Read this article to learn about the following four measures for control of capital expenditure, i.e., (1) Capital Expenditure Budget, (2) Request for Funds, (3) Variance Analysis, and (4) Follow Up.
Planning is the first and most essential step for control. Hence, the first step in the capital expenditure control is the preparation of capital expenditure budget.
This budget outlines the various types of projects such as new projects, expansion projects, modernization projects and diversification projects to be taken up and also explains how these projects should be financed over a given period. The request for capital expenditure projects emanate from different divisions of the organization.
While submitting their requests for capital expenditure projects, they provide the following information:
(a) Description of the proposal,
(b) Justification for making such a proposal,
(c) Cost estimates,
(d) Estimates of effective economic life, and
(e) Net benefits expected from the proposal.
The individual requests are submitted to the budget committee for preliminary review, screening, coordination, and final consolidation.
While considering the individual requests, the committee mainly looks into the proposal for the following aspects:
(a) That all requests fit well into the company’s long-range planning and programmes,
(b) They are financially feasible, and
(c) Individual request Joes not create any departmental imbalances.
For example, the consideration of an expansion project may lead to departmental imbalance if the sales department is unable to sell the excess production. Once the proposals are found worthwhile, they are recommended to the higher-level management for final approval.
Once the projects are approved, the concerned department should submit a detailed request for appropriation of funds.
This request may be a request for:
(a) Original capital budget,
(b) Additional funds, and
(c) Substituted new project.
Owing to certain changed conditions or circumstances, if the approved project could not take up, it may be abandoned by providing proper reasons for abandonment. When the abandonment is approved, the funds allotted and later on canceled are used for other projects based on priorities.
This is an important task in capital expenditure control. The actual performance is compared with estimates and variance or deviations are noted, analyzed and reported upon.
As the project implementation work progresses the actual expenditures incurred are compared with the budget estimates. When it is expected that the actual cost may exceed the original estimates, a formal request for additional funds or for revision of plan will be made.
To have a better control, a system of calling for monthly or weekly reports on individual projects or jobs is introduced. These reports may be in the form of Capital Project Expenditure, Summary of Current Capital projects, Periodic Capital Project Cost Statement, and Weekly Statement of Cost Details.
A follow up of the performance of capital projects is very essential. It enables the management to determine whether the expected savings have actually been realized or not.
The follow up in the form post completion audit serves two purposes:
1. It indicates the areas of weaknesses to the management.
2. It creates confidence on the future capital expenditure control programme. However, the post completion audit is a difficult task.
Many offsetting factors like volume and price changes and wage increase, etc. may conceal or mislead the actual results obtained from the project. Hence, a post completion audit committee is constituted with Chief Engineer, Plant Manager, Internal Auditor, etc., as members.
The committee should prepare a report in the proforma laid down in the capital budget manual. The committee report should specifically indicate the causes for deficiency, if any, the corrective measures to be taken, and the period within which the measures be taken.