Question

Identify alternatives available in the budgeting process

Answer 1

Ans) Alternative Budgeting Systems:

• Fixed and Flexed Budgets:

- Fixed budgets are those which are set at the beginning of the budgeting period and do not change. There are a number of styles of fixed budgets, and methods of arriving at the final budget, for example ‘Top-down’ and ‘Bottom-up’.

Fixed Budgets

Flexed budgets recognise that there are different cost behaviour patterns and thus allow for changes as production volume changes. Contingency budgets can be prepared if plans are likely to change and the budget can be controlled by flexing it when the actual output is known – this makes figures and costs more reliable and certain. For flexed budgets in particular, it is important that cost behaviour is understood in relation to output (regression, learning curve, forecasting etc.), as this may significantly affect costs and other financial decisions.

- Incremental Budgeting:

Incremental budgeting is simply increasing prices and costs on a budget from one period to the next, with no significant changes to the budget. These marginal increments in prices and costs are most likely reflections of inflation. The basic process is;

Use last years budget as a starting point
Allow for any changes in the budget
Add a percentage increase or decrease to reflect changes in prices and costs
The problem with this method of budgeting is that it builds budgetary slack (providing a cushion in the budget in order to avoid an unfavourable variance at the end of the budgeting year). This may be achieved by spending up to the budget to get the same amount the following year, by spending money on discretionary and unnecessary items etc. Although budgetary slack makes the budget easier to attain and allows managers to plan for uncertainty, it creates bad habits.

Rolling (Continuous) Budgets:

Managers may need to re-budget due to changes such as; organisational structure change, competition, technology, environment, activity level, inflation etc. Rolling budgets can deal with these changes by constantly being updated. The budget is reviewed periodically (this ‘period’ varies in length depending on how frequently the budget is reviewed) and changes are made to reflect the current conditions. This means that this method of budgeting provides more up-to-date and realistic information, thus any feedback during the reporting and analysis process is much more meaningful.

Zero-based Budgeting:

This is essentially the same as ‘bottom-up’ budgeting – the department/business starts with a budget of £0 and works its way up to a spending limit. There is a three-step technique adopted in carrying out this budgeting method;

Define the decision packages (in blue):
Rank the decision packages using cost/benefit analysis (starting with 1 as most important)
Allocate resources accordingly
Zero-based Budgeting

This type of budget allows us to see, if the spending limit was to be cut, which decision package should be dropped, or which decision package to take on if the spending limit is increased. It is usually only practical to review the activities every 3 or 4 years, or if new activities are introduced. There are many advantages to using this type of budgeting system, for example; it creates an environment where change is accepted, helps to focus on the company’s objectives and goals, identifies inefficient and obsolete operations, shows where money could be spent if they have additional funds, and others. However, defining decision packages and ranking them takes more time than other methods e.g. incremental, and therefore it may be considered a more disruptive method (although it may only be disruptive every few years).