Audit, Or Control, Phase Of Capital Budgeting

Process The audit, or control, phase is the final step of the capital budgeting process for approved projects. In this phase, the analyst tracks the magnitude and timing of expenditures while the project is progressing. A major portion of this phase is the post-audit of the project, through which past decisions are evaluated for the benefit of future project analyses. Many firms review spending during the control phase of approved projects. Quarterly reports often are required in which the manager overseeing the project summarizes spending to date, compares it to budgeted amounts, and explains differences between the two. Such oversight during this implementation stage slows top managers to foresee cost overruns. Some firms require projects that are expected to exceed their budgets by a certain dollar amount or percentage to file new appropriation requests to secure the additional funds. Implementation audits allow managers to learn about potential trouble areas so future proposals can account for them in their initial analysis. Implementation audits generally also provide top management with information on which managers generally provide the most accurate estimates of project costs. In addition to implementation costs, firms also should compare forecasted cash flows to actual performance after the project has been completed. This analysis provides data regarding the accuracy over time of cash flow forecasts, which will permit the firm to discover what went right with the project, what went wrong, and why. Audits force management to discover and justify any major deviations of actual performance from forecasted performance. Specific reasons for deviations from the budget are needed for the experience to be helpful to all involved. Such a system also helps to control intra-firm agency problems by helping to reduce ‘‘padding’’ (i.e., overestimating the benefits of favorite or convenient project proposals). This increases the incentives for department heads to manage in ways that will help the firm achieve its goals. Investment decisions are based on estimates of cash flows and relevant costs, while in some firms the post-audit is based on accrued accounting and assigned overhead concepts. The result is that managers make decisions based on cash flow, while they are evaluated by an accounting-based system. A concept that appears to help correct this evaluation system problem is economic value added (EVA). The control or post-audit phase sometimes requires the firm to consider terminating or abandoning an approved project. The possibility of abandoning an investment prior to the end of its estimated useful or economic life expands the options available to management and reduces the risk associated with decisions based on holding an asset to the end of its economic life. This form of contingency planning gives decision makers a second chance when dealing with the economic and political uncertainties of the future.