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Capital Budgeting and Capital Accounting Systems

Capital Budgeting and Capital Accounting Systems 

These internal accounting systems facilitate and support decision-makers in assessing potential investments with respect to cost effectiveness.

The purpose of capital accounting systems support decision-makers in monitoring and planning liquidity.

Capital budgeting and capital accounting

What is Capital Budgeting?

Capital budgeting is the planning process used to determine whether an organization’s long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth the funding of cash through the firm’s capitalization structure.

Capital budgeting systems is a framework that support management in making decisions in the context of capital investment decisions.

In particular, capital budgeting systems help to determine whether or not a capital investment will earn back the original expenditure  and in addition provide a reasonable return.

This type of decisions usually entails large amounts of organizational resources at risk and, at the same time, affects the future development of the organization .

Capital budgeting systems usually focus on capital investment decisions that cover many years. This discriminates capital budgeting systems from income determination and planning which usually focus on the current period.

Capital investment decisions usually encompass cash inflows and outflows that accrue at different points in time which are usually answered by adding accrued interest of discounting of cash-flows.

Capital budgeting process consists of six steps:

  1. Project Generation
  2. Estimation Of Cash-Flows
  3. Progress Through The Organization
  4. Analysis And Selection Of Projects
  5. Authorization Of Expenditures And
  6. Post-Audit Investigations. 

In the step of

(1) project generation, potential investments are chosen for which in step

(2) potential cash-flows are estimated. In step

(3), i.e., progress through the organization,  certain projects require approval of top-management. In step

(4),  analysis and selection of projects, the selected projects are assessed with respect to the fact that cash inflows and outflows usually realize at different points in time. In Step

(5), authorization of expenditures, captures the final decision (usually made by top management) on whether or not to invest into the selected project. Finally, in step

(6) captures a post-audit investigation, i.e., after a certain period of time actual results might be gained which potentially provide input for control purposes.

Capital budgeting systems particularly support management in step (4), i.e., the analysis and selection of projects. Capital accounting systems support management in planning and controlling liquidity.

Courtesy: S. Leitner, Information Quality and Management Accounting, Lecture Notes in Economics and Mathematical Systems