Question 12

The company is using incremental budgeting.

Incremental budgeting involves adjusting the previous year's budget to account for changes, such as increases or decreases. In this case, the company is increasing last year's budget by 5%, which aligns with the incremental budgeting approach.

A) Flexible budgeting

Flexible budgeting allows for adjustments based on varying levels of activity or sales. However, in this scenario, the company is not adjusting its budget based on activity levels but rather increasing a fixed amount from the previous year, making this option incorrect.

B) Incremental budgeting

Incremental budgeting is characterized by making small adjustments to the previous budget, usually based on a percentage increase or decrease. The company's decision to increase last year's budget of $20,000 by 5% clearly illustrates the use of this budgeting approach, confirming it as the correct answer.

C) Zero-based budgeting

Zero-based budgeting requires that every expense must be justified for each new period, starting from a "zero base." This approach does not involve simply increasing the previous year's budget, so it does not apply in this context.

D) Activity-based budgeting

Activity-based budgeting focuses on the costs of activities necessary to produce goods or services and allocates resources based on those activities. Since the question specifies a percentage increase of a previous budget rather than a focus on activities, this option is not relevant.

Conclusion

The correct answer, incremental budgeting, is defined by its method of adjusting the previous budget, which is exactly what the company is doing by increasing last year's budget by 5%. Other options fail as they either focus on different budgeting principles or do not apply to the situation presented. Therefore, incremental budgeting is the most appropriate approach in this case.