CFA Practice Question

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CFA Practice Question

Capitalizing an expenditure rather than expensing it results in ______.

I. greater amounts reported as cash from operations
II. lower profitability ratios in the early years
III. greater shareholders' equity in the early years
Correct Answer: I and III

Capitalizing an expenditure results in higher profitability ratios in the early years.

User Contributed Comments 5

User Comment
cong I: cash expenditure for capitalization results in a reduction in cash OUTFLOW from operations, thus an increase in CFO.

III: Less is expensed in early years for capitalization.
weehongw the cash flow is categotized as CFI if capitalized thus results in a higher CFO
Paulvw Capitalizing a single expense only results in higher profitability ratios in the first year, lower thereafter (Reading 22, pp 60-61). Multiple capitalizations can produce false profitability numbers for a number of years.
quanttrader capitalizing is CFI and thus CFO is higher vs expensing

exppensig is CFO and thus CFI is higher vs capitalizing
VazquezCol Answer I is more complicated than it seems. As said in previous answers, the first year the cash outflow when capitalizing is of Investing type but it will be operating if the asset gets expensed. That is clear. But what after the first year? Then, if the asset was expensed, there is no depreciation and therefore the company will pay more taxes because Earnings Before Taxes will be higher than if it was capitalized. So expensing will have higher operating cash outflows than capitalizing also in the long run. That is why the answer I doesn't mention long or short term at all.
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