10 December 2015

Current considerations for appraising capital expenditures

As I was alluding to yesterday, the appraisal of capital expenditures has become much more complex since CMA Canada last explored the topic in 1981. Here are some aspects to consider:

  1. The greater participation of the public sector has called for different types of focus. While the cost of capital will tend towards the risk-free rate, there are also greater requirements for considering optimism bias and sensitivity analysis in different components of proposals, the allocation of risks that arise in public-private partnerships, and consideration of relevant benefits to society (including discussion of what is not relevant).
  2. In the private sector, more rigorous pre-acquisition analysis is required to determine which components are capital and which are expense, for both financial reporting and tax purposes. This is effectively a 2x2 grid, and there is very little summary literature on the topic.
  3. In the private sector, the after-tax cost of capital will need to be risk-adjusted depending on the nature of the investment. While this is largely a matter of judgment, some rules of thumb for annual rates that have arisen over time are 40% for venture capital and 50% for angel investments. Aside from those, there is the risk of being overly conservative in the assessment of relatively straightforward proposals, as well as from conflating financing issues (government grants, refundable tax credits, and pre-approved financing) with operations issues.
  4. The tax shield arising from the availability of capital cost allowance is well-settled doctrine, whether through the full-year, half-year or other available methods of calculation. Very little work has been done in assessing the calculations under the US MACRS régime, for those Canadian companies that are fully integrated into US operations for tax purposes, but that could be relevant in certain circumstances.
  5. Equivalent annual cost calculation is a powerful assessment technique that is still little discussed or applied.
  6. Very little discussion has been given to the different types of capital investment that are undertaken. Som principal categories I have been familiar with include new business, expansion, process improvement, replacement, investment properties, regulatory compliance, and general corporate requirements (eg, head offices, branding, and company-wide IT or communications structures). In any case, different techniques are available for different purposes, and their application should be given detailed discussion.
  7. Financial reporting under IFRS (but even before that, under the old CICA Handbook) calls for assessment of fair value and impairment of assets under specified conditions. These are important limits that must be considered in any risk analysis for acquisitions.
If anyone can think of other issues that should be raised, I would appreciate hearing about them.

Updates:  Typo corrected; "process improvement" and "investment properties" added in investment categories; give examples of non-relevant financing issues.

09 December 2015

A Body of Knowledge passé?

Several decades back, CMA Canada was doing extensive work in analyzing and compiling best practices for management accounting, and established the CMA Canada Research Foundation to focus on that work. In addition to commissioning various studies, it also issued the Management Accountants Handbook and Management Accounting Practices Handbook for CMAs to abide by. They're quite prominent in my library.

I was recently wondering what is happening to that focus, now that all CMAs, CAs and CGAs are now part of CPA Canada. It turns out that notice was given in 2013 that the Foundation intended to surrender its charter. That has not happened yet, but it appears that it will lapse because of non-continuance under the Canada Not-for-Profit Corporations Act.

That's not all. The Handbooks themselves have never been updated since 1998, although electronic copies of the contents were always available from the CMA Canada website. That site is no longer available, and the new CPA Canada Store does not have access to them.

That's a pity. There was a lot of great advice that came out of this work, and much of the research was seminal in developing management accounting as we know it today. One study in particular, A Practical Approach to the Appraisal of Capital Expenditures, deserves to be updated to cover today's broader range of issues.

I hope CPA Canada revives access to this work. Otherwise, it would appear that our amalgamation was in reality a takeover.