If the company changed policy and capitalizes some costs instead of expensing them, the company will: A) have a higher reported income as long as capitalized expenditures exceed depreciation on them. C) have a higher reported income initially, with lower income levels to follow invariably.
Why is the answer A and not C? What does A means?
This is what I think they mean with answer A. Let’s say in 2014, Company X only has an expense of $ 100
2014 P&L with expensing: $ (100)
2014 P&L with capitalizing (4 yr depreciation): $ (25)
P&L using capitalizing is higher because capitalized expenditures > depreciation.
Then in 2015, there’s no activity at all:
2015 P&L with expensing: $ 0
2015 P&L with capitalizing $ (25)
Now, P&L using capitalization is lower because capitalized expenditures < depreciation.
C) implicitly assumes every year thereafter these capital expenses are taking place. Eg. assume EVERY year 100 dollars is either expensed or capitalized. so company A expenses 100 every year and company B capitalizes 100 every year. well the capitalizing company will remain more profitable of the two UNTIL their cumulative depreciation starts exceeding that 100 dollars.