Scenario 1: If equipment depreciation expense is capitalized on a construction project, should the original depreciation expense be kept as is and the income statement include a credit to operating expense for the amount of the capitalized depreciation? If reported like this, the cap ex in investing activities would not include the amount of the capitalized depreciation since it was a non-cash expenditure and depreciation on income statement and cash flow would match. Scenario 2: Alternatively, depreciation could be credited directly in both the income statement and cash flow. Cap ex still would exclude the capitalized depreciation, but in the operating cash flow section a new line would be included labeled “Capitalization of non-cash expenses,” which would be an add back to net income for the amount of the capitalized depreciation. Depreciation in the cash flow and income statement would be less than scenario 1 by the amount of the capitalized depreciation. I couldn’t find guidance that addressed this fact pattern. Scenario1 is nice because you don’t have to add a new line to the cash flow statement, but the argument against it is some may say that depreciation expense is overstated since some of the reported depreciation was capitalized. Thoughts?
Deprection only hits the cash flow statement as a reversal.
It also usually occurs in just 2 places
When going from Net Income to CFO
The going from change in PPE to CFI
Overall they balance each other out
In your circustance you have to think where the depreciation would have gone.
If a part of assets depreciation has been added to capitailised cost of project it is not hitting net income at all.
It is effectjust moving from one fixed asset to another.
You have reduced the value of, for example , an excavator and added to the vallue of the warehouse you are building.
On the CFI statement
We will see no deprecaition of the exavator - it is not cash
And we won’t include the allocated deprecation of the excavator in the cash investment cost of the warehouse.