Definition
An incremental budget is a financial planning method that sets the new budget based on the figures of the previous period’s budget or actual performance, with additional amounts added incrementally. This approach adjusts budget figures upward or downward slightly from the prior period, without substantial re-evaluation of each line item. This kind of budgeting is typically based on the assumption that all existing activities and funding levels are appropriate and will continue.
Detailed Explanation
Incremental budgeting mainly focuses on the adjustments of revenues and expenses due to predictable changes. These adjustments are typically due to factors such as inflation, changes in costs of goods, or planned business expansions.
However, this approach is often criticized for its potential to perpetuate inefficiencies and lack of responsiveness to changing business environments. Incremental budgeting can result in budgetary slack where departments receive more funds than necessary, based purely on past spending behaviors.
Key Points:
- Based on Previous Period: Starts using last year’s budget as a baseline.
- Incremental Adjustments: Adds or subtracts small amounts based on anticipated changes.
- Efficiency Issues: May retain inefficiencies from previous budgets.
- Stagnant Planning: Fails to consider the changed operating conditions of the new budget period.
Examples
- Corporate Budgeting: A company that had a marketing budget of $50,000 last year might increase this by 5% due to expected inflation and forecasted growth in marketing activities, resulting in a new budget of $52,500.
- Government Budgeting: A local government authority might increase funds allocated to road maintenance by 3% per year to account for expected increases in materials and labor costs.
Frequently Asked Questions (FAQs)
Q1: What are the advantages of incremental budgeting?
- A1: Incremental budgeting is simple and easy to implement. It saves time since only small adjustments are needed. Moreover, it ensures stability and consistency in budgeting across departments or periods.
Q2: What are the disadvantages of incremental budgeting?
- A2: It can perpetuate inefficiencies and wastes, as it does not challenge current spending levels. This method may also ignore changing conditions or new opportunities, resulting in outdated and irrelevant budgeting.
Q3: How does incremental budgeting compare to zero-base budgeting?
- A3: While incremental budgeting makes small adjustments to the previous period’s budget, zero-base budgeting starts from zero, requiring every expense to be justified for each new period without reference to prior spending.
Q4: Is incremental budgeting suitable for all types of organizations?
- A4: It is more suitable for stable environments where costs can be predicted with reliability. For dynamic industries or those experiencing rapid changes, zero-base or flexible budgeting might be more effective.
Q5: How can one mitigate the disadvantages of incremental budgeting?
- A5: Periodically conducting zero-base budgeting or performance reviews can help to minimize inefficiencies and ensure that budgets align closely with current organizational needs and conditions.
Related Terms
- Zero-Base Budgeting: A method where every expense must be justified for each new budget period, starting from a “zero base.”
- Flexible Budget: A budget that adjusts or flexes with changes in volume or activity levels.
- Rolling Budget: Continuously updated budget projections, typically monthly or quarterly, to reflect real-time changes and conditions.
Online References
Suggested Books for Further Studies
- “Budgeting Basics and Beyond” by Jae K. Shim and Joel G. Siegel
- “Cost and Management Accounting” by Colin Drury
- “Zero-Base Budgeting: A Practical Management Tool for Evaluating Expenses” by Peter A. Pyhrr
Accounting Basics: “Incremental Budget” Fundamentals Quiz
### What is incremental budgeting primarily based on?
- [x] Previous period's budget or actual performance
- [ ] Zero-based evaluations
- [ ] Random allocations
- [ ] New revenue predictions
> **Explanation:** Incremental budgeting uses the previous period's budget or actual performance as the starting point, and adds incremental amounts for the new budget period.
### Which of the following is a main criticism of incremental budgeting?
- [ ] Too complex to implement
- [ ] Requires significant re-evaluation regularly
- [x] Fails to account for changes in operating conditions
- [ ] Involves frequent revisions
> **Explanation:** Incremental budgeting often fails to consider changing operating conditions, potentially perpetuating inefficiencies from previous budgets.
### What type of adjustments are commonly made in incremental budgeting?
- [ ] Random fluctuations
- [x] Incremental amounts added or subtracted
- [ ] Complete re-budgeting
- [ ] Fixed periodic amounts
> **Explanation:** Incremental budgeting involves incremental amounts that are added or subtracted, based on predictable changes like inflation.
### What budgeting approach requires each expense to be justified from zero?
- [ ] Incremental Budgeting
- [x] Zero-Base Budgeting
- [ ] Line-Item Budgeting
- [ ] Flexible Budgeting
> **Explanation:** Zero-Base Budgeting requires every expense to be justified from zero, unlike incremental budgeting which adjusts based on previous data.
### Incremental budgeting is most suitable for which type of environment?
- [x] Stable environments with predictable changes
- [ ] Rapidly changing industries
- [ ] Start-ups
- [ ] Non-profit organizations
> **Explanation:** Incremental budgeting is suitable for stable environments where costs and revenues can be forecasted with relative certainty.
### What main feature differentiates zero-base budgeting from incremental budgeting?
- [ ] Focus on revenue generation
- [ ] Use of historical data
- [x] Justifying expenses from zero every period
- [ ] Annual audits
> **Explanation:** Zero-base budgeting starts from a "zero base," requiring each new period's expenses to be justified without relying on historical data.
### Which of the following is NOT typically adjusted in incremental budgeting?
- [ ] Operational costs
- [ ] Inflation rates
- [ ] Sales budgets
- [x] New product launch costs
> **Explanation:** Incremental budgeting adjusts for predictable changes in ongoing costs but may overlook new activities like product launches which require different budgeting approaches.
### Which method can help mitigate the inefficiencies of incremental budgeting?
- [ ] Adding more increments automatically
- [x] Conducting periodic zero-base budgeting or performance reviews
- [ ] Extending the budget period
- [ ] Decreasing the budget limits
> **Explanation:** Periodically using zero-base budgeting or performance reviews helps ensure up-to-date and efficient budgeting practices.
### Incremental budgeting is often criticized for:
- [ ] Its simplicity
- [ ] High implementation cost
- [x] Encouraging budgetary slack
- [ ] Complex adjustments
> **Explanation:** Incremental budgeting can encourage budgetary slack where departments justify inflating their budgets based on achieved figures rather than actual needs.
### A company adjusting last year's maintenance budget by 5% due to inflation is practicing which type of budgeting?
- [ ] Zero-Base Budgeting
- [ ] Continuous Budgeting
- [ ] Activity-Based Budgeting
- [x] Incremental Budgeting
> **Explanation:** The company is practicing incremental budgeting by adjusting last year's budget upwards by a percentage due to predictable changes, such as inflation.
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