208 ACCOUNTING FOR MANAGERS
žmotivate managers to achieve targets;
žprovide a means to control activities; and
ževaluate managerial performance.
In establishing the budget allocation to specific profit centres, cost centres or
departments, there are four main methods of budgeting: incremental, priority
based, zero based and activity based.
Incremental budgetstake the previous year’s budget as a base and add (or
subtract) a percentage to give this year’s budget. The assumption is that the
historical budget allocation reflected organizational priorities and was rooted in
some meaningful justification developed in the past.
Priority-based budgetsallocate funds in line with strategy. If priorities change
in line with the organization’s strategic focus, then budget allocations would follow
those priorities, irrespective of the historical allocation. A public-sector version of
the priority-based budget is theplanning, programming and budgeting system
(PPBS)that was developed by the US space programme. Under PPBS, budgets are
allocated to projects or programmes rather than to responsibility centres. Priority-
based budgets may be responsibility centre based, but will typically be associated
with particular projects or programmes. The intention of PPBS and priority-based
budgeting systems is to compare costs more readily with benefits by identifying
the resources used to obtain desired outcomes. An amalgam of incremental and
priority-based budgets ispriority-based incremental budgeting. Here, the budget-
holder is asked what incremental (or decremental) activities or results would
follow if budgets increased (or decreased). This method has the advantage of
comparing changes in resources with the resulting costs and benefits.
Zero-based budgetingidentifies the costs that are necessary to implement
agreed strategies and achieve goals, as if the budget-holder were beginning with a
new organizational unit, without any prior history. This method has the advantage
of regularly reviewing all the activities that are carried out to see if they are still
required, but has the disadvantage of the cost and time needed for such reviews.
It is also very difficult to develop a budget while ignoring current resource
allocations.
Activity-based budgetingis associated with activity-based costing (ABC, see
Chapter 11). ABC identifiesactivitiesthat consume resources and uses the concept
ofcost drivers(essentially the cause of costs) to allocate costs to products or services
according to how much of the resources of the firm they consume. Activity-based
budgeting (ABB) follows the same process to develop budgets based on the
expected activities and cost drivers to meet sales (or capacity) projections.
Whichever method of budgeting is used, there are two approaches that can be
applied. Budgets may be top down or bottom up.Top-down budgetsbegin with
the sales forecast and, using the volume of sales, predict inventory levels, staffing
and production times within capacity limitations. These are based on bills of
materials, labour routings and standard costs. For services, the top-down budget
is based largely on capacity utilization and staffing levels needed to meet expected
demand. In both cases, senior management establishes spending limits within
which departments allocate costs to specific line items (salaries, travel, office