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Chapter 12
Managerial Accounting
Capital Budgeting
Prepared by Diane Tanner
University of North Florida
Capital Budgeting Decisions
What are capital budgeting decisions?
 Investment planning decisions involving the
acquisition of long-term assets
 Impact more than one accounting period
 Long-term assets costs are allocated
over multiple accounting periods
 Require a ‘capital’ investment
 i.e., Acquisition of a capitalized asset
 Related cash flows appear as investing
activities on the statement of cash flows
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Examples of Long-Term Assets
Plant and equipment assets
Equipment
Furniture & fixtures
Buildings
Land
Expansions such as subsidiaries
Intangible assets
Patents
Trademarks
Copyrights
Franchises
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Financial Accounting Review
• Upon acquisition, capitalize a long-term
asset:
•Increase the respective Asset account
•Decrease Cash
• Depreciate or amortize the cost of the asset
over its useful life
• Asset reporting
• In the Long-term Assets section of the
balance sheet, and
• As an investing activity on the statement
of cash flows
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Capital Budgeting Methods
 Methods of evaluating capital budgeting
decisions
 Net present value (NPV)
 Internal rate of return (IRR)
 Payback period method (PBM)
 Accounting rate of return (ARR)
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Cash Flows with Capital Budgeting
Decisions
 Types of cash flows present in all capital
budgeting decisions
 Operating cash flows
 Occur every year as net inflows (hopefully)
 Inflation and other budgeting issues may cause
differences in amounts each year
 Investing cash flows
 Occur at time 0 (beginning of year 1) as an
outflow for the cost of acquiring the asset
 Occur at end of the useful life as a cash inflow for
the salvage value
 If an old asset if sold, occurs at the time the new
asset is being acquired
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Planning Capital Budgeting Decisions
 Use time lines to identify timing of cash flows
 Why?
 Because acquisition of long-term assets
requires a period of time for the company to
get its ‘money’ back
 Time lines should show all cash inflows and outflows
 Operating cash flows from revenues and expenses
 Investing cash flows from acquisition and disposition
0
1
2
3
(500)
120
90
140
4
110
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Assumptions of Cash Flows
 All revenues are received in the same year
earned
 All expenses are paid in the same period as
incurred
 Annual operating cash flows occur at the end of
the year
 Conservatism
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Time Value of Money (TVM)
• Why is the timing of cash flows considered?
• Because investments extend over long
periods of time
• Investments that promise larger returns earlier
in time are preferable to those that promise
larger returns later in time
• Time value of money is needed to assess cash flows
• Interest can be considered to be a rental cost of money
Methods of Determining TVM
 Financial calculator (BAII plus professional)
 Excel
 Mathematical formulas
 Tedious
 Time value of money tables
 Limited due to very little differential in interest rates
is provided
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TVM Approach
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 Draw a time line showing all cash flows
 Discount each cash flow
 Removes the interest portion of each cash flow
 The amount remaining after discounting is the
amount that can be invested to accumulate to the
total cash for some future period
 Use the NPV (net present value) approach
 Net together all of the discounted inflows and
outflows to get the present value, or
 Use the IRR (internal rate of return) approach
 Internally determine the rate that the cash flows earn
The End
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