Zera Based Budgeting

8/13/2019 Zera Based Budgeting

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Zero-base budgeting(ZBB), a prioritybudgetingforresources allocation can

be used by nonfinancial managers to identify, plan, and control projects and

programs. It enhances effectiveness and efficiency. here is a matching of service

levels to available resources. !ach manager must justify a budget re"uest in detail,

beginning #ith the $ero balance. It can lo#er production, service, and operating

costs.

%hat is $ero-base budgeting &ZBB' o# is the $ero-base budgeting processed

his post discusses the ZBB process, its effects, activity units, decision pac*ages,

ran*ing proposals, and project (program) budgets. Enjoy!

%hat is Zero-base Budgeting &ZBB'

ZBB is a priority form of budgeting, ranking activities such as products and services. It

may be used by managers to review and analye programs, proposals, activities, andfunctions to increase profitability, enhance efficiency, or lower costs. ZBB results in theoptimum allocation of company resources. here e"ists an input#output relationship.

ZBB considers the objectives of the activity and how they are to be accomplished. hefailure to fund an activity may result in adverse conse$uences that have to be taken intoaccount. %or e"ample, the failure to produce a particular product may adversely effect thesales of related products in the company&s overall product line.

+anagers #ho benefit from using ZBB include production managers, purchase

managers, mar*eting eecutives, general managers and other administrative staff,

engineers, research managers, personnel managers, operations research staff,attorneys, and economists. or eample, ZBB can be used by mar*eting managers

to appraise competing alternative product lines, formulate an advertising strategy,

evaluate salesperson performance, and establish and monitor mar*eting priorities.

cost/benefit analysis should be underta*en for each sales program in terms of

staff, product, and territory. he objectives of each subunit (e.g., department,

responsibility center) should be consistent #ith the overall goals of the company.

Zero-base Budgeting 0rocess

Zero base budgeting &ZBB' begins #ith a $ero balance and formulates objectives to

be achieved. ll activities are analy$ed for the current year. he manager may

decide to fund an eisting project at the same level as last year after the revie#.

o#ever, it is most li*ely that funding #ill be increased or decreased, based on ne#

information. It is also possible that an alternative #ay may be used for that project,

based on current cost or time considerations.
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he ZBB approach sets minimum funding amounts for each major activity 'e.g., product,service(. )mounts above the minimum level must be fully justified in order to beapproved by upper management. Each program, product, or service is looked at each yearto determine its benefit. If an activity cannot be supported as having value, it is notfunded. he manager is not concerned with the past but rather looks at the current and

future viability. he manager, in effect, discards the deadwood. *rograms withinefficiencies, waste, and anything that no longer makesfinancialsense are dropped.

he ZBB process involves+

eveloping assumptions

-anking proposals

)ppraising and controlling

*reparing the budget

Identifying and evaluating decision units

ctivity 1nits

+anagers should have control over the activities in their responsibility unit. hey

must be thoroughly familiar #ith ho# their department functions and #hat

resources are needed for staff and money. ctivities should be detailed to sho# #or*

flo#.

he activity unit is an important cost element of ZBB. It is the lowest unit within thecompany for which a budget is prepared. )n activity unit may represent a function,

program, organiational unit, or line item. ) manager is typically accountable for theperformance of a unit. ecision units include research and development, $uality control,computer services, legal, engineering, production, marketing, and personnel.

here are alternative operating modes for activity units, including centraliing theactivity, decentraliing the functions, integrating the operations, e"panding or reducingactivities, and eliminating the function. *roductivity and effectiveness measures shouldbe utilied. he manager should consider financialinformation, workload, andestablished standards.

+easures of performance include+

0roduction controlnumber of manufacturing trouble spots and poor

productivity 2uality controlnumber of rejections and other deficiencies

3egional mar*eting managernumber of lost accounts and reasons for their

loss

4ontrol measures include+
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/uarterly output appraisal, using predetermined performance standards

/uarterly modifications to the budget, based on current information

0omparing actual cost and time to budgeted cost and time for variance

determination

ecision units should be compared within the company, particularly those that arecomparable in sie 'e.g., number of workers, total assets, and revenue(. *riority should begiven to activities that must conform to legal re$uirements, industry practice, or otherconstraints.

5ecision 0ac*ages

he first major step in $ero base budgeting &ZBB' is the development of decisionpac*ages for eisting and ne# programs. he decision pac*age contains a

description of the project, specific measures, and employee responsibilities. he

pac*age includes the manager6s recommended #ay of producing a product or

rendering a service in terms of cost and time. lternative #ays of performing the

activity are also specified. or eample+ improving the $uality will increase the cost.%urther, reducing the time also may increase the cost because of overtime pay.

decision pac*age contains this information+

escription of the activity and reasons to carry it out

1tatement of objectives and benefits to be derived he plan to achieve the program

he priorities established

0ost and time estimates along with evaluation

)lternative methods of achieving the activity stated in cost and time

2easures of output

-esources needed, including physical and personnel support from other

responsibility centers 3egal, technical, and operational aspects

-isk considerations

ecision packages must be reviewed carefully for possible deficiencies. 2anagers shouldassure themselves that the packages are complete and independent. %urther, decisionpackages should not cross functional and organiational lines. If information is missingor packages are lumped together, misleading conclusions may be drawn.


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) decision package can be either mutually e"clusive or incremental. he former arealternative options, meaning that the acceptance of one precludes the acceptance ofanother. Incremental packages involve additional effort levels. %or e"ample, one packagemay necessitate 4,555 labor hours per month while another may re$uire 4,655 hours forthat month.

ecision packages may cover either a short#term or long#term period. ) matching ofresources with objectives is necessary. Emphasis should be placed on higher return areas.he format of decision packages should be standardied. 7pper management has toapprove the decision packages formulated by managers.

3an*ing 0roposals 4onduct

In ran*ing proposals, upper management #ill rely heavily on the recommendations

made by managers #ho have a *een *no#ledge of their decision units. 2uantitativeand "ualitative factors must be considered. cost/benefit analysis should be

performed for each decision unit.

he ranking of decision packages goes in the order of decreasing benefit. he managermust identify those products or services that are the most crucial. he highest priorityshould be assigned to the minimum increment of service below which the unit cannotoperate effectively.

op management performs the final ranking after obtaining initial recommendations ofmanagers within the company&s divisions, departments, and cost centers. If a manager&s

recommendations are rejected, he or she should be notified why.

) dollar cutoff must be established for programs depending on budgetary constraints. %ore"ample, an 85 percent cutoff may be set, so if the programs total 9: million, only9855,555 is in available funds. he manager should also rank non#funded packages, inthe event that additional funds become available at a later date.

) low#priority item may later become a high#priority one because of changedcircumstances. %or e"ample, the political climate may change due to a new legislature,governor, mayor, or president. *riorities may change during the year, so adjustments maybe necessary.

ifferent ranking techni$ues may be used, such as single standard, voting, and majorcategory. 1ingle standard is best for similar packages. )ll packages are evaluated basedon only one feature, such as revenue, earnings, return on investment, net present value,amount saved, and cost;benefit ratio. his approach is not suitable for dissimilar packagesbecause it may not incorporate an essential aspect, such as health and safety. 7nder thevoting method, there is a voting committee. Each member appraises the decisionpackages. he packages then are discussed at the committee meeting.
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he ranking is based on a committee vote. 7nder the major category approach, decisionpackages are classified into areas. ecision packages are then ranked by categories, withmore important ones receiving greater emphasis. ) category promising rapid growth mayreceive :5 times the funding of a $uestionable category of high risk and limited earningpotential.


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) project should be segregated into major activities or tasks, which should then besubdivided into specific sub#activities. *rogram budgeting e"amines the tasks needed tocomplete a program, the manpower re$uired, and the time period for each activity.

*rogram budgeting includes planning, programming, and budgeting. It accumulates data

and reviews the detailed plans. It contains a mi" of resources, including staff, e$uipment,raw materials, and capital to achieve the desired objective within a reasonable timeperiod. )lternatives are appraised. here is a downward progression of the decision#making process. here is an emphasis on output goals of products and services ratherthan input goals. he budgeting is future#oriented, e"amining the effect of currentdecisions on future results.

*rogram budgets are used for programs or projects of a one#time, long#term natureinvolving large cash outlays. )ny potential problems should be anticipated.-esponsibility should be assigned for particular activities. )djustments to the plan maybe re$uired.

) cost;benefit analysis should be undertaken for programs. here should be a ranking ofprograms in priority order. *rogram interrelationships must be identified. here should bea tracing of costs to individual projects, products, services, or individuals. his may beaccomplished by assigning project numbers and having staff enter code numbers into thecomputer when supplies are re$uisitioned, e"penses incurred, and salary payments made.

=ork packages have to be approved by segment managers. ) time sheet is prepared forproject activities. Estimated and actual times are compared to see if deadlines are beingmet. here should be a time schedule for each stage of the project. his schedule shouldcover the phases of planning, programming, and budgeting. )ctivities should be timed

and scheduled, using the program evaluation and review techni$ue '*E-(. =ork shouldbe inspected at key points.

Zero-base Budgeting !ffects

he manager must consider the negative effect, if any, of not accepting a proposed

project. or eample, if the production manager does not buy a certain type of

machine, that #ill cause "uality problems #ith the product.

cost/benefit analysis must be underta*en to see if the benefits derived from $ero-base budgeting &ZBB' are #orth the costs incurred. Because of the costs and time

re"uired, ZBB should be conducted over a span of years (e.g., three years) instead of

one year. n annual evaluation is not cost effective. ZBB is a continual process

because decision pac*ages must be revised for un-epected events .

statement of cash flo#s is a re"uired part of a complete set of financialstatements

for business enterprises and not-for-profit organi$ations. he primary purpose of
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ac$uired or incurred. In other words, it is necessary to evaluate the facts andcircumstances of each situation, rather than applying a mechanical prescription.

inancing ctivities# %inancing activities result from transactions with owners

and lenders that provide financial resources to the reporting entity or return orrepay those resources to those owners and lenders. he financing activities of

not#for#profit organiations also include receiving contributions from donors thatre$uire the resources to be used for long#term purposes, such as an endowmentrestricted for the purchase of long#lived assets.

;perating ctivities#


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5isclosure of


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5isclosure of the follo#ing noncash investing and financing activities may be added

to the statement or reported in the accompanying notes+

)c$uiring an asset through a capital lease or by incurring long#term

debt0onversion of debt to e$uity

E"change of noncash assets or liabilities for other noncash assets or liabilities Issuance of ownership shares to ac$uire assets

tatement &4ase !ample'

1nder a cash and cash e"uivalents basis, the changes in the cash account and any

cash e"uivalent account is the @bottom lineAfigure of the statement of cash flo#s.1sing the ?99@ and ?99A balance sheets sho#n belo#, let6s try to construct a @4ash

lo# >tatement@both for direct and indirect method.

Balance >heet !ample


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!arning and 4omprehensive Income >tatement !ample


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dditional Information (all relating to ?99A)

E$uipment costing 9,555 with a book value of 9>,555 was sold for 96,555.

he company received a 94,555 dividend from its investment in CDZ, accounted

for under the e$uity method and recorded income from the investment of 96,555that is included in other income.

he company issued >55 shares of common stock for 96,555.

he company signed a note payable for 9,555.

E$uipment was purchased for 98,555.

he company converted 9:6,555 bonds payable into 655 shares of common

stock. he book value method was used to record the transaction.

) dividend of 9:>,555 was declared. E$uipment was leased on ecember 4:, >55. he principal portion of the first

payment due ecember 4:, >5:5, is 9F55. he company sold half of their available#for#sale investments during the year for

98,555. he fair value of the remaining available#for#sale investments was98,655 on ecember 4:, >55.

he income ta" rate is 4G.

0reparing 4ash lo# >tatement 1sing 5irect +ethod

%hen preparing the statement of cash flo#s using the direct method, gross cash

inflo#s from revenues and gross cash outflo#s to suppliers and for epenses arepresented in the operating activities section.

In preparing the reconciliation of net income to net cash flo# from operating

activities (indirect method), changes in all accounts (other than cash and cash

e"uivalents) that are related to operations are additions to or deductions from net

income to arrive at net cash provided by operating activities .


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-account analysis may be helpful #hen preparing the statement of cash flo#s .

-account is set up for each account, and beginning (?99@) and ending (?99A)

balances are ta*en from the appropriate balance sheet. dditionally, a -accountfor cash and cash e"uivalents from operating activities and a master or summary -

account of cash and cash e"uivalents should be used.

he -ccounts


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(a). 0ash and 0ash E$uivalents5 'netincome( and the credit is to -etained Earnings.

(b). epreciationis not a cash flowH however, depreciation e"pense was deducted toarrive at net income. herefore, )ccumulated epreciation is credited and 0ash and

0ash E$uivalents,555, which is the result of the e$uity in the earnings of CDZ of 96,555 and the receiptof a 94,555 dividend. ividendsreceived 'an inflow of cash( would reduce theinvestment in CDZ, while the e$uity in the income of CDZ would increase theinvestment without affecting cash. he journal entries #ould have been+

ebitJ. 0ash 'dividend received( K 94,5550reditJ. Investment in CDZ K 94,555
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ndHebitJ. Investment in CDZ K 96,5550reditJ. E$uity in earnings of CDZ K 96,555he dividend received '94,555( is an inflow of cash, and the e$uity earnings are not.

ebit Investment in CDZ for 96,555, credit 0ash and 0ash E$uivalents,555ndHebitJ. ividends payable K 9,5550reditJ. 0ash ,555

hese transactions result in an outflow of cash. ebit -etained Earnings 9:>,555 andcredit ividends *ayable 9:>,555. )dditionally, debit ividends *ayable 9,555 andcredit 1ummary of 0ash and 0ash E$uivalents 9,555 to indicate the cash dividends paid

during the year.

(j). )ccounts -eceivable'net( decreased by 9>,555. his is added as an adjustment tonet income in the computation of cash provided by operating activities. he decrease of9>,555 means that an additional 9>,555 cash was collected on account above and beyondthe sales reported in the income statement. ebit 0ash and 0ash E$uivalents,555.
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(*). Inventories increased by 96,555. his is subtracted as an adjustment to net income inthe computation of cash provided by operating activities. )lthough 96,555 additionalcash was spent to increase inventories, this e"penditure is not reflected in accrual#basiscost of goods sold. ebit Inventoryand credit 0ash and 0ash E$uivalents,555 e"pense L 9:,555 increase in interest payable(. ebit 0ash and 0ashE$uivalents,555 for the

e"pense.

(p). he following entry was made to record the incurrence of the ta" liability+

ebitJ. Income ta" e"pense K 9,:850reditJ. Income ta"es payable K 9,:850reditJ. eferred ta" liability K 94,555

herefore, 9,:85 was deducted in arriving at net income. he 94,555 credit to eferredIncome a"es was accounted for in entry e. above. he 9,:85 credit to a"es *ayabledoes not, however, indicate that 9,:85 cash was paid for ta"es. 1ince a"es *ayable

increased 9:,:85, only 96,555 must have been paid and 9:,:85 remains unpaid. ebit0ash and 0ash E$uivalents


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ebitJ. Bonds payable K 9:6,5550reditJ. 0ommon stock '655 shares O 9:5 par( K 96,5550reditJ. )dditional paid#in capital K 9:5,555

)djust the #accounts with a debit to Bonds *ayable, 9:6,555H a credit to 0ommon

1tock, 96,555H and a credit to )dditional *aid#in 0apital, 9:5,555.

(r). Item 8. under the additional information indicates that leased e$uipment was ac$uiredon the last day of >55. his is also a noncash financing activity and should be reportedin a separate schedule. he follo#ing entry #as made to record the lease transaction+

ebitJ. 3eased asset K 96,5550reditJ. 3ease obligation K 96,555

(s). he company sold half of its available#for#sale investments during the year for98,555 'additional information, item .(. he entry for the sale of the investments #as+

ebitJ. 0ash K 98,5550reditJ. Investment in available#for#sale securities K 9F,6550reditJ. Main on sale of investments K 9655

his transaction resulted in an inflo# of cash. ebit 1ummary of 0ash and 0ashE$uivalents 98,555, credit Investment in )vailable#for#1ale 1ecurities 9F,655, and credit0ash and 0ash E$uivalents,655 O 4G( K 955

he change in %P of the remaining securities at year#end 'as listed under additional

information, item .( must be adjusted. he book value of the securities before theadjustment above is 9,555 '9F,655 L 9:,655(. he fair value of the securities is 98,655.)n adjustment of 9>,655 is necessary.

(t). he cash and cash e$uivalents from operations '9:6,555( is transferred to the1ummary of 0ash and 0ash E$uivalents.ll of the changes in the noncash accounts have been accounted for and the balance


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in the >ummary of 4ash and 4ash !"uivalents account of ?8,999 is the amount of

the year-to-year increase in cash and cash e"uivalents. he formal statement may

no# be prepared using the -account, >ummary of 4ash and 4ash !"uivalents .

he alphabetic characters in the statement belo# refer to the entries in that -

account. he follo#ing statement of cash flo#s is prepared under the directmethod.

ection

4ash received from customersK Net sales Q Beginning );- L Ending );-9:5>,555 K 9:55,555 Q 9::,555 L 9,555

4ash paid to suppliersK 0ost of goods sold Q Beginning );* L Ending );* Q Endinginventory LBeginning inventory

9F6,555 K 95,555 Q 9:>,555 L 9>,555 Q 9:?,555 L 9,555

4ash paid for operating epensesK


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Interest paidK Interest e"pense Q Beginning interest payable L Ending interest payable9:,555 K 9>,555 Q 9>,555 L 94,555

aes paidK Income ta"es Q Beginning income ta"es payable L Ending income ta"espayable

L 0hange in deferred income ta"esoperating portion96,555 K 9,:85 Q 9:,555 L 9>,:85 L 94,555

0reparing 4ash lo# >tatement 1sing Indirect +ethod

%hen a statement of cash flo#s is prepared using the direct method of reporting

operating cash flo#s, the reconciliation of net income to operating cash flo#s must

also be provided. he -account, 4ash and 4ash !"uivalents;perating ctivities

is used to prepare the reconciliation.

he alphabetic characters in the reconciliation belo# refer to the entries in the -

account.

Documents

Zera Based Budgeting