## **Learning Outcomes**

After reading this article, you will be able to explain and compare incremental, zero based, and activity based budgeting. You will identify the strengths and weaknesses of each approach, discuss behavioural considerations linked to budgeting, and apply these principles to ACCA exam scenarios. By the end, you should be able to recommend suitable budgeting methods for different organisational contexts and anticipate behavioural responses.

## **ACCA Advanced Performance Management (APM) Syllabus**

For ACCA Advanced Performance Management (APM), you are required to understand how different budgeting models impact performance management and organisational behaviour. In particular, focus your revision on:

- Evaluating the strengths and weaknesses of incremental, zero based, and activity based budgeting
- Comparing traditional and modern budgeting methods
- Assessing behavioural implications, such as motivation and resistance to change, in different budgeting systems
- Making recommendations for effective budget setting in dynamic business environments
- Applying knowledge to scenario-based exam questions

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Which budgeting approach requires managers to justify all expenditures for each budget period, starting from a "zero" base?  
   a) Incremental budgeting  
   b) Zero based budgeting  
   c) Activity based budgeting  
   d) Fixed budgeting
2. A company that simply adjusts last year’s figures for inflation or minor changes is using which budgeting method?  
   a) Zero based budgeting  
   b) Activity based budgeting  
   c) Incremental budgeting  
   d) Rolling budgeting
3. True or false? Activity based budgeting focuses on estimating costs for activities that drive overheads, rather than relying on historical spending patterns.
4. Briefly explain one advantage and one disadvantage of zero based budgeting.
5. List two behavioural impacts that may arise from how a budget is set and communicated.

## **Introduction**

Budgeting is a core part of performance management, enabling planning, control, and motivation across departments. ACCA candidates must be able to compare different budget models and critically assess their strengths, weaknesses, and behavioural effects. This article examines incremental budgeting, zero based budgeting, and activity based budgeting—including how they operate and how they influence organisational behaviour.

> **Key Term: budgeting**  
> The process of preparing a detailed, quantitative plan that guides an organisation’s financial operations over a specific time period.

## INCREMENTAL BUDGETING

Incremental budgeting uses last year’s figures as the base, with adjustments for known changes or inflation. The new budget is set as the previous year’s amounts plus or minus incremental changes.

### How Incremental Budgeting Works

Managers typically review last year's budget, then add or subtract amounts for expected changes. Discretionary costs, such as marketing or R&D, may simply roll forward unless challenged.

### Advantages of Incremental Budgeting

- Simple and quick to prepare
- Low administrative cost
- Stable budgets if operating conditions are predictable

### Disadvantages of Incremental Budgeting

- Perpetuates past inefficiencies and errors—problems are carried forward
- Discourages critical review of costs; "use it or lose it" mentality may increase spend
- Poor fit for dynamic or fast-changing environments

### Behavioural Impacts of Incremental Budgeting

Incremental budgets may reduce conflict and motivate managers by providing achievable targets, but can also lead to complacency and lack of innovation.

### **Worked Example 1.1**

A university department uses incremental budgeting to set next year’s budget. Last year’s allocation was £500,000. The only planned change is an increase for inflation of 3%. The new budget is set at £515,000.

> **Answer:**  
> The department’s budget simply rolls forward prior spending, with only an uplift for inflation. There is no detailed review of whether all activities or costs remain necessary.

## ZERO BASED BUDGETING (ZBB)

Zero based budgeting requires managers to justify all budget requests, starting from a zero base. No expenditure is automatically carried over; every cost must be evaluated and approved.

> **Key Term: zero based budgeting**  
> A budgeting method where each cost element must be justified and approved in full, with no reference to prior budgets.
>
> **Key Term: decision package**  
> A document outlining an activity’s purpose, costs, and expected benefits, enabling evaluation and ranking against other activities for resource allocation.

### How ZBB Works

1. Define organisational activities and develop decision packages for each.
2. Analyse and rank these packages based on cost-benefit analysis.
3. Allocate resources to activities according to rank, until the available budget is exhausted.

### Advantages of Zero Based Budgeting

- Facilitates cost control by requiring thorough justification for all spend
- Promotes efficient allocation of resources
- Helps identify and discontinue outdated or redundant activities

### Disadvantages of Zero Based Budgeting

- Highly time-consuming and resource-intensive
- Challenging to objectively compare diverse activities with qualitative benefits
- May encourage short-term focus at the expense of long-term strategy

### Behavioural Impacts of Zero Based Budgeting

ZBB can drive more rigorous spending decisions and staff engagement, but heavy workloads may cause demotivation or resistance, especially if managers perceive the review process as excessive or unfair.

### **Worked Example 1.2**

A city council switches to zero based budgeting. The parks department submits decision packages for each park, showing costs and community benefits. After ranking, two underused parks receive reduced funding, while more resources are allocated to a popular central park.

> **Answer:**  
> Resources are directed to activities with the strongest case, rather than splitting the budget evenly or following historic trends.

### **Revision Tip**

Zero based budgeting is rarely used for all organisational spending every year. It is often reserved for discretionary areas or applied cyclically to avoid excessive workload.

## ACTIVITY BASED BUDGETING (ABB)

Activity based budgeting builds budgets based on the planned activities and the drivers that cause costs, rather than past spending levels.

> **Key Term: activity based budgeting**  
> Budgeting in which expected activity levels and cost drivers determine resource requirements, typically derived from activity based costing analysis.

### How ABB Works

1. Identify key activities required to achieve objectives.
2. Estimate the number of cost driver units (e.g. machine hours, customer service calls).
3. Calculate the resources and costs needed to support each activity, creating a detailed budget built from the ground up.

### Advantages of Activity Based Budgeting

- Links budgeting directly with strategy and operational plans
- Encourages better understanding and management of what drives costs
- Highlights non-value-adding activities for process improvement

### Disadvantages of Activity Based Budgeting

- Requires significant data collection and accurate activity analysis
- Implementation can be complex and time-consuming
- Not always suitable if overheads are not driven by measurable activities

### Behavioural Impacts of Activity Based Budgeting

ABB can increase accountability and encourage cross-functional collaboration, but may face pushback from managers due to increased transparency and perceived loss of budgetary autonomy.

### **Worked Example 1.3**

A manufacturer uses ABB to determine its maintenance budget. Forecasts predict 1,000 machine setups at an average cost of \$50 per setup. The total maintenance budget is set at \$50,000, instead of simply rolling forward last year’s spend.

> **Answer:**  
> The budget is based on forecasted activity, aligning spend with operational plans and helping management control the cost drivers.

## BEHAVIOURAL CONSIDERATIONS IN BUDGETING

Budget approaches do not only affect numbers—they shape attitudes, motivation, and organisational culture.

Key factors include:

- **Participation:** Allowing managers to be involved in setting budgets tends to improve acceptance and motivation, but may invite budgetary slack.
- **Goal Congruence:** Budgets must align individual objectives with organisational goals to avoid dysfunctional behaviour.
- **Pressure and Stress:** Unreasonable or unclear targets can demotivate and lead to manipulation of results.

### **Exam Warning**

In ACCA APM scenarios, always consider how the budget setting process and chosen methodology could impact motivation, performance, and behaviour. Criticising systems only on technical grounds may miss core exam marks.

## COMPARISON OF BUDGETING APPROACHES

| Approach             | Strengths                            | Weaknesses                           | Typical Use                |
| -------------------- | ------------------------------------ | ------------------------------------ | -------------------------- |
| Incremental          | Quick, stable, familiar              | Carries over inefficiencies          | Stable environments        |
| Zero based (ZBB)     | Challenging, cost-focused            | Time-consuming, subjective rankings  | Discretionary spending     |
| Activity based (ABB) | Aligned with activities/cost drivers | Data intensive, complex to implement | Where activities are known |

## **Summary**

Incremental budgeting is efficient but risks entrenching inefficiency. Zero based budgeting forces reassessment of all spend but is demanding to implement. Activity based budgeting provides detailed alignment with operational needs, but needs accurate data. Behavioural impacts—such as motivation, empowerment, and resistance—must always be considered when recommending a budget system.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Explain and distinguish between incremental, zero based, and activity based budgeting
- Assess the advantages and disadvantages of each approach
- Describe behavioural impacts linked to different budgeting systems
- Apply budget model knowledge to ACCA scenario questions
- Recognise typical exam pitfalls when discussing budgeting behaviour

## **Key Terms and Concepts**

- budgeting
- zero based budgeting
- decision package
- activity based budgeting

Budget approaches and behavioural impacts - Incremental zero based and activity based budgeting