Solutions to Assignments
MCO-05 Accounting for Managerial Decisions
Question 2
(a) What do you understand by zero base budgeting? How is it different from traditional budgeting?
Zero-based budgeting (ZBB) is a budgeting approach that involves developing a new budget from scratch every time (i.e., starting from “zero”), versus starting with the previous period’s budget and adjusting it as needed. In theory, this forces decision makers to constantly look at the business with fresh eyes, free from the limitations of past assumptions and targets.
Implemented effectively, ZBB is a cost discipline enabling businesses to improve resource planning, employee engagement, and organizational collaboration. Although ZBB is often credited with measures to reduce costs, its approach doesn’t exclusively focus on savings and can help test assumptions, solve problems, and ensure spending is aligned to the growth objectives of the organization. If performance does not meet expectations, ZBB can empower businesses to identify how to best course-correct for the months ahead.
Done right, ZBB can translate into cost savings that fund future strategic initiatives and drive growth.
- Examples on Zero based Budgeting
The good news for zero-based budgeting users is they appear to be moderately more successful at meeting their cost targets. Sixty-three percent of respondents, globally, who did not conduct ZBB did not meet their cost targets, while the same is true for 58 percent of those that did use ZBB. Although ZBB users in the US reported higher cost program failure rates than non-ZBB users (65 percent vs. 57 percent), in all other regions the failure rate for ZBB users was lower than for non-ZBB users (57 percent failure rate vs. 68 percent in Latin America; 52 percent vs. 56 percent in Europe; and 60 percent vs. 71 percent in the Asia Pacific).
However, companies using ZBB tend to report higher barriers to effective cost management, which suggests ZBB may be more difficult to implement and use than other cost management methods. Two barriers that ZBB users rate particularly high are “weak/unclear business case” (42 percent vs. 25 percent for non-ZBB users) and “poorly designed tracking and reporting” (43 percent vs. 23 percent for non-ZBB users)
In the US, high-cost targets and high failure rates suggest companies might be misapplying zero-based budgeting, using a tactical approach to pursue aggressive targets that likely require strategic cost actions. In Brazil, where ZBB first rose to prominence, declining usage seems to be driven by implementation challenges.
Use of ZBB is expected to remain flat in the Asia Pacific, except in China, where it is expected to rise—perhaps due to lower implementation barriers and lower failure rates.
In Europe, use of zero-based budgeting is relatively low but expected to hold steady. Cost targets in the region are much less aggressive than elsewhere; also, structured approaches to cost management are much less common. In this environment, ZBB—as a structured approach—may be appealing to some companies simply because it is better than nothing.
- How zero-based budgeting is different from traditional budgeting
The ZBB methodology operates in stark contrast to traditional annual budgeting approaches. Traditional annual budgets are often produced by taking the previous year’s actuals and adding a few percentage points to account for wage rises and inflation. This simplified and incremental budgeting can lead to inefficiencies and missed opportunities for greater cost savings.
ZBB requires organizations to build their annual budget from zero each year (thus its name) to help verify all components of the annual budget are cost-effective, relevant, and drive improved savings.
Here is a brief outline of the principles of both traditional cost-cutting and a zero-based approach.
