Zero Based Budgeting (ZBB):
Learning Objective of
- 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
Definition and explanation of zero based
Advantages and disadvantages of zero based
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
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
- 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
- Identifies opportunities for outsourcing.
- Forces cost centers to identify their
mission and their relationship to overall goals.
Disadvantages | Limitations of zero based
- 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
- 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
- Honesty of the managers must be reliable
and uniform. Any manager that exaggerates skews the results.
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