Earnings of capitalizing vs expensing firms in an expansion phase

CFA Level II
#1

(To provide some context: this is from LOS 18.a and this situation is mentioned in a “professors note” on p.35 of Schweser book 2.)

I understand that the net income of a capitalizing firm will be lower in subsequent years compared to an expensing firm in most circumstances. It’s simple.

However I’ve read that for firms in an expansion phase - capitalizing expenditures may result in higher net income over “many” subsequent periods compared to an expensing firm (because the amount of depreciation from previously capitalized expenditures is less than the amount of additional costs being newly capitalized).

I feel like this concept may be simple but I cannot see it for myself, and therefore I am confused. I cannot imagine how the net income of a capitalizing firm could possibly be higher than that of an identical expensing firm over “X” subsequent number of years, as the capitalizing firms income statement includes depreciation/amortization while the expensing firm does not.

What am I missing?! Thanks in advance!!

#2

hmmm i think I’m starting to see it, but I would still appreciate if someone could clarify…

…I can see how this may be the case if we assume the firms are continually making expenditures each period, which get smaller and smaller as time goes on.

#3

As the firm expands, it is assumed it will continue to capitalize. Simultaneously, the comparable firm will expense the same amount (I think this is what you were missing?). So the firm that continues to capitalize, continues to grow its asset base while the other firm [loosely put] may come across as being crappy.

#4

a capitalizing firm’s expense is depr expense - while a expensing firm spends the entire amount in 1 period.

That depreciation expense is smaller and therefore Net Income would be higher.

Firm A spends 100$ (Capitalized) - and depreciates 10$ per year for 10 years.

Firm B - spends 100$ expensed.