When it comes to making decisions, the relevance of capital budgeting cannot be understated. Some of the most important decisions that are informed by capital budgeting include but are not limited to marketing decisions as well as financing decisions. In this text, I explore the main differences between capital and current expenditure budgeting. I also concern myself with why we should treat capital any differently.
There are a number of decisions that confront business as well as government entities on a day to day basis. These decisions include whether or not to undertake certain projects i.e. on whether to build a new premise, whether to reconstruct a run-down social hall, whether to undertake an alternative project etc.
It is also important to note that if an entity undertakes investment decisions haphazardly without instituting a number of decision making tools including but not in any way limited to capital as well as current expenditure budgeting vast amounts of money may end up being lost as some courses of action may largely be untenable as well as inherently uneconomic.
According to Jacobs, distinguishing non-investment expenditures from investment expenditures can in some instance end up being an uphill task (Jacobs 8). This is more so in the case where we may have preferential treatment being given to investment spending. In such a case, when such treatment informs the annual budgeting process, we may have some current expenditure being classified as capital expenditure.
Hence as it is noted elsewhere in this text, it might be prudent to come up with a threshold of sorts so as to ensure that current expenditures are put apart from capital expenditures. According to Jacobs when it comes to budgeting, the time period involved is in most cases invoked to differentiate current expenditure and capital expenditure (Jacobs 10). By definition, current expenditure represents all the purchases of items whose consumption shall be undertaken in the near future i.e. a single financial year.
In most instances, we have petty expenditures being billed as current expenditures. It can be noted that when it comes to distinguishing current expenditure budgeting from capital expenditure budgeting, a number of approaches can be taken. To begin with, capital budgeting involves projects that are in one way or the other larger than those instituted when it comes to current expenditure budgeting. Hence when it comes to budgeting capital expenditure, we do have a threshold of sorts for those projects which are significantly large.
With that in mind, there is need to investigate a project and take note of its total outlay before deciding on whether the same falls under capital budgeting or current expenditure budgeting. Some of the tropical projects which fall under capital budgeting include but are not in any way limited to the purchase of equipments, carrying our long-term advertisement campaigns as well as instituting R&D projects.
One of the main reasons of why we can’t use current expenditure budgets for large projects is due to the large funds outlays involved. Hence there needs to be a clear and concise way of raising such funds as well as a plan on how the repayment of the same should be done. Hence because capital budgeting calls for commitment that is relatively long-term, it comes across as better placed for large projects.
Secondly, another issue that informs variation in how we budget capital as opposed to current expenditure is the time frame involved. In most instances, if a given project takes more than one year to its completion, capital budgeting may come in handy. It is important to note that decisions touching on capital budgeting call for a commitment that is significantly long term.
Capital budgeting is relevant for the long-term because of the mechanics involved. For instance, when there are significant amounts to be raised, it may be prudent to pay particular attention to a number of factors including but not in any way limited to the prevailing interest rates as that is what largely affects the cost of capital. Some of the models that are most often used when it comes to capital budgeting include the profitability index models, the IRR or what is known in other words as the internal rate of return, the present value, the accounting rate of return and finally the payback period.
All these models require the long-term outlook and this is the main reason why in some scenarios, it may be preferable to make shifts which are largely relevant when it comes to either utilizing capital budgeting or current expenditure budgeting. It can hence be noted that over time, business organizations as well as government units have come up with a number of procedures which are designed to indicate the relevance as well as procedures of budgeting capital and those of budgeting current expenditure.
According to Jacobs, there are many reasons why capital and current expenditure ought to be treated differently (Jacobs 8). To begin with, there is need to highlight capital expenditure within a budget for purposes of clearly bringing out those issues which according to the government are priorities. Further, as it shall be detailed in the section below, there are a number of capital-specific procedures which must be followed as a result of the sums of money involved.
These procedures are mainly founded on not only the evaluation but also the selection of projects and in some instances; they might be brought in to assist in the management of various projects as well as the procurement of a number of assets. Further, their relevance can be extended into the capital assets disposal. In regard to tax, it is important to note that some projects which capital finances are not settled in the year in which they are incurred. Instead, they are capitalized and in so doing, the economic lives of such projects essentially extend beyond one year.
Peterson & Fabozzi note that such projects must be capitalized (Peterson & Fabozzi, 112). It hence follows that the capital expenditures incurred in this case must be spread over the life of the project or asset and hence the utilization of a number of tools including but not limited ton amortization (for intangible assets) and depreciation. However, it may also be noted that this has been one of the most contentious issues in capital expenditure budgeting as it is largely unclear which expenses are to be expensed and which are to be capitalized.
Towards that end, current expenditure should ideally appear in the financial statements in that period in which they were incurred while when it comes to capital expenditures; the emphasis is largely on the depreciation or amortization of the incurred costs over the economic life of that which was acquired. Next, capital in this case has to be treated differently because of the nature of undertakings as well as projects involved. As already indicated in the earlier sections of this discussion, some projects tend to require significant outlays in financing and with that in mind, they can end up having significant impacts on the financial wellbeing of the firm.
Hence in that regard; capital has to be treated in a significantly different way because of the procedure involved in project selection. Closely related to this is the need to come up with estimates that are essentially reliable when it comes to making forecasts in regard to the particular decision to be made. Capital planning must therefore be undertaken by taking into consideration a number of things including but not in any way limited to equipment capital costs, the payable taxes, the shifts in working capital well as the costs of operation and technology in place (Dayananda, 101).
It is also necessary to note that there is a significant difference between the administration of current expenditure decision and the capital expenditure decision and hence in this regard, capital must be treated differently as a result of such deviations. The process that is utilized in capital budgeting is significantly longer and it typically begins with the preliminary proposal which is then followed closely by a review of the project (preliminary). After this comes the request inters of appropriation and then the final approval of the proposal review committee.
It is immediately after the said approval that the project can be initiated. The process in this case is significantly more detailed than when it comes to that involved in current expenditure budgeting because as it is stated elsewhere in this text, capital budgeting decisions have the very likelihood of affecting the financial wellbeing as well as stability of the entity.
Capital is also treated differently in some instances due to the component of borrowing though borrowing does not constitute the only component of a capital budget. However, as an important source of funds, the relevance of borrowing cannot be understated. However, despite the fact that capital should be treated differently, it is worthwhile to note that there are some instances that call for the joint consideration of both current as well as capital expenditures.
This is especially when there is a need for efficient budgeting as well as planning. It is also important to note that when there is a need for appraisal of investment proposals in terms of operating as well as capital costs, it could be prudent to undertake the joint consideration of both current as well as capital expenditures.
In conclusion, it is important to note that the distinction between current as well as capital expenditure budgets can be set apart in not only the reporting expenditure but also in the spending units accounts. However, there tends to be an emphasis on expenditure programs in their entirety when it comes to parliament debates.
Dayananda, D. Capital budgeting: financial appraisal of investment projects. Cambridge
University Press, 2002
Jacobs, D.F. Capital Expenditures and the Budget. IMF, April 2009
Peterson, P.P. & Fabozzi, F.J. Capital budgeting: theory and practice. John Wiley and