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3 explain and evaluate how capitalizing versus

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3. Explain and evaluate how capitalizing versusexpensing costs in the period in which they areincurred affects financial statements and ratios.
i.Assuming no differences in tax treatment,total C/F will be the same, differ only theclassification.ii.If the tax treatment is changed to match thefinancial reporting treatment of theexpenditure, expensing will result in higheroperating in the first year b/C of the taxsaving.iii.If tax treatment is independent of the fin.Reporting treatment, taxes and thereforec/F. are unaffected by the choice.d. Financial Ratios >> capitalized, asset and E arehigher. Debt to asset and to Equity are lower(large denomination) and will in the first yearresult in higher ROA, and ROE the result ofhigher NIe. Be careful when comparing firm b/c immediatelyexpensing an expenditure gives the appearanceof growth after the first year.f.Interest coverage Ratio (EBIT/ interest expense)measure the ability to make required interestpayment on its debt. Capitalizing results in lowerinterest expense compared to expensing. Sohigher interest coverage (smaller denominator).i.Interest coverage ratio should includecapitalized interest b/c required paymentand better measure of firm’s solvency. Andwill reduce the interest coverage ratio. Bondrating included.

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Term
Spring
Professor
N/A
Tags
Depreciation, Financial Ratio, Generally Accepted Accounting Principles, COGS

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