Incremental budgets

Question 1

What is an incremental budget

Answer 1

An incremental budget is based on a previous budget but with a % increase added. This is to allow for inflation and other cost increases.

Question 2

What are the advantages and disadvantages of incremental budgeting

Answer 2

Advantages

• It is a simple, low-cost budget system
• If the business is fairly stable, the budget produced by this method might be sufficient for management needs.
• There are some items of cost where an incremental budgeting approach is probably the most practical. For example, the easiest way of budgeting telephone expenses for next year might be to base the planned cost on the previous year’s budget.

Disadvantages

• The main disadvantage is that it assumes that all current activities should be continued at the current level of operations and with the same allocation of resource.
• It is backward looking in nature, since next years budget is based on what has happened in the past. In a dynamic and rapidly changing business environment, this approach to planning is inappropriate.
• It is often seen as a desk bound planning process, driven by the accounts department.
• The performance targets in the budget are often unchallenging, based on past performance. Incremental budgeting does not encourage managers to look for ways of improving the business.
• Where there are excessive costs in the budget for the current year, these will be continued in the future. Incremental budgeting is not a planning system for cutting out waste and overspending.
• Consideration will not be given to the justification for each activity. They will be undertaken merely because they were undertaken the previous year
• Different ways of achieving the objective will not be examined
• Past inefficiencies will be continued
• Managers know that if they fail to spend their budget, it is likely to be reduced in the next period. They therefore try to spend the whole budget, regardless of whether or not the expenditure is justified.