Budgeting: An Overview Of Capital Budgeting And Its Practices In Australia And Canada

You are required to prepare a report about your findings from the literature research, and discuss how it has helped your understanding of your chosen topic. The report should cover the following:
a. An explanation of the selected management accounting topic.
b. An explanation of the purpose of the two studies and what research question(s) they set out to explore about the topic.
c. A discussion about the similarities and differences in the findings of the two studies.
d. Provide four (4) specific outcomes or lessons learned from the two studies' research findings that will be useful for management accountants in Australian companies to learn from, and justify your answer [i.e. provide 2 outcomes from each study].

Types of Budgeting

Budget is a term associated with almost any economic activity that we perform in our day-to-day lives. Its application can be seen in across all forms of routine time. In simpler terms budget can be defined as an activity to monitor, plan and control. The thing to be monitored, planned or controlled can be either time or money or any other resource that is not unlimited and carries a value. Every company needs to have a proper budget based on which they can decide what future course of action they need to take. There are many such areas in which the company might have to struggle if proper budgeting is not done (Appelbaum, et al., 2018). Budgeting helps in deciding what if there is any situation in which the management is stuck how they will come out of it. The necessity of budget comes from not only from a control perspective but also from a perspective of discipline. Without a definite course of action being set on utilization of a limited resource there are chances of it might being under or over utilized which could in turn deviate actual results of a task from the target. Now the question arises as to how to determine a budget. This process involves a host of calculations that calls for estimation and assumptions of certain costs and incomes that are to arise in the future periods.

Budget to some extent eliminates uncertainty and offers smoothness in terms of flow of funds. Regardless of the nature of the organization, its size of operations, extent of availability of a resource, it must plan and implement a budget to achieve desired results. There are various categories of budgets that are involved that are widely used in the corporates. Some of them include – Sales budget, capital budget, cash budget, project budget and revenue budget. In addition, production budget. Sales budget is considers estimated the quantum of sales the company is likely to have given the market conditions (Arnott, et al., 2017). Cash budget lists out the relevant cash expenditures to be made during a period and the amount of cash the entity expects to generate from various sources to have a picture of the cycle. Production budget is being considered with the units to be produced during the year with given amount of resources. Capital budget calculated the capital expenditures required taking into consideration the present value of time. Project budget points out all the incomes and expenses that are or will be related to a project during its operational phase. These various types of budget can be presented annually, its frequency may be increased to quarterly, or monthly depending on the requirements felt by the management as to if, it wants to have shorter period targets. There are other classifications of budgets as well based on certain attributes it possesses. There flexible budgets as well which are considered more realistic than static or fixed budgets. Flexible budgets account for increase in prices of material and labour or other factors. Management in some cases also sets performance budgets, which measure actual performances during the year against planned levels of execution (Bromwich & Scapens, 2016). One of the newer versions of budgeting is the Zero-based Budgeting, which is used when the resources are scarce and the entity feels that the pre-defined parameters of control are not effective, and computation need to be analysed from the scratch.  Out of the numerous types of budgets discussed above, we will put our focus to Capital budget, which also the topic discussed on the two journals. Along with it, we shall also have a walk-through of various advantages and disadvantages budgeting possesses (Choy, 2018).

Capital Budgeting Practices in Australia

The process of budgeting carries a host of benefit if used in an appropriate manner. Few of them are enlisted as under:

1. Financial goals are kept intact using budgeting. Unnecessary splurge of limited resource can be curtailed so that this fund could be channelized towards rewarding avenues and avoid a crunch in resources.
2. Through Budgeting, an organization can better organize its planned savings and expenditure (both capital and revenue). They can have a clear view of how much of the savings and quantity of the expenditure to be allocated to different categories. By using budgeting, the organization is better positioned to deal any adjustments that might be required to be made in each point of time(Calvasina & Calvasina, 2017).
3. With the use of budget, the organization can muscle its control over its resources. It can monitor and authorize the flow of funds, which ensures that if there were any deviations from the usual path, attention would immediately be drawn towards it. This removes the possibility of any last moment shortage of funds.
4. Budgeting removes the primary level of uncertainty and answers several ‘How’s. For instance, preparation of a cash budget will help the firm in knowing what are its expected outflows and whether it will be have the required liquidity coming from the inflows to meet the payments. If they do not have sufficient funds, they are being made aware of it at a very early stage giving them the time to act accordingly(Tysiac, 2017).
5. Since the organizations can plan the movement of their resources, life would become easier for the management when it comes to deciding the goal congruence objectives of the company.
6. Budgeting helps in improving the performance of the management and employee of the company and based on that they can decide if their functions are effective or not. If the results are not as per the budget set they can take steps to find, where the loopholes are and accordingly can function.

Like any other method of management accounting, Budgeting too carries certain downsides attached to it. Some of them are enlisted as under:

• The planning for a budget involves extensive use of time, effort and people. There is working involved in assimilation of data, its presentation and computation requirements. This involves extra cost as well.  In addition, the data prepared will need to be verified by the people who are charged with the governance responsibilities of the entity. There could be situation where the organization might not be able to stretch its resources this much. Even if they do, there could be instances where their regular operations are compromised because of this exercise(Delone & Mclean, 2004).
• Through budgeting there are allocating of resources to various departments within an entity, which at times will not be equal or proportional to their size. This has the potential to create rift between departments and where it turns out that the allocations are beneficial to one department more than the other is. There are possibilities of allegation of bias being thrown. Since it is the duty of the management to perform these allegations, it might become a very cumbersome task for them to pay more attention to the judicious nature of the allocation(Erik & Jan, 2017).
• There have been instances where there were inaccuracies observed in the calculations done in a budgeting exercise. The whole exercise involves extensive use of estimation and assumptions since budget is a way to forecast events. The parameters for this estimations and assumptions are based on the market conditions at the time of study. Since market conditions are generally volatile its highly likely that the standards set may become unrealistic in a very short span of time thereby not achieving the objective despite all the efforts in putting the budget map.
  • Sometimes the funds allocated in a budget may send a signal that is never intended the way it is perceived. There could be situation where certain may not require all the funds allocated to it. However, due to a fear of being reprimanded for spending less or being allocated less resources in the coming years, the managers end up spending the resources in a manner that may not be considered legible or may not be a wise choice. This leads to wastage of resources(Fukukawa & Mock, 2011).

For discussing the certain attributes of budgeting in detail, we have shortlisted two journals. In our assignment we have selected capital budgeting as a topic to discuss. The first journal to be selected is written and documented by Giang Truong, Maurice Peat and Graham Partington. The article is titled as “Cost of Capital Estimation and Capital Budgeting practice in Australia” (Truong, et al., 2008). The second chosen topic in this assignment is articulated and authored by Karim Bennouna, Teresa Marchant and Geoffrey G. Meredith. The article is titled “Improved Capital Budgeting Decision making: Evidence from Canada”.

The first journal focuses on the capital budgeting practices followed by listed Australian entities. The second journal is inclined towards about the evolvement of the decision-making process in Canada facilitated by capital management process. A detailed analysis is presented under:

The first journal focuses on the evolution of capital budgeting as a management analysis tool in Australia and how capital asset pricing model, which is an integral part of this tool, has been widely used in the country. Among the things highlighted are the adoption of real option in place of discounting technique of cash flow, the differences in the practices and treatment of corporate methodologies and regulatory framework, the inputs considered by companies when using the CAPM model, etc. There were surveys done by MacMohan, Hobbes and Lilleyman (Linden & Freeman, 2017). The survey highlighted the increasing relevance of discounted cash flow techniques and the growing acceptance of Weighted Average Cost of Capital as the discounting rate in computations involved in capital budgeting. There were multiple surveys conducted to assess the spread of use of CAPM model in many countries. A survey conducted by Kester in Australia as well as in the Asia pacific region showed that an overwhelming 73 percent of the companies across the regions surveyed had adopted to use the CAPM technique. The computation of tax credit was another important aspect covered by the journal. For various purposes of evaluation, a total of 488 firms were included in August 2004. It was called the ordinaries index and consisted of only Australian companies as the emphasis was laid down on studying the practice of capital budgeting in Australian entities. The surveyors were more inclined to take in large companies for the survey as the chances of their participation was combatively higher when compared to the smaller ones. The survey consisted of 20 questions. 24.4 % invitees responded to the survey (Hall & Rapanotti, 2017). The cumulative revenue of the respondent was pegged at 1.32 billion dollars. It was observed by the authors articulating the surveys that that there were many companies which did not blindly relied on capital budgeting techniques and rather cross checked the results by performing some other computational techniques. Among them the NPV, Payback period method and Internal rate of return techniques were also used. However, it was clear that the CAPM technique was the most sought-after technique among others. There were 82 companies found to be users of the NPV technique, which forms 94 percent of the entire population. A miniscule percentage of respondents were found to be using other techniques. A host of tables and charts presented in the journal analyse the above-mentioned techniques. It was observed that a few companies missed out adjustments related to dividend imputations, which was very much required to be done.

Capital Budgeting Practices in Canada

Ongoing through the contents of the second journal we come across certain additional facts. This journal is centred on the financial tools in the Canadian corporate space. The report suggests that the Canadian firms are lagging when it comes to using advanced tools like capital budgeting for the purposes of decision-making. It is being said that the last study was perhaps conducted about 5 decades ago. Methods like discounting factor usage in computing cash flows are not used (Bennouna, et al., 2010).  Their study seems to point out that the correct way of using discounted cash flow technique is also one area that needs attention as it determines the how much effective the study would be as it was observed in some of the instances that cash flows were not properly determined. Besides this, a few other deviations were observed in the Canadian since. For instance, instead cash flows the firms were found to be using accounting income. Inflation was being recognized in the computation. In finding the weighted average cost of capital, the firms were found using boom value of the debts and equity instead of the market values.  Also, there was lack of research in finding the weights as well. They were also found to be missing either debt or equity in computing the cost of capital. It was observed that 17 out of 88 firms who were part of the survey did not use the discounted cash flow technique. Therefore, the surveyors had to restrict the participants to a few large corporate houses who were using the method (Segal, 2017). The report issues certain advisories about the administration aspect of the companies as well. The study revealed that in Canada, sensitivity analysis was a very popular tool that was used. 92.8 % of the firms used it as against 85.3 % of users of scenario analysis. Risk adjusted discount rate (RADR) was used in 76.8% of the participants. Sensitivity analysis and RADR saw a significant rise in usage as compare to the last time a research was conducted. It was also observed that a quite a few Canadian and American companies find it difficult to segregate cost of capital division wise.

Following are the similarities observed between the two journals:

1. In both the journals, the discounted cash flow technique was touted to be the most widely used Capital budgeting technique.
2. The authors of both the journals laid emphasis on the importance on the correct knowledge and proper application of the capital budgeting technique to yield useful results(Werner, 2017).

These differences were observed between the two journals:

• The first study paper primarily dealt with how to estimate the cost of capital appropriately. However, the core emphasis of the second study paper was focused on enhanced tools used in capital budgeting technique.
• The first study discussed upon the decision-making process about capital budgeting in the Australian work environment whereas the other journal was more concerned about the extent of improvement required in the use of capital budgeting techniques in Canada and highlighting the current flaws(Schoenberger, 2016).

Overview of the relevant learnings from the research findings and the specific outcomes out of it:

Below are the pertinent points to note observed during our review of the materials contained in the first journal-?

1. The popularity of the real option as technique for evaluating projects is on the rise. However, it is being used by the minor players of the industry and hence is not making a significant impact.
2. The company do not blindly follow a single technique of capital budgeting. Apart from the NPV method, other methods like the payback period and IRR also used for evaluation purposes(Chron, 2017).
3. The companies have been founding using a static discount rate period after period despite having the knowledge about the significance of variations through time.
4. Both in the Asia pacific region as well as in Australia, weighted average cost of capital is being widely used for estimating cost of capital, CAPM is used extensively.

Similarities and Differences between the Two Journals

 While reviewing the second journal, we came across several aspects that were critical piece of information:

1. Limitations such as isolation of observations to one country was observed in this study paper. The study has successfully highlighted the significance of capital investment. The challenges that the entities face in the implementation of the discounted cash flow technique are also brought under light in the paper(Dumay & Baard, 2017).
2. The technique of discounted cash flow has become almost synonymous to the capital budgeting practice. This is actually because of the wide acceptability the technique enjoys across industries. Though other techniques are used not very frequently adopted or used in many organizations but it, there is no extinction of those methods. They are still used in certain pockets of the industry.
3. The wide usage and acceptability of the discounted cash flow method however does not absolve itself from the fact that its correct application is still posing as a challenge. There is an immense scope of improvement in which the organizations are supposed to apply its principles. Until that happens, the desired benefit that should come with its use will not follow. There is an urgent need to address these issues(Félix, 2017).

Conclusion

In the given assignment, based on the overall analysis it can be said that budgeting is an important tool for the management of the company and they should try to use it as much as they can. The two article highlights the different areas of budgeting which, as user is helpful; they help in understanding how companies can improve their process of budgeting so that they get the best result. Hence based on the overall analysis it can be said that budgeting should be focused on long-term needs of the company and less on the short-term goals. Budgeting helps the company in foresight the several issues that might crop up in the future. So overall, it helps in improving the efficiency of the company in leaps and bounds and hence should be adopted.

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