1 FSA Q Bank question

Hello All, I have one quick question from Q Bank for FSA With the increasing scrutiny by the SEC and the financial markets, Dobkin Company decided to expense costs that it would have otherwise capitalized. This will result in: A) lower quality earnings; lower assets levels; higher equity levels. B) higher quality of earnings; lower asset levels; and lower liability levels. C) higher quality of earnings; lower asset levels; and lower equity levels. D) lower quality of earnings; higher asset levels; and higher liability levels. Your answer: B was incorrect. The correct answer was C) higher quality of earnings; lower asset levels; and lower equity levels. I dont understand why B is wrong, since the difference between B and C is lower liability level for B and lower equity level for C. When you decide to capitalize, dont you have more liability coming from all the future lease payments you have to make, why you dont have any liability for expensing? Also, just to make sure, the reason why we get lower equity level for expensing, it’s because lower retained earning , is it right ? Thanks

Why not lower liability? I think that it is not necessary that you finance this project with a debt. You could use equity instead to raise the funds. 2) Yes, lower equity because high expenses, lower taxes, lower but quality earnings, lower retained earnings, hence lower equity levels. Thanks

When you capitalize asset levels go up and so do liabilities when you. Remember that you are basically purchasing the asset when you capitalize. So with expensing the assets and liabilities would fall which is the opposite of when you capitalize. With expensing, equity would fall because you have higher expenses and thus lower retained earnings which leads to lower equity.

B is incorrect because when a company expenses costs then liabilities will be higher relative to if it were capitalizing costs. The decrease in retained earnings is recorded to offset the increase in liabilities.

Guys, note that the question talks about capitalizing or expensing COSTS, not a lease. So all the talk about future lease payments etc doesn’t apply. You are confusing capitalising costs vs. leases