Hi all, I have two questions: 1. whats the difference between capitalising assets and capitalising expenses? 2. what goes on the the accounts for US GAAP and IFRS for capitalising those? Thanks in advance!
When you capitalize an expense it becomes capitalized asset. Generally, “to capitalize” means that you don’t expense something, but instead you capitalize it on your BS. Not sure I understand the second q. Hope this helps. Cheers
All ‘assets’ are capitalised. An asset is something you have bought which will generate profit in the future. If it makes money in the next period, like a maturing investment for example, it’s a current asset. If it’s likely to make money further into the future, like a machine, it’s a long-term asset. Firms obviously want to capitalise as much as possible. First it shows as an asset which makes risk ratios like Assets/Liabilities look good. Second, there is likely to be less expense (through depreciation) so Net Income will be higher. The big question comes with less tangible expenses such as Research and Development. That is an expense which will arguably be used to generate money in the future. Under US GAAP all “research” (the early stage process) should be expensed but “development” (the later stage costs once feasibility has been established) may be capitalised. Basically they are saying an expense which has a very low probability of generating profit like early stage research costs should be expensed. Once it has been established to feasibly generate profit, it becomes an asset.
In general, capitalizing means moving something into BS instead of IS. e.g. interest and leases.
Thanks all!
so will capitalizing an expense yield less NI…? for an asset or lease, it yields less NI at the beginning but more at the end…
Depends on the time frame. For capitalizing leases, NI is understated in short run and overstated in long run. What you should pay attention to is CF because the capitalizing process involves reclassifying of CFO and CFF.
How is it reclassified? From CFO to CFF (expensing to capitalising) right?
When you are expensing a lease, everything is charged to CFO. If you capitalize, part of that expense got reclassified into capital investment and so it decreases CFI while increases CFO. When you are expensing interest, the interest component is charged to CFO whereas the principal payment is charged to CFF. If you capitalize interest, the expense is charged to CFI instead of CFO and CFF. As a result, CFO would be overstated while CFI is understated.