Advance cost accounting - Article Example

Advance Cost Accounting Capital budgeting is the planning process that entails the determining by a business whetherits long term investments, which include projects such as new buildings, machinery, plants and products, are worth the cash funding through its capitalization structure. Capital investment recognizes money’s time value and has its focus on individual investment projects throughout their full lives. This serves the purpose of considering cash flows and savings from investing in one project.

On the other hand, cost analysis can be viewed as a technique of economic evaluation involving methodical collection, classification and analysis of intervention or program costs. Hongren, Datar and Foster explain capital budgeting as having six stages that are, in that order, identification, search, information acquisition, selection, financing and implementation and control stages (7). Formal methods employed in capital budgeting that use incremental cash flows of potential projects include techniques such as discounted cash flow, internal rate of return, equivalent annuity, net present value, payback period and profitability index.

Essentially, through the discounted cashflow method, the expected outward and inward flow of cash in a project are calculated as if they took place together at one time so they can be averaged appropriately. The net present value and internal rate of return are methods of discounted cash flow, and the internal rate of return is a function of the expected net annual cash flow and present value annuity factor (Hongren, Datar & Foster 19). Compared to internal rate of return, net present value is more advantageous because its end result is not expressed as a percentage but, rather, in dollars, and it provides the opportunity to add individual projects.

Further, it is applicable in situations in which the required rate of return of a project varies throughout its life. On the other hand, it is not possible to add or average a project’s individual rate of return to derive internal rate of return of several combined projects (Hongren, Datar & Foster 22). Through the identification stage, the need to consider venturing into a new project is identified by the management, and several alternatives will be yielded in the search stage, although the focus will remain on a particular project (Hongren, Datar & Foster 8).

Decisions deemed to be of a strategic nature call for the management to consider a wide scope of factors that cannot be easily estimated. While information will be acquired by the administration in the information acquisition stage, it is the management that will decide whether to proceed with the particular project in the selection stage. Essentially, they will only accept projects with positive or zero net present values. Ideally, through capital budgeting, firms plan their long term corporate fiscal projects that relate to investments that are funded by and affect their capital structures.

From this perspective, cost analysis takes on two dimensions, which are project dimension and accounting period dimension (Hongren, Datar & Foster 3). Life-cycle costing is the accounting system corresponding to project dimensions and the duration it will take to earn a project’s initial investment is measured through the payback method. Post-investment audits compare a project’s actual results to the expected costs and benefits at the time of selecting that particular project by providing feedback on performance.

Works CitedHongren, D., Datar, C., and Foster, S. Capital Budgeting and Cost Analysis. New Jersey: Prentice, 2003. Print.