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Performance Management · Budgetary systems and types of budget

Budgeting Approaches: Incremental, Zero-Based and Activity-Based Budgeting

Updated 11 October 2026 · Fact-checked

Incremental budgeting adds or subtracts a percentage from last period's figures. Zero-based budgeting (ZBB) starts from zero and makes every activity justify its cost through decision packages. Activity-based budgeting (ABB) builds budgets from activities and their cost drivers. Compare them on cost, effort, control and suitability.

Understand Budgeting Approaches: Incremental, Zero-Based and Activity-Based

A budget needs a starting point. The three approaches differ in where they start and how much they question existing spending.

Incremental budgeting takes last period's budget or actual results and adjusts them for expected changes, such as inflation or volume. It is quick and simple. Its weakness is that past inefficiency and unneeded spending are carried forward. It also encourages managers to spend their whole budget so it is not cut next year.

Zero-based budgeting (ZBB) ignores last year's figures. Every activity must be justified from scratch, as if it were new. Managers prepare decision packages. Each package describes an activity, its purpose, its cost, its benefits and the alternatives. Management then ranks the packages and funds them in order of priority until the budget runs out. It suits discretionary costs such as training, marketing, HR and IT support. It is less suited to direct production costs, where output drives cost.

Activity-based budgeting (ABB) applies the ideas of activity-based costing to budgeting. You identify the activities that cause cost, find each activity's cost driver, forecast the volume of each driver, and multiply by the cost per driver unit. The budget is built from the activity level needed to support planned output, not from last year's spend. It suits organisations with high overheads and varied products.

The exam asks you to explain the differences, give advantages and disadvantages, and judge which approach suits a given organisation. Always tie your answer to the scenario.

Key rules to remember

Incremental budget
New budget = Previous budget or actual × (1 + expected % change)
Adjust for inflation and any known volume or policy changes. Check whether the base is last year's budget or actual, as the question states.
ZBB decision package ranking
Rank packages by benefit relative to cost; fund from the top until the budget is used
Minimum-level packages come first. Increments above the minimum are separate packages ranked on their own merit.
Activity-based budget
Activity budget = Forecast cost driver volume × Cost per driver unit
Cost per driver unit = activity cost pool ÷ driver volume. Driver volume comes from planned output.

How to solve Budgeting Approaches: Incremental, Zero-Based and Activity-Based questions

Use this method for numerical and discussion questions on budgeting approaches.

  1. 1Read the scenario and note the type of cost: discretionary overhead, production cost, or a service or public body.
  2. 2Identify which approach the question asks about, or which you must recommend.
  3. 3For incremental figures, apply the stated percentage to the correct base and check whether it is budget or actual.
  4. 4For ZBB, define the minimum level of each activity, list the incremental levels, rank the packages and fund them in order within the limit.
  5. 5For ABB, list the activities, identify each cost driver, forecast driver volumes and multiply by the cost per driver unit.
  6. 6For discussion, give advantages and disadvantages, and link each point to facts in the scenario.
  7. 7Finish with a clear recommendation and one reason, noting any condition such as management time or cost of the exercise.

Quickest way: Approach selection shortcut

When to use it: Use this for Section A and B objective questions that ask which approach fits a situation.

  1. Look for the clue. Stable costs and a need for speed point to incremental.
  2. Discretionary costs, bloated budgets or a need to cut costs point to ZBB.
  3. High overheads, cost drivers and many products point to ABB.
  4. Note that ZBB is time-consuming and can bias managers toward short-term benefits. Incremental is cheap but perpetuates waste.
  5. Eliminate options that attach a feature to the wrong approach, such as decision packages with incremental budgeting.

Common mistakes in Budgeting Approaches: Incremental, Zero-Based and Activity-Based

  • Saying ZBB means every budget is set to zero.

    The name sounds literal.

    Fix: Say it starts from a zero base and requires each activity to be justified. Activities that pass are funded.

  • Recommending ZBB for direct production costs.

    Students remember ZBB as a cost-cutting tool and apply it everywhere.

    Fix: Link ZBB to discretionary and support costs. Production costs are driven by output, so a justification exercise adds little.

  • Treating ABB as the same as ABC.

    Both use cost drivers.

    Fix: ABC calculates product costs. ABB uses the same activity thinking to plan and control resources in the budget.

  • Listing generic advantages and disadvantages with no link to the scenario.

    Students memorise lists.

    Fix: Pick the points that fit the organisation and explain each in one sentence using scenario facts.

  • Applying the incremental percentage to the wrong base.

    The question gives both budget and actual figures.

    Fix: Underline the base in the question and apply the percentage only to it.

  • Ignoring the cost and time of ZBB in a recommendation.

    Students focus on its benefits.

    Fix: Always mention management time, training and the need for skilled managers, and suggest rotating ZBB across departments or years.

Worked examples

Example 1

A department's actual costs last year were ₹8,00,000. Next year's budget is to be set incrementally. Prices are expected to rise by 5% and activity is to fall by 10%. The cost is fully variable with activity. Calculate the budget.

Show the solution
  1. Base is actual cost: ₹8,00,000.
  2. Adjust for activity: ₹8,00,000 × 0.90 = ₹7,20,000.
  3. Adjust for price: ₹7,20,000 × 1.05 = ₹7,56,000.

Answer: The incremental budget is ₹7,56,000.

Example 2

A company has a training budget limit of ₹5,00,000 under ZBB. Packages: A, minimum training, ₹2,00,000. B, extra technical courses, ₹1,50,000. C, leadership programme, ₹2,00,000. D, optional away-days, ₹1,00,000. Management ranks them A, B, C, D in order of priority. Which packages are funded and what is the total? Then explain one advantage of the approach used.

Show the solution
  1. Fund A: ₹2,00,000. Remaining ₹3,00,000.
  2. Fund B: ₹1,50,000. Total ₹3,50,000. Remaining ₹1,50,000.
  3. C costs ₹2,00,000, which exceeds the remaining ₹1,50,000, so it cannot be funded in full.
  4. D costs ₹1,00,000 and fits in the remaining ₹1,50,000. Whether to fund D ahead of a partial C depends on whether C can be scaled. Assuming packages are all-or-nothing, fund D.
  5. Total funded: ₹2,00,000 + ₹1,50,000 + ₹1,00,000 = ₹4,50,000.
  6. Advantage: managers must justify each activity, so low-value spending such as away-days is tested against alternatives and is funded only if money remains.

Answer: Fund A, B and D, total ₹4,50,000. C is not funded because it does not fit in the remaining ₹1,50,000. The limit is not fully used, so management could consider a reduced version of C.

Exam tips

  • Write 'discretionary costs' when recommending ZBB. Examiners look for it.
  • In a discussion answer, give a balanced view and then a clear recommendation. Do not stop at lists.
  • For ABB, name the activity and its cost driver for each cost, for example purchasing and the number of orders.
  • In objective questions, match each feature to the right approach. Wrong matches are common distractors, and a wrong answer scores zero.
  • If a question mentions budgetary slack or 'spend it or lose it', link it to incremental budgeting.

Practice questions from Budgetary systems and types of budget

Budgeting Approaches: Incremental, Zero-Based and Activity-Based in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Budgeting Approaches: Incremental, Zero-Based and Activity-Based: frequently asked questions

What is the main difference between incremental and zero-based budgeting?

Incremental budgeting starts from last period's figures and adjusts them. Zero-based budgeting starts from nothing and requires each activity to be justified. ZBB questions existing spending, while incremental budgeting largely accepts it.

What are the advantages and disadvantages of zero-based budgeting?

Advantages include removing waste, linking spending to need and encouraging managers to look for alternatives. Disadvantages include the time and cost of preparation, the skill needed to write packages, and a risk of favouring short-term benefits. It can also create conflict between departments.

What is a decision package in ZBB?

A decision package describes one activity, its purpose, its cost, its expected benefits and the alternatives. Packages usually include a minimum level and extra levels. Management ranks them and funds them in priority order.

How is activity-based budgeting different from activity-based costing?

ABC allocates overhead to products using cost drivers to find product costs. ABB uses the same activities and drivers to plan the resources needed for the budget. ABB looks forward, while ABC is usually used to cost output.