Question

Capitalize versus Expense

During the year, Custom Parts Co. retooled its production line in order to accommodate the required changes to auto parts for new vehicle models. The retooling costs were capitalized to Custom Parts’ balance sheet. Company observers suggested that the retooling costs should have been charged against income at the time of purchase rather than capitalized to the company’s balance sheet.

Required

If Custom Parts Co. switched from capitalizing and amortizing the costs of retooling to immediately expensing them (for reporting to shareholders only), indicate how the following financial statement items would be affected:

1. Operating revenue

2. Operating expenses

3. Cash flow from operations

4. Assets

5. Liabilities

Answer 1

1. Operating revenue will have no impact as costs will get increased and that will reduce operating margins.

2. Operating expenses will get increased as the amount of retooling will be added to it.

3. Cash flow from operations will also get reduced with the amount of retooling.

4. Assets will be reduced as the cost of retooling will be removed from assets.

5. Liabilities will have no impact but shareholder's equity will get reduced due to reduction in net margins to be added to equity.