Two companies are identical except for accounting treatment of research and development costs. One company expenses all such costs immediatedly, while the other company capitalizes a portion of the costs. Compared to the company that capitalizes costs, the company that expenses immediately will most likely A. earn lower return on assets B. earn higher return on assets C. will have lower financial leverage D. will have same financial leverage ROA= N.I/Asset, Fin Leverage= Asset/Equity N.I-expenses =lower N.I, Assets remain the same? My guess is A How would asset and equity be affected by expensing or capitalizing costs?

The company capitalizing will have higher assets and thus a lower ROA. I would go with B.

If you expense immediately, your net income will go down for that year. Assets will actually be less for the firm who expenses versus the capitalizes who capitalizes his costs. However, the expense and resulting lower net income overtakes in the decrease in assets. Note this is initially, eventually it’s the other way around. I would go with A. I’ve seen Financial leverage as two definitions Assets/equity and debt/equity. In the capitalization chapter, they refer to it as debt/assets or debt/equity. Assets will be higher for capitalizing firm, assets will be higher, meaning D/A will be lower. Thus, leverage ratios will be higher for expensing firms.

Yea…A seems more right than B…lol The effect of a lower NI will supercede the effect of lowered assets…

Three for A! What’s the answer?

A I think. Explanation is that % decrease in income is greater than % decrease in assets.

A, pretty straight forward! Firms that expense have lower NI, ROE, ROA in current and short term periods, and higher of the same in long term.