Traditional Budget and Zero-Based Budget | Free Essay Example

Traditional Budget and Zero-Based Budget

Words: 620
Topic: Business & Economics
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Introduction

Modern organizations use several types of budget creation. Each approach has its advantages and is suitable for specific tasks. The following paper identifies the differences between the most common approaches – a traditional budget and a zero-based budget.

Concept Definitions

In order to understand the differences, it is first necessary to provide the definition of each concept. The traditional budget can be defined as an approach that depends on cost accounting facilitated through traditional means, that is, the allocation and absorption of products’ overheads (Reka, Stefan, & Daniel, 2014). Traditional budgeting employs an incremental approach, in which the budget of the previous year serves as a basis for the creation of the new one. This is usually accomplished through the introduction of adjustments intended to increase or decrease the budget in accordance with the previously observed trends and strategies. Certain factors, such as the projected demand, the rate of inflation, and the conditions of the market, are commonly taken into account.

Zero-based budgeting can be defined as an approach in which each factor is considered separately and from zero in the process of creating a budget (Callaghan, Hawke, & Mignerey, 2014). In other words, every aspect of organizational performance is considered and assessed equally rigorously without using historical data on the subject. No connection is made to the past occurrences and phenomena – instead, independent justification is provided for each cost decision, similar to a situation where the data is unavailable. In this regard, the responsibility of justifying the expenditures as well as outlining the expected benefits associated with the proposition lies in the managers of the organization. Consequently, they are required to explain the risks associated with the rejection of the proposed budget. The described assessment process involves several tools used to measure each decision’s validity and determine its relative relevance for the organization.

Differences

As can be seen from the descriptions above, the main difference between a traditional and a zero-based budget is the use of historical data in the decision-making process. In this regard, the former relies more on previous experience, whereas the latter requires an analytical approach in order to be performed. Several aspects of this difference require a closer inspection. First, the traditional budget requires access to expenditure levels of the previous years. A zero-based budget, on the other hand, discourages such an approach and instead focuses on the current tasks at hand. Essentially, the former approach adjusts the familiar model, whereas the latter one prompts the creation of a new proposal for each specific case. For the same reason, it is possible to state that zero-based budgeting is driven by decisions whereas the traditional approach employs the cost accounting principles.

By extension, the said decision-making requires justification for the proposed course of action whereas for the cost accounting process, the account of cost and benefit is usually sufficient. Another important distinction is the authority behind each approach. Due to the specificities of the process, the traditional budget requires the approval of the top management for each area of application. The zero-based budget, on the other hand, relies on the decisions of managers from each decision unit. Next, the priority of historical data in traditional budget usually means that certain factors, such as inflation rate, are assigned secondary priority. In zero-based budgeting, the systematic assessment of each factor’s relevance provides a more comprehensive outlook.

Conclusion

As can be seen from the information above, traditional budget involves less decision-making and does not account for certain factors such as a possible priority of market conditions over the available historical data. In addition, it excludes the managers of the decision units from the process. Therefore, it can be said that zero-based budgeting is more transparent and responsive.

References

Callaghan, S., Hawke, K., & Mignerey, C. (2014). Five myths (and realities) about zero-based budgeting. Web.

Reka, C. I., Stefan, P., & Daniel, C. V. (2014). Traditional budgeting versus beyond budgeting: A literature review. Annals of Faculty of Economics, 1(1), 573-581.