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Cost Analysis of the Research and Development Projects |
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Cost accounting is a managerial tool for business strategy implementation. Managers use cost accounting to choose, communicate and implement investment goals. Capital budgeting is the decision making technique that analyzes investments for long term projects. Methods Used to Evaluate the Projects:
Discounted cash flow focuses on inflows and outflows rather than on operating income that is used in financial accounting. Depreciation is not deducted from income for these calculations. The net present value method calculates the expected net monetary gain or loss from a project by discounting all future cash flows to the present point in time. Only projects with positive net present value are acceptable. The minimum acceptable rate of return on an investment is used for calculations. It is the interest the organization expects to receive for an investment of comparable risk. The internal rate of return is the discount rate at which net present value of expected cash inflows from a project equals the present value of cash outflows. Internal rate of return is the discount rate that makes net present value equal zero. The payback method measures the time it will take to return initial investments on a project. Payback = Net initial investment/uniform increase in annual cash flows. Two major weaknesses of payback method are a) it neglects the time value of money and b) predicted cash flows in later years are uncertain. Accrual accounting rate of return or return on investment (ROI) is the ratio of increase of annual operating income to initial investment. This method focuses on how investment decisions affect operating income routinely reported by organizations. |
Tax Impact on Cash Flows
The impact of income tax on cash flows is straightforward. For example, if capital proposal results in annual savings of
$40,000 and the company has marginal tax rate of 40%, then the company cash outflow through income tax will be $16,000. On the
contrary, the decrease of income because of assets depreciation will result
Tax Incentives The Canadian government provides significant tax incentives in support of scientific research and experimental development activities (SR & ED). Eligible activities include design, mathematical analysis, computer programming, data collection, testing and psychological research. The term “scientific research and experimental development” indicates that most of industrial R & D activities are focused on the experimental development of new products or processes rather than pure research. Generally the research and development expenditures made in the year are fully deductible. As a further incentive the income Tax Act provides investment tax credit (ITC), which is calculated as 20% of qualified SR & ED. ITC that is not applied in a year can be carried back 3 taxation years and forward 10 taxation years. An additional 15% ITC incentive is provided when a taxpayer is a Canadian Controlled Private Corporation. The additional 15% credit is restricted to $2,000,000 of qualifying expenditures. Since many small Canadian businesses may have weak profit or losses incurred, cash refunds are available to qualify for Canadian Controlled Private Corporations. Consistent consideration of all sources of cash flows and outflows allows an accurate evaluation and comparison of research and development projects.
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Ontario, British Columbia, Alberta, Manitoba, Saskatchewan, Quebec, Nova Scotia, New Brunswick |
Capital
Budgeting
in
the decrease of tax outflow.