Accounting of Long-lived Assets - Expensing vs. Capitalizing
Long-lived assets refer to PPE, natural resources, and intangible assets. This section largely focuses on property, plant and equipment (PPE), but there will be some discussion of intangible assets.
PPE on the balance sheet is may be shown on a gross (total amount paid to acquire and ready the equipment for use) and net basis.
- Gross: Property, Plant, & Equipment
- Less: Accumulated Depreciation
- Net: PP&E
Expensing to the income statement vs. Capitalizing to the balance sheet
- Management typically has some discretion in determining if the cost of an item should be capitalized to the balance sheet and depreciated (or amortized if it is an intangible asset) to the income statement over time or if the cost of the item should be fully expensed to the income statement in the current period.
- Example: A company may capitalize production facility upgrade investments above $100,000 and expense a facility related purchases below this amount.
- Capitalization of Interest Expenses: US GAAP and IFRS-IAS provide treatment of the capitalization of interest expenses associated with the construction of long-lived assets.
- The following table provides examples of the effects on a company’s financial statements and ratios when expensing in-year versus capitalizing in-year.
|Net Income, Profit Margins, Equity||Lower||Higher|
|Debt to Equity Ratio||Higher (Equity is Lower)||Lower (Equity is Higher)|
|ROA and ROE||Lower||Higher|
Cash Flows and Expensing vs. Capitalizing of Purchases
- On a total cash flow basis, the decision to expense or capitalize has no impact because depreciation is a non-cash expense. However, when Cash Flows are separated by: Operating Activities, Investing Activities, and Financing Activities, the decision to expense or capitalize takes on more meaning.
- Cash Generated by Operating Activities – when a company expenses an item paid with cash, instead of capitalizing it, the firm will show lower operating cash flows.
- Cash Generated by Investing Activities – when a company expenses an item paid with cash, instead of capitalizing it, there will be NO CHANGE to investing cash flows. However, if the company capitalizes the item as a physical investment in PPE, investing cash flows will be lower.
- CFA Level 2: Financial Reporting Part 1 - Introduction
- Financial Reporting: Important Definitions
- FIFO and LIFO Methods for Inventory Expensing
- Inventory Accounting and Financial Statements
- Inflation/Deflation and Inventory Accounting Analysis
- LIFO – Tax and Cash Flow Note
- LIFO Reserve and Converting LIFO Net Income to FIFO Net Income
- LIFO Liquidation
- Inventory at Net Realizable Value
- Impacts of LIFO and FIFO Inventory Methods on Selected Financial Ratios
- Accounting of Long-lived Assets - Expensing vs. Capitalizing
- Depreciation Methods for Property, Plant, and Equipment (PPE)
- Impact of Depreciation Method
- Depreciation - Important Points
- Impairment of Long-lived Assets
- Impact of Asset Impairment
- Revaluation of Property, Plant, & Equipment (PPE)
- Leasing versus Purchasing Assets
- Traditional Lessee Accounting in US GAAP
- Effects of Leases on Selected Financial Reporting Items for Lessees
- Lessor Accounting for Leases
- Lessors and Sales-Type Capital Leases
- Lessors and Direct Financing Capital Leases
- Effect of Leases on Financial Statements for Lessors
- Future of Lease Accounting
- CFA Level 2: Financial Reporting 1 - Recommendations
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