Topic: Management Accounting1. Discuss the main stages of capital budgeting procedure and explain why the original estimate may be not achievable? (10 marks)The main stages of capital budgeting procedure include the following steps. Each step below is therefore is a stage in the procedure. Step 1. Know the past performance data with similar projects or industry; Step 2 Forecast the future (forecast of relevant cash inflows and cash outflows arising from the implementation of a project); Step 3. Evaluate the forecast by using capital budgeting methods such as: NPV, IRR, ROI, Payback Period; Step 4.
Decide and Implement ( Accept or reject decision and implementation)Step 5. Actual results of the project will indicate whether the project has been a success and whether stockholders wealth increased or decreased. (Saldana, page1055 ) The original estimate may not be achievable because of different factors which may include internal and external events. Internal events may sudden death of the company’s chief officers, poor management, high cost, strife between the stockholders with the board of directors. External factors may include competition in terms of product and prices and adverse conditions in the economy.
The latter may include inflation and political strife causing economic dislocations. 2.What should the divisional management have done in these new circumstance, assuming the revise market assessment is valid? (20 marks)The divisional management should have been more observant of the market situation. If we take the findings of the market research boys that if the price is £ 9 per unit, it should have earned a higher net operating cash flow at £80,000 pounds as compared to its actual net cash flow of L 60,000.
Please see computation below. Price(£)Volume P. A. Cash InflowCash OutflowNet Operating Cash Flow12 £ 0 £ 0 £100,000 £ (100,000)1120,000220,000220,000 01040,000400,000340.000 60,000960,000540,000460,000 80,000880,000640,000580,000 60,000But it is every thing is already gone, what is important to learn the lesson. This is where the importance of post-audit activities finds purposed purpose. Without the post audit, this miscalculation would not have found. Although top management must not tell the divisional management to have under performed without any basis, the divisional management must clarify to top management that it is not their fault that estimates were wrong. When the divisional management people agreed to the estimate (assuming they did, because they are normally part of the planning) before the performance, top management was also part of the planning, hence, the divisional management could not be faulted with the wrong estimate.
The result of the post audit should be made prospective and not retroactive. Prospective means, effects will apply from now and into the future while to make it retroactive means changing the past estimates. To make it retroactive will be depriving the power of the management, of which the divisional managers are part, to make the estimate.
Case fact says, “The main-purpose of the post-audit procedures was to back-check the thoroughness rather than the accuracy of the initial project appraisal, with a view to “sharpening-up” the evaluations of subsequent investment projects. ”The managers must also realize that part of the disadvantages of an evaluation system is that employees normally have adverse reaction but the benefit that it would give is more than the perceived disadvantages.