : ZERO BASED BUDGETING
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8. Rolling Budget
A rolling budget is a budget that is continually updated to add a new budget period as the most recent
budget period is completed. Thus, the rolling budget involves the incremental extension of the existing
budget model. A rolling budget calls for considerably more management attention than is the case when
a company produces a one-year static budget, since some budgeting activities must now be repeated every
month. In addition, if a company uses participative budgeting to create its budgets on a rolling basis, the
total employee time used over the course of a year is substantial. Consequently, it is best to adopt a leaner
approach to a rolling budget, with fewer people involved in the process. For Example ABC Company has
adopted a 12-month planning horizon, and its initial budget is from January to December. After a month
passes, the January period is complete, so it now added a budget for the following January, so that it still
has a 12-month planning horizon that now extends from February of the current year to January of the
next year. A rolling budget is also described as continuous budgeting. For years, organizations have relied
on creating annual budgets to plan for the upcoming fiscal year. Today, many organizations with annual
budgets are feeling their ability to react to changes in the marketplace is restricted. While annual budgets
used to be a vital piece of the financial process for almost every company, more and more businesses are
replacing their annual budgets with a rolling forecast. An annual budget is designed to provide an
organization with a roadmap of where their company is headed for the next 12 months. By creating
priorities across the entire organization, a budget helps a business decide which projects and initiatives
are worth pursuing in the coming year and which are not. However, opponents will argue that this process
locks departments into committing to certain initiatives, which may or may not continue to be valuable as
the fiscal year progresses. The business environment has been notoriously tumultuous in the past several
years, and annual budgets make it harder for organizations to adapt to changes in the marketplace. In
addition, the budgeting process is often just that, a process. Many businesses spend up to 6 months creating
a budget to plan for the next 12 months, but the budget is outdated as soon as it is finalized. Many have
noted that researching new markets and prioritizing initiatives should happen on a continual basis. An
organization’s financial structure needs to reflect this.
Much like budgeting, a rolling forecast attempts to predict future environments. Predicting the future is
always difficult, and thus the main purpose of a rolling forecast is not to get the prediction exactly right,
COMMERCE PAPER No.06 : ACCOUNTING FOR MANAGERIAL
DECISIONS
MODULE No.12 : ZERO BASED BUDGETING
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but to provide an organization’s leaders with the information they need to make decisions. Seasoned
managers and executives may be better at predicting markets than others, but forecasting will almost never
be 100% accurate. However, by having a forecasting model in place, an organization is structured to
receive information and adapt something that is tougher to do operationally under an annual budget. It is
clear that having a rolling forecast allows an organization to be much more responsive to the business
environment and adapt accordingly, yet forecasted numbers will arguably be less biased than budgeting
numbers. When an organization sets a budget, department goals and budgeting numbers can often be one
in the same. Sales managers set targets for their team or the production line sets waste goals, and these
figures are used to plan the budget. Forecasted numbers are not tied to performance, and organizations
can still have targets to reach while the metrics used in rolling forecasting can remain separate, resulting
in a more accurate prediction of future operations.
The advantages of rolling budget:
1. They reduce uncertainty in budgeting which is important in highly volatile industries where sales
levels and prices may fluctuate;
2. Managers need to reassess the budget frequently;
3. More realistic budgets will aid motivation;
4. Planning and control will always be based on up to date information which covers a significant
period into the future.
5. Planning and control will be based on a recent plan which is likely to be far more realistic than a
fixed annual budget made many months ago.
The disadvantages of rolling budgeting:
1. It is time consuming.
2. Managers may find the constant revision of budgets disruptive and unsettling;
3. Continuous updating may not be justified where the changes are not continuous.
4. Revisions to the budget might involve revisions to standard costs too, which in turn would involve
revisions to stock valuations. This could replace a large administrative effort from the accounts
department every time a rolling budget is prepared.
5. It is costly for the organization as special Man-power is required.
COMMERCE PAPER No.06 : ACCOUNTING FOR MANAGERIAL
DECISIONS
MODULE No.12 : ZERO BASED BUDGETING
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9. SUMMARY
Zero based budgeting is an important technique of budgeting tool for the future planning and control.
Zero based comprises many advantages like proper allocation of funds, systematic evolution and
efficient utilization of funds but it also having some disadvantage like Computation of cost-benefit
analysis is essential, it has no scope in flexible budgeting and requirement of trained staff for proper
execution of the plans. Similarly rolling budget also the budget which incorporate the new budget
period as recent period is complete but a rolling budget calls for considerably more management
attention than is the case when a company produces a one-year static budget.
COMMERCE PAPER No.06 : ACCOUNTING FOR MANAGERIAL
DECISIONS
MODULE No.12 : ZERO BASED BUDGETING
