| Cost Benefit Analysis must be carried out to | | | | occurred. Accruals have no role here. |
| accepted principles. If not, your reputation and the | | | | Critical Item #3. Price Changes Due to Inflation |
| company could suffer. There are some elements | | | | The Discount Rate used in the model is designed |
| that should never be included in Cost Benefit | | | | to take account of inflation during the life of the |
| Analysis. Some of these are listed in this article. | | | | project. The Discount Rate reduces the value of |
| Let's start, shall we? | | | | the costs and benefits as time progresses, just |
| Critical Item #1. Sunk Costs | | | | as inflation does. If inflation-based price changes |
| Irrecoverable cash outlays that occurred prior to | | | | were included in the analysis, then they would be |
| the evaluation of the project are excluded, only | | | | double-counted. |
| the present and future costs/benefits are | | | | Critical Item #4. Book Gains or Losses |
| assessed. You cannot go back in time to add in | | | | Accountants use this method to take account of |
| past costs, only deal in the current and the future, | | | | the fact that the value of the asset at time of |
| as best you can. | | | | disposal is not equal to the depreciated value in |
| Critical Item #2. Arbitrary Accounting Cost | | | | the company's books. This often happens, since it |
| Income Allocations | | | | is not always possible to accurately predict the |
| Depreciation - Depreciation is not a cash item. It | | | | selling price or disposal value at the time of |
| relates to cash expended on capital purchases in | | | | purchase when the life of the asset is longer than |
| previous periods. It is intended to show the | | | | a year or two. |
| decreasing value of the asset as time passes and | | | | However, in Cost Benefit Analysis models the |
| as the asset ages through use or obsolescence. | | | | purchase price and the selling price are always |
| To include depreciation in Cost Benefit Analysis, | | | | clearly stated, so there is no need to adjust. |
| would be to double-count the expenditure. The | | | | Critical Item #5. Loan Repayments |
| decreasing value of the asset is shown by the | | | | The use of the Discount Rate is designed to take |
| difference in the purchase price and the eventual | | | | account of the cost of financing the project |
| disposal or sales price at the end of its life. | | | | whether in terms of interest rate (if the funds |
| Accruals - Accruals are an accounting method of | | | | are borrowed) or return on equity (if the funds |
| moving costs and income to different years as | | | | are provided by shareholders). The actual cash |
| compared to when the transaction actually | | | | repayments on the loan have no place in this |
| occurred. In Cost Benefit Analysis, we are dealing | | | | analysis. Neither does the interest component of |
| only in cash transactions in the year they | | | | the repayments. |