AQA A-Level Accounting (7127)

## Learning Outcomes

- Define **incremental budgeting** and **zero-based budgeting**
- Explain how each method is prepared and why the starting point differs
- Calculate a simple incremental budget step by step
- Compare the advantages and limitations of both methods
- Apply each method to business situations such as stable operations or cost review
- Evaluate which method is more suitable in context for exam answers

## AQA A-Level Accounting (7127) Syllabus

For the AQA A-Level Accounting (7127), you are expected to understand budgeting methods, with a focus on the following syllabus points:

![Incremental and zero-based budgeting methods, showing previous-period adjustments versus budgeting from zero with expenditure justification.](https://static.pastpaperhero.com/images/aqa-a-level-accounting-7127-budgeting-zero-based-vs-incremental-budgeting_00.png)

_Incremental budgeting revises prior figures, whereas zero-based budgeting requires each item of expenditure to be justified from zero._

- Know that a **budget** is a financial plan prepared in advance for a future period
- Identify **incremental budgeting** as using previous budgeted or actual figures with adjustments
- Identify **zero-based budgeting** as starting from zero and requiring each item of expenditure to be justified
- Explain the advantages of incremental budgeting, including speed, simplicity and suitability for stable operations
- Explain the limitations of incremental budgeting, including carried-forward inefficiency, overspending and uneconomic activities
- Explain the advantages of zero-based budgeting, including better cost control, stronger justification and improved resource allocation
- Explain the limitations of zero-based budgeting, including time, cost, training needs and short-term focus
- Evaluate which budgeting method is more appropriate in a given business context

## Test Your Knowledge

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

1. What is the difference between **incremental budgeting** and **zero-based budgeting**?
2. Why might incremental budgeting be suitable for a stable business?
3. Why can zero-based budgeting improve resource use?
4. What is meant by “spend it or lose it” behaviour?
5. In an evaluation question, when would zero-based budgeting be more suitable than incremental budgeting?

## Introduction

Budgeting is part of management accounting and helps a business plan for the future. In Paper 2, you need to know not just what a budget is, but how different budgeting methods affect planning, cost control and decision-making.

This subtopic focuses on two methods: **incremental budgeting** and **zero-based budgeting**. They are often tested through short explain or discuss questions, but they can also appear in longer evaluation answers where you must decide which method suits a business best.

> **Key Term: budget**
> A financial plan for a business, prepared in advance.

## Introduction

A business can prepare budgets for sales, purchases, labour, cash and many other areas. The key issue here is the **method used to set the budget**. Does the business build the budget from last period’s figures, or does it start again from zero?

> **Key Term: budgetary control**
> The use of budgets to compare actual results with planned figures and investigate variances.

The strongest exam answers do more than define each method. They explain how each method works, what assumptions it makes, and why one may be better than the other in a particular situation.

### What incremental budgeting means

Incremental budgeting uses the previous budget or previous actual figures as a starting point. The new budget is then adjusted for known changes such as inflation, wage rises, expected growth in activity or other predictable cost changes.

> **Key Term: incremental budgeting**
> A budgeting method that starts with the previous budget or actual figures and adjusts them for the new period.

A useful memory phrase is:

- **incremental budgeting = last year’s budget plus adjustment**

This method assumes that the current pattern of spending is broadly acceptable. That is its strength in stable conditions, but also its weakness when old spending patterns are poor.

A simple format is:

- previous budget
- plus or minus agreed adjustments
- equals new budget

Worked example:

A department had a wages budget last year of **£120,000**. Wages are expected to rise by **5%**.

Step 1: Calculate the increase  
£120,000 × 5% = **£6,000**

Step 2: Add the increase to the previous budget  
£120,000 + £6,000 = **£126,000**

New budgeted wages = **£126,000**

If activity is also expected to rise, students should adjust carefully and only where relevant. Not all costs increase by the same percentage.

Worked example with two adjustments:

Previous maintenance budget = **£40,000**  
Inflation increase = **4%**  
Expected extra activity cost = **£3,000**

Step 1: Inflation adjustment  
£40,000 × 4% = **£1,600**

Step 2: Add all adjustments  
£40,000 + £1,600 + £3,000 = **£44,600**

New maintenance budget = **£44,600**

Common student errors:

- using only the inflation increase and forgetting other stated changes
- increasing all costs by the same percentage even when some are fixed
- treating incremental budgeting as always poor, instead of recognising that it can work well in stable conditions
  > **Test Tip:** If a question says “based on last year’s figures” or “using the previous budget as a starting point”, that points to **incremental budgeting**.

### Advantages and limitations of incremental budgeting

Incremental budgeting is generally **quick and easy to prepare**. That makes it useful when a business has routine operations and limited management time. If costs and activity are predictable, a small adjustment to last period’s figures may be enough.

It also gives continuity. Managers can plan using a familiar structure, and the administrative cost of producing the budget is relatively low.

However, the method has clear weaknesses. It does not question whether existing expenditure is still necessary. As a result, **inefficiencies and overspending remain in the budget**.

A business might continue with uneconomic activities. For example, it may keep making components in-house even if buying them in would now be cheaper. Because the method rolls forward existing spending, waste can continue unnoticed.

Another limitation is behaviour. Budget holders may spend their full allowance simply to protect next year’s budget. This is often described as **“spend it or lose it”** behaviour.

> **Key Term: budgetary slack**
> Deliberate overstatement of costs or understatement of expected performance to make targets easier to achieve.

Incremental budgeting can also keep outdated assumptions in place. If the business environment changes sharply, the previous budget may no longer be a sound base.

Summary of advantages:

- quick to prepare
- easy to understand
- low administrative cost
- suitable for stable operations

Summary of limitations:

- carries forward inefficiency
- may include uneconomic activities
- can encourage “spend it or lose it”
- weak when conditions are changing

### What zero-based budgeting means

Zero-based budgeting starts from zero. No item of expenditure is automatically included just because it was in last year’s budget. Each item must be justified before resources are allocated.

> **Key Term: zero-based budgeting (ZBB)**
> A budgeting method that starts from a zero base so each activity or cost must be justified before inclusion in the budget.

A useful memory phrase is:

- **zero-based budgeting = start from zero and justify everything**

This does **not** mean that all budgets are cut to zero. It means that past spending has no automatic right to continue. If spending is justified, it may stay the same or even increase.

The process usually involves managers reviewing activities, explaining why they matter, estimating costs and showing how the spending supports business objectives.

In practice, this may include ranking spending priorities. If funds are limited, the most important activities are funded first.

Example:

A marketing department previously spent money on:

- online advertising
- trade exhibitions
- promotional gifts

Under incremental budgeting, all three might continue with a small increase. Under zero-based budgeting, the manager must justify each one separately. If promotional gifts bring little benefit, that spending may be reduced or removed.

Zero-based budgeting is especially useful for **discretionary costs**, where there is no fixed link between spending and output.

> **Key Term: discretionary costs**
> Costs that management can choose to increase, reduce or stop, such as training, advertising or research.

It is also useful when a business wants to challenge old habits, improve cost control or respond to pressure on profits or cash.

Common student errors:

- saying ZBB means every budget is reduced
- confusing “starting from zero” with “making cuts”
- describing ZBB without explaining the need to justify each item
  > **Test Tip:** If the question says “justify each item of expenditure” or “start from scratch”, this indicates **zero-based budgeting**.

### Advantages, limitations and exam evaluation

The main strength of zero-based budgeting is that every item is examined. This makes it better for identifying waste, removing unnecessary spending and improving **resource allocation**.

> **Key Term: resource allocation**
> The process of directing money and other resources to the activities that best support business objectives.

Because managers must explain the purpose of spending, zero-based budgeting can link the budget more closely to the objectives of the business and its current environment.

It can also involve more staff in the budgeting process, which may increase motivation if employees feel their judgement matters.

But zero-based budgeting has major limits. It is **time-consuming** and more difficult to prepare than incremental budgeting. Managers may need training, and the process may cost more than the savings it produces.

That is why many businesses do not use it every year. A common practical approach is to use zero-based budgeting from time to time, with incremental budgeting in the years between.

Another weakness is that the focus may become too short term. Managers might find it easier to justify immediate benefits than longer-term spending that is still valuable.

Summary of advantages:

- every item must be justified
- can remove waste and inefficiency
- improves resource use
- links spending to business objectives

Summary of limitations:

- time-consuming
- more complex to prepare
- may need staff training
- may not be cost-effective every year
- can focus too much on the next budget period

A clear comparison is helpful in exams:

| Feature        | Incremental budgeting             | Zero-based budgeting                  |
| -------------- | --------------------------------- | ------------------------------------- |
| Starting point | Previous budget or actual figures | Zero base                             |
| Main idea      | Last year plus adjustment         | Justify all spending                  |
| Best for       | Stable, routine operations        | Changing or cost-pressured situations |
| Main strength  | Simple and quick                  | Stronger cost control                 |
| Main weakness  | Carries forward inefficiency      | Time and effort required              |

### How to structure an evaluative answer

AQA rewards application and judgement. So do not finish with “zero-based budgeting is better” or “incremental budgeting is better” without context.

A stronger evaluative answer should:

- define both methods briefly
- explain at least one advantage and one limitation of each
- apply them to the business in the question
- reach a conditional judgement

For example:

- if the business is stable, with routine costs and limited management time, incremental budgeting may be more suitable
- if the business suspects waste, faces falling profits or wants to review discretionary spending, zero-based budgeting may be more suitable

Financial evidence to cite:

- size of existing costs
- likely administrative cost of the budgeting process
- areas where spending may be wasteful
- whether costs are routine or discretionary

Non-financial points to discuss:

- manager time
- training needs
- staff motivation
- pace of change in the business environment

A good final judgement sounds like this:

“Incremental budgeting is likely to be more suitable for a stable department where costs are predictable and the cost of detailed review would outweigh the benefit. However, if the business needs tighter cost control or believes previous budgets contain waste, zero-based budgeting would be more suitable.”

## Key Point Checklist

_This article has covered the following key knowledge points:_

- A **budget** is a financial plan prepared in advance
- **Incremental budgeting** uses previous budgeted or actual figures as a starting point
- Incremental budgeting adjusts past figures for changes such as inflation or activity levels
- Incremental budgeting is quick, simple and suitable for stable operations
- Incremental budgeting can carry forward inefficiencies and uneconomic activities
- Incremental budgeting may encourage “spend it or lose it” behaviour
- **Zero-based budgeting** starts from zero and requires each item of expenditure to be justified
- Zero-based budgeting can improve cost control and resource allocation
- Zero-based budgeting is especially useful for reviewing discretionary costs
- Zero-based budgeting is time-consuming and may require staff training
- Zero-based budgeting does not automatically mean all budgets are reduced
- The best budgeting method depends on the business context rather than one method always being best

## Key Terms and Concepts

- budget
- budgetary control
- incremental budgeting
- budgetary slack
- zero-based budgeting (ZBB)
- discretionary costs
- resource allocation


Budgeting - Zero-based vs incremental budgeting