Q. When a company decides to capitalize a cost compared to expensing it, future accounts will give an impression of:
A. Lower growth in profits
B. Higher growth in profits
C. The same growth in profits
Explain your answer.
Thanks
I would guess A. When you expense a cost, the entire costs hits the balance sheet in the same period, reducing profits. When an expense is capitalized, it is put on the balance sheet and amortized over time. In the first year the profits will be higher under a capitalized cost, but will increase slower in future years because of the amortization expense. if the cost is expensed, it will result in a lower profit for that year, but a larger growth in profits in the future because profits will not be hit by the amortization cost.
I agree with jrd1212 but the wording of the question makes it unclear. What is ‘future accounts’ referring to? The most likely answer is net income because of profit growth in the questions but imo they could have worded the question better as to not cause confusion.
A) because if you expense it, it is a one period reduction in net income, but if you capitalize it, you will be depreciating in the future lowering the net income in future periods.