Free Accounting Essay - Zero Based Budgeting
With reference to any non-profit making organisation of your choice, comment on how zero based budgeting may operate and evaluate its usefulness for the type of decision that the organisation has to make.
This essay explores how zero based budgeting may be used within non-profit organisations, with particular reference to Hampshire County Council. It will then evaluate the usefulness of this method for decision-making in non-profit organisations.
Zero based budgeting (ZBB) may be defined as ‘budgeting from the ground up, as though the budget is being prepared for the first time with every proposed expenditure coming under review’. (Horngren et al, 1996) Zero-based budgeting (also known as priority-based budgeting) is therefore a management approach to budgeting, under which the budget for every activity starts at zero for each new budget period. An analysis of this technique in a non-profit context is important given that ‘ZBB has mostly been applied in local and government organisations where predominant costs are of a discretionary nature’. (Drury, 2004)
Under ZBB, during the budgeting process, each activity must be justified in terms of its continued usefulness. No expenditure is authorised without an analysis of why the organisation is better off with that expenditure. The ZBB approach therefore forces management to rethink each phase of an organisation's operations before allocating resources. One of the key differences between traditional budgeting and zero based budgeting is that ZBB places emphasis on activities rather than overall departments, and the budget is arrived at by assuming that all activities are being started for the first time.
Traditionally in public sector organisations, such as Hampshire County Council, the budgetary process takes its basis from the previous year’s allocation. This gives rise to a situation whereby departments are allocated a percentage increase in budgets for the coming year based on the previous year’s figures, without a full examination of the basis of these costs. This in turn can lead to a situation of dysfunctional behaviour, whereby managers who have successfully controlled costs during the year spend their remaining budget allocation at the end of the year on non essential items, as a means of protecting the level of money allocated to their department in the coming budgetary year.
This is a recognised problem when using incremental budgeting, and ZBB attempts to remedy the problems associated with this method. Rather than allocating managers’ requirements based on previous budgets, with the assumption that the situation will continue in the same way, the focus instead becomes efficiency and achieving organisational strategic objectives.
This essay will now explore the operation of ZBB in a non-profit organisation, via an analysis of Hampshire County Council (HCC).
‘There are some services which would be obvious candidates for the zero-based budgeting approach. These include residential accommodation, home care, day centres for people with learning disabilities, occupational therapy service, family centres and family resource centres.’ (HCC, 1993)
Hampshire County Council implemented a process of zero based budgeting in its social services department in 1992/3, as an extension of the devolved budgeting system it implemented in 1990. ‘The budgeting approach in social services was in effect a hybrid of these two systems’. (HCC, 1993)
This change led to the creation of over 300 cost centres, which were then broken down into decision packages. Decision packages are individual groups of activities undertaken by a department or organisation. A ‘base-level’ package for each of the social services departments’ activities was then established, representing the minimum level of service provided using 90% of the existing cost allocation. This showed the level of service the council were able to provide using 90% of the money already in use. Incremental decision packages above the 90% level therefore showed levels of service provisions at higher levels of cost.
The council was able to review the levels of expenditure across activities and where best to spend the money by ranking the decision packages in order of priority. In a non-profit organisation such as this, rather than using profit as the basis for ranking, the council used priority of service depending on the statutory requirements laid down by the government. This meant that areas such as elderly care, which had low levels of statutory requirements, received lower rankings than areas such as learning disabilities when using this cost-benefit analysis approach to budgeting.
The cost-benefit approach has benefits over more traditional methods of budgeting. Whilst incremental budgeting looks at past data and increases the amounts in the new budget dependent on these, ZBB allocates resources depending on benefits. This results in a change in management culture, giving managers both ‘operational responsibility and budget responsibility’ (Pendlebury, 1994), which places an emphasis on questioning existing practice rather than just accepting it. The utilisation of decision packages allows for outputs to be measured against value for money, with detailed levels of cost effectiveness identified.
Another advantage of ZBB over traditional methods is that it allows for new projects included in the budgetary process to be compared with existing activities, thereby encouraging innovation; since existing activities are not automatically continued.
The incremental budgeting process previously used by Hampshire County Council, based current allocation of resources on past spending. The implementation of ZBB means that budgets are now built using cost centres as their base, with the sum of each cost centre budget providing the overall budget for the entire division.
There are, however, also many drawbacks to implementing ZBB, including the exceptionally complex and potentially expensive nature of the operation. Also, by assuming that all activities are starting anew in each budgetary period, emphasis may be placed on short term rather than long-term planning. Equally, splitting departments into activities that overlap or have links between them may ultimately lead to an uncoordinated approach.
The prioritisation process of decision packages is subjective, and open to abuse from internal political influence. This may be particularly prevalent in non-profit making organisations where the goals are socially motivated.
In conclusion, the analysis has shown that there are a number of advantages associated with the use of ZBB as opposed to more traditional budgeting methods in non-profit organisations. However, drawbacks of ZBB have also been identified, the greatest of which is likely to be the extra cost associated with this more complex process. This could be hard to justify, especially given that it may be tax payers’ money which is used to pay for it, as in the case of Hampshire County Council.
Bibliography
Burrows, G. and Syme, B. (2000), Zero-base Budgeting: Origins and Pioneers, Abacus, Vol. 36, No. 2
Drury, C. (2004), Management and Cost Accounting, 6th Edition, Thomson Learning
Hampshire County Council, Social Services Finance – A ‘Zero-based budgeting’ approach, 23rd July 1993, www.hants.gov.uk/scrmxn/c11208.html, [Accessed, 3rd March 2005]
Hampshire County Council, Social Services Finance – Zero based budgeting, 17th September 1993, www.hants.gov.uk/scrmxn/c11607.html, [Accessed, 3rd March 2005]
Henley, D. et al (1992), Public Sector Accounting and Financial Control, 4th Edition, London: Chapman and Hall
Horngren, C.T. et al (1996), Cost Accounting in Australia: A Managerial Emphasis, Prentice Hall
Jones, R. and Pendlebury, M. (2000) Public Sector Accounting, 5th Edition, Financial Times - Division of Pearson Education
Pendlebury, M.W. (1994), Management Accounting in Local Government, Financial Accountability and Management, 10 (2)
