Question

What would persuade a company to choose capitalizing vs. expensing borrowing costs under ASPE? What would persuade you the other way?

Answer 1

Answer: Expenditure can either be capitalized as a cost of the asset on the Balance Sheet of the company or it can be expensed in the Income Statement of the period in which it is incurred. Under IFRS, the following rules govern the categorization of the expenditure as an asset:

• If the expenditure is expected to give economic benefits in the future over several accounting periods.
• If one can measure the cost reliably.

Why Choose Capitalising: When an expenditure is capitalized, it affects the financial statements in the following ways in the period incurred:

1. Increases the assets on the company’s balance sheet.
2. Recorded on the cash flow statement as a cash outflow for investing.
3. Cash flow from operations is higher.
4. The profitability is higher in this case as compared to expensing the expenditure in the first year.
5. The shareholder’s equity is also higher as compared to expensing initially.
6. Higher ROE and ROA for initial years.
7. Lower ROE and ROA in later years as depreciation expense reduces net income.
8. This effect of an increase in profitability due to capitalizing continues until the capital expenditure is more than the depreciation expense.

In the later periods, the effect is as follows:

1. The capitalized amount is distributed over the useful life of the asset as a depreciation/ amortization expense.
2. Net income and the asset’s value is reduced due to the depreciation expense.
3. No effect on the statement of cash flows as depreciation is a non-cash expense.
4. The decrease in profitability.

So these are the benefits of using the capitalized method.

Why choose Expensing Costs: When any expenditure is categorized as an expense, it affects the financial statements in the following ways in the period incurred:

1. No recording of the asset on the balance sheet.
2. EBITDA and Net Income (NI) is lower.
3. The lower net income translates into lower retained earnings.
4. Cash flows from operations are reduced as the expense is considered as the cash outflow from operations.
5. No expense related to depreciation/amortization in later periods.
6. The profitability in the first year is lower as compared to capitalizing the expense.
7. Lower ROE and ROA initially but increases in later years.
8. The profitability in subsequent periods is higher as compared to the capitalizing of expenses.
9. Results in increased market multiples which might make the company’s share look overvalued.
10. This calls for adjusting the market-based multiples for capitalizing on having better comparisons.

So both methods have their own merits and de-merits, its according to the objectives, size and financial position that should be kept in mind while taking the decision