Bases of budgeting

Cost/Management Accounting notes

Activity based budgeting
In ordinary/conventional budgeting, budget expenses for the current activities are normally based on previous year budget adjusted for price changes and anticipated future changes. Such costs are considered to be fixed in relation to the activity level. Activity based budgeting manages costs more effectively by authorizing the supply of only those resources required to perform activities directed towards meeting the budget. Activity-based costing is the reverse of Activity based costing in that it starts with the output to determine the level of activity, which in turn is used to estimate the resources required to meet the output. The following steps are followed in coming up with an activity-based budget

(i) Estimation of production and sales volume by individual products and customers.

(ii) Estimation of demand for organizational activities

(iii) Determination of the resources required to perform organizational activities

(iv) Estimation of quantity for each resource that must be supplied to meet the demand

(v) Taking appropriate action to adjust capacity of resources.
Zero Based Budgeting
It is also referred to as Priority based budgeting. It is a cost benefit approach budgeting where it assumes that the cost allowance is Zero for any item until the manager responsible justifies its existence in terms of costs and benefits. It ignores all previous budgets and assumes that items in the budget are no longer required

CIMA definition: A method of budgeting whereby all activities are re-evaluated each time the
budget is set.

It takes away the implied right of existing activities to continue receiving resources unless they can be shown to be the best use of such resources.

It is concerned with alternative means that established activities have been compared with alternative uses of the same resources. It works from the premise that projected expenditure for existing programmes should start from base zero with each year’s budget being compiled as if the programmes were being launched for the first time. It seeks to overcome the deficiencies of incremental budgeting, which include perpetuation of past inefficiencies and waste inherent in the past way of doing things.

Perpetuation of inefficiencies arise because indirect costs and support activities are prepared on an incremental basis i.e. the budget for the current period is prepared based on the previous period’s operations but adjusted for changes expected to occur in the current period. In this way, majority of expenditure associated with the base level of activity remain unchanged.
Stages of Implementation
(i) Definition of decision package: This is the comprehensive description of the organization’s functions or activities.

(ii) Evaluation and ranking of packages: This is on benefit basis.

(iii) Resource allocation according to priorities


(i) More efficient allocation of resources

(ii) Focus attention on values for money and makes clear relationship between input and output.

(iii) Develops a questioning attitude and makes it easier to identify obsolete, inefficient and less cost effective operations.

(iv) Leads to greater staff and management knowledge of operations


1. Time consuming.

2. High skills required.

3. May encourage wrong impression that all decisions must be made through budgets.

4. Short-term benefits may be emphasized to the detriment of long-term benefits.

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