Question

how an expenditure that is capitalized will affect the financial statements in the year the expenditure is incurred

Answer 1

An expenditure if capitalized will increase the profits of the company on the one hand and on the other, it will increase the asset position of company. It may mislead all the stakeholders who rely upon profits and asset position of the company for taking informed decisions. Finanacial ratios,trends will not give true information.

in other words, when an expenditure is capitalized, it affects the financial statements in the following ways in the period incurred:

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