Compared to expensing the long lived assets would capitalizing the the costs increase: Debt-Equity Ratio (YES/NO) . . . . . . . I would think yes, as a asset and liability is placed so it will increase this ratio, but the answer states that because an asset and equity INCREASE, so debt-to-equity will decrease? This kinda takes me back a couple of months!!
I think the problem is that anytime someone says capitalzing vs expensing the pavlovian response is to asume that they are talking about capital leases. This isn’t always the case and don’t assume it unless they say so. Example: A= L+ SE so let’s say 1000=700+300 (debt to equity is 2.33X) You fix up your building for $100 and decide to expense the cost. Ignoring taxes (and let’s assume that you were at breakeven net income before this) you now have 900 (1000 less 100 cash spent)= 700+ 200(300 minus the 100 loss this creates) debt to equity is 3.5X Your accountant says, hey, this $100 will provide a benefit in the future and its material, so let’s capitalize it. You now have 1000 (since you traded two assets, cash and building improvement)=700+300 and you are back at 2.33X So as can be seen, capitalziing produces the lower (2.33) ratio vs expensing (3.5), becuase liabilities stay the same in both cases, but expensing reduces the denominator (equity)
thanks super 1 - good luck