188 Understanding the Numbers
Capital Expenditure Budget (26)
The capital expenditure budget is one of the components of the financial bud-
get. Each of the components has its own unique contribution to make toward
the effective planning and control of business operations. Some components,
however, are particularly crucial in the effective management of businesses,
such as the cash and capital expenditure budgets.
Capital budgeting is the process of identifying, evaluating, planning, and
financing an organization’s major investment projects. Decisions to expand
production facilities, acquire new production machinery, buy a new computer,
or remodel the office building are all examples of capital-expenditure deci-
sions. Capital-budgeting decisions made now determine to a large degree how
successful an organization will be in achieving its goals and objectives in the
years ahead. Capital budgeting plays an important role in the long-range suc-
cess of many organizations because of several characteristics that differentiate
it from most other elements of the master budget.
First, most capital budgeting projects require relatively large commit-
ments of resources. Major projects, such as plant expansion or equipment re-
placement, may involve resource outlays in excess of annual net income.
Relatively insignificant purchases are not treated as capital budgeting projects
even if the items purchased have long lives. For example, the purchase of 100
calculators at $15 each for use in the office would be treated as a period ex-
pense by most firms, even though the calculators may have a useful life of sev-
eral years.
Second, most capital expenditure decisions are long-term commitments.
The projects last more than 1 year, with many extending over 5, 10, or even 20
years. The longer the life of the project, the more difficult it is to predict rev-
enues, expenses, and cost savings. Capital-budgeting decisions are long-term
policy decisions and should ref lect clearly an organization’s policies on growth,
marketing, industry share, social responsibility, and other goals. This is dis-
cussed in greater depth in Chapter 10.
For purposes of this exercise, we have assumed that C&G’s Gift Shop will
not be making any capital expenditures in the upcoming year. As a result, prop-
erty, plant, and equipment (PP&E; line 26) remains constant. Net PP&E (line
28), however, is reduced each period by the addition of depreciation expense
to accumulated depreciation.
Budgeted Accounts Payable (33)
Accounts payable represent amounts owed to other businesses for the purchase
of goods and services. These are usually non-interest bearing. We have as-
sumed that all the inventories are purchased on open account and that the
terms of credit require payment in full in the following month. As a result, ac-
counts payable are equal to the cost of inventories in this example.