Capitalizing over 12 months *VS* expensing

  • Thread starter Numbers Afficionado
  • Start date

N

Numbers Afficionado

How are these 2 methods above different? I can see how the former
(capitalizing over 12 months) leads to smoother costs. However, the
net effect is the exact same after 1 year time.

I'm reading how AOL engaged in aggressive accounting during the '90s,
and they would capitalize cots and then amortized them over a 12 month
period. Also, they excluded these costs from the income statement -
which is what I'm failing to understand here.

Did AOL shift an income statement item (the costs of doing business)
into a liability on the balance sheet? Please help me understand how
capitalizing costs is more aggressive than expensing.
 
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Paul Thomas, CPA

Numbers Afficionado said:
How are these 2 methods above different? I can see how the former
(capitalizing over 12 months) leads to smoother costs. However, the
net effect is the exact same after 1 year time.

I'm reading how AOL engaged in aggressive accounting during the '90s,
and they would capitalize cots and then amortized them over a 12 month
period. Also, they excluded these costs from the income statement -
which is what I'm failing to understand here.

Did AOL shift an income statement item (the costs of doing business)
into a liability on the balance sheet? Please help me understand how
capitalizing costs is more aggressive than expensing.



I'm not sure what depreciating over 12 months has to offer, except to smooth
out the monthly financials and create "make work" for the accounting staff.

As far as capitalizing expenses, they probably took something that ordinary
people would consider an expense and treat it as having a long-term benefit
(their justification for capitalizing it).

Take an advertisement campaign, where they spend hundreds of thousands of
dollars just to create the ad spot, and more to air it to the public. They
may have deduced that the ad carries a long-term benefit for sales, so
capitalize it and amortize it over time.

You don't show any expense (or very little), and show an asset. The books
look good in both directions. The shareholders are happy. Management gets
their billion dollar bonuses. They retire to a private island with an
excess benefit plan. The new guy says "What's this crap?" And the stock
hits the bottom of the toilet.
 
N

Numbers Afficionado

Paul,

When something is capitalized, does this mean that the cost is not
deduced from revenues, and instead, it gets subtracted from the equity
portion of the balance statement? This would have the impact of
increasing earnings, but decrease equity of the company.
 
P

Paul Thomas, CPA

Numbers Afficionado said:
When something is capitalized, does this mean that the cost is not
deduced from revenues, and instead, it gets subtracted from the equity
portion of the balance statement?


No. When you buy an asset or pay for something that's a capital item, only
balance sheet items are affected. Cash goes down and the asset goes up is
the basic example. If you bought on credit, you increase the asset and
increase the liability. There's no impact on the income statement. So the
more things you can treat as a capital expenditure, the less go down as an
expense on the income statement.

Equity only is impacted if there is a distribution of profits or another
transaction onvolving stocks or shareholders.
 
B

Beverly

No. When you buy an asset or pay for something that's a capital item, only
balance sheet items are affected. Cash goes down and the asset goes up is
the basic example. If you bought on credit, you increase the asset and
increase the liability. There's no impact on the income statement. So the
more things you can treat as a capital expenditure, the less go down as an
expense on the income statement.

Equity only is impacted if there is a distribution of profits or another
transaction onvolving stocks or shareholders.
But amortization/depreciation over 12 months causes the item to be
expensed within a year and expenses, as an income statement item,
eventually hits equity.

The only purposes I can see of doing it this way is a) to show a
better net income figure to users of interim financials or b) to split
the expense between two fiscal years (i.e. if the company's fiscal
year is the same as the calendar year and the item in bought in June,
then half of it will be expensed this fiscal year and the other half
next year).
Beverly
 
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Paul Thomas, CPA

Beverly said:
But amortization/depreciation over 12 months causes the item to be
expensed within a year and expenses, as an income statement item,
eventually hits equity.

But for all but the expenses made in the first month will bleed over to the
next fiscal year.


The only purposes I can see of doing it this way is a) to show a
better net income figure to users of interim financials or b) to split
the expense between two fiscal years (i.e. if the company's fiscal
year is the same as the calendar year and the item in bought in June,
then half of it will be expensed this fiscal year and the other half
next year).


If the expense is something that carries a 12 month life, then it's done
that way for GAAP. Like making the annual premium payment for insurance,
you capitalize it and amortize it for the term of the policy. That's SOP
as far as I'm concerned.
 
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