Costing and Budgetary Control Methods: Zero Base Budgeting | Management Optional Notes for UPSC PDF Download

Introduction

• The budgeting process serves as a tool for establishing goals and objectives, identifying organizational weaknesses, and overseeing the diverse activities of various agencies within large organizations, whether public or federal. This process involves examining past organizational resource usage, evaluating and planning future accomplishments, and allocating resources for the upcoming budget period. Zero-Based Budgeting (ZBB), an analytical technique developed in 1969 by Texas Instruments, was first applied to government by Governor Jimmy Carter for his fiscal year 1973 budget and later mandated by President Carter for federal government use in 1977. 
• The primary goal of ZBB is to achieve optimal resource allocation, a task incremental and other budgeting systems struggle with. Managers are required to identify and justify their work areas in terms of decision packages before commencing work. Unlike common approaches that only demand justification for incremental changes, ZBB mandates managers to rationalize all budgeted expenditures, assuming a baseline of zero. 
• Widely used in business, non-profits, and government organizations, ZBB enhances scrutiny and transparency in the budgeting process. Although initially introduced for government use, small businesses can also benefit from ZBB by identifying cost reductions, investing resources more strategically, and assessing the benefits of budgeted tasks or projects. ZBB operates in opposition to the traditional budgeting process, providing a systematic reassessment of every line item in the budget, starting from the zero-base, regardless of whether the total budget or specific line items are increasing or decreasing.

Concept of Zero Base Budget

• Zero-Base Budgeting (ZBB) was developed in the 1960s at Texas Instruments by Peter Phyrr, serving as a financial and management approach to enhance the cost-effective delivery of public services. In this approach, managers are expected to have the lowest amount of funding for basic departmental operations, and additional funding must be justified reasonably. 
• The primary goal is to continually align finances with business objectives, eliminating or scaling back activities no longer relevant to those objectives. Sarant emphasized that ZBB complements existing planning, budgeting, and review processes, identifying alternative and efficient resource utilization methods. 
• This flexible management approach provides a reliable justification for reallocating resources through a systematic evaluation and explanation of funding and performance levels for current programs. President Jimmy Carter introduced ZBB in the federal government in 1977 to control program costs, and subsequent improvements have been made in various governments. Studies suggest that ZBB is more suitable for private businesses, with some cases demonstrating greater success in private business applications compared to government implementations.

The basic steps under Zero Base Budgeting

• The process of zero-based budgeting involves two main steps: developing "decision packages" and ranking these packages. Decision packages are documents that outline specific goals, objectives, performance measurements, costs, benefits, and alternative courses of action. These decision packages are then ranked at each management level until a comprehensive agency-wide ranking is achieved. 
• Conceptually, zero-based budgeting is a systematic approach to allocating resources where they can have the most positive impact. The application and extent of this approach must be decided in the subsequent phases of zero-based budgeting, involving prioritizing activities, conducting cost-benefit analysis, and finalizing the budget by selecting and approving decision packages.
• Studies, such as those by Argyris in the 1950s and Hopwood in the 1970s, have explored the behavioral effects of budgeting processes within organizations. It has been observed that the specific process used can lead to dysfunctional behavior in subordinates, regardless of the technical modifications made to the budgetary system. 
• Zero-based budgeting may require more time, money, and paperwork, but it provides a systematic approach to addressing an organization's financial challenges, allowing for better resource allocation. Combining zero-based budgets with rolling budgets or other forms of budgeting that spread the workload of justifying new budgets each cycle can integrate zero-based budgeting without causing undue stress for all managers with budgetary responsibilities simultaneously.

Advantages of Zero Base Budgeting

Organizations that embrace zero-based budgeting experience several advantages.

• Zero-based budgeting requires managers to explore alternative methods for executing each activity and assess the impact of different spending levels. This process prompts managers to consider alternative approaches to running the business.
• Another benefit is the prevention of budget inflation. As expenditures must be linked to activities, it becomes less likely that managers can artificially inflate their budget, making any such attempts easily detectable. 
• The zero-based budgeting process triggers substantial discussions within the management team regarding the corporate mission and how it can be achieved. This review process compels managers to assess which operations align with the company's objectives, enabling them to target non-essential activities for elimination or outsourcing. 
• The concept of zero-based budgeting forces managers to define the distinct missions of their departments. Through this evaluation, it may be revealed that various departments are conducting the same activities, leading to the elimination of duplicative efforts and a focus on centralized management. Companies that regularly implement zero-based budgeting can periodically examine various aspects, establishing it as a microeconomic tool to translate objectives into efficient operating plans.

Disadvantages of Zero Based Budgeting

• Despite its advantages, zero-based budgeting comes with certain drawbacks. One major disadvantage is the substantial effort required to scrutinize and document department activities. 
• This task is challenging even when performed annually, leading some entities to adopt the procedure infrequently, such as once every few years or only when significant changes occur within the organization. 
• An alternative approach is to implement zero-based budgeting on a rolling basis across different parts of a company over several years, allowing management to handle fewer reviews each year. The extensive analysis, meetings, and reports demanded by zero-based budgeting necessitate additional staff to manage the process. 
• Some managers may attempt to manipulate budget reports to concentrate expenditures on the most critical activities, ensuring that their budgets remain intact. Controlling or validating expenditure levels for areas of a business that do not yield tangible results can be challenging. 
• The operational evaluation mandated by zero-based budgeting consumes a significant amount of management time, requiring managers to undergo specialized training in the process, further increasing the annual time commitment.

Modified Zero Based Budgeting

• Service-level budgeting is an adapted approach to zero-based budgeting that aligns spending levels with the services to be delivered. In contrast to zero-base, where an effort is made to document personnel and expense requirements accepted as necessary, modified zero-base establishes a base higher than zero, a concept sometimes referred to as service-level budgeting.
• In summary, Zero-Based Budgeting is an effective cost transformation initiative that implements resource planning successfully. Theoretical descriptions often characterize Zero-Based Budgeting as budgeting "from the ground up," as if preparing the budget for the first time with a thorough review of every proposed expenditure (Horngren et al, 1996). 
• Applied in local and government organizations where predominant costs are flexible, it differs from traditional budgeting by scrutinizing all expenses for each new period, not just incremental expenditures in obvious areas. Zero-Based Budgeting compels managers to analyze all spending, requiring justification for every expense item. 
• It enables companies to significantly reshape their cost structures and enhance competitiveness, examining which activities should be executed at what level and frequency and evaluating how they could be improved through streamlining, standardization, outsourcing, offshoring, or automation. Although supportive of aligning resource allocations with strategic goals, the process can be time-consuming and challenging to measure returns on certain expenditures.

Zero Based Budget In India

• Recently, the Union Finance Minister, Nirmala Sitharaman, introduced a proposal for zero-budget farming, describing it as a return to fundamental principles. She highlighted that some states in the country are already practicing zero-budget farming. This farming approach involves methods that eliminate credit for agriculture and exclude the use of chemical fertilizers. 
• The zero-budget farming model aims to significantly reduce farming expenses, eradicate dependence on loans, and minimize reliance on purchased inputs by promoting the use of self-produced seeds and locally available natural fertilizers. It emphasizes a farming approach in harmony with nature, avoiding the use of chemical fertilizers.
• Zero-Based Budgeting (ZBB) was initially introduced in India in the Department of Science and Technology in 1983. The Indian government officially adopted ZBB as a technique for determining expenditure budgets in 1986. However, the application of Zero-Based Budgeting in India is currently limited.