As I was reading FRA Chapter 17 on long-lived assets, specifically capitalizing versus expensing, I came across Example 1 (pg 51). From the example, it seems that company CAP capitalized the 900 in year 1, whereas company NOW expensed the 900 in year 1. But when you just bought something and decided to capitalize it, do you first add the asset to your balance sheet at the time of purchase, then wait for the next period to start depreciating, in this case, Year 2? In the exhibit, it looks like it starts depreciating right away at the time of purchase instead of waiting til the next period?
Hi, If you capitalize an asset today for 1000 and your depreciation is 100 per year. you are going to depreciate 100 at the end of the year, right? Thats what is done.
You bring the asset onto your Balance Sheet at purchase, and then begin depreciating it once the asset goes “in-service”, which means you begin using it in your business. As a practical matter, these two dates are often the same. I have seen three different equally valid policies for when to begin depreiating:
– in the month the asset goes in service
–the next month after it goes in service
–depends on in-service date. If before the 15th of the month, take a full month of depreciation. If after the 15th, wait until next month to begin depreciating.
For CFA Exam questions, look for clues as to when the asset went into service. If they say “beginnning of year” then it is probably safe to asssume that they want you to take afull year of depreciation.
In the example, it says “At the beginning of operations, each company pays 900 to purchase equipment.” So I assume they pay 900 at the beginning of year 1, so then by the end of year 1, we need to take a full year of depreciation, thus explains what’s shown in the solution.
There you go then. If they made the purchase in January, company management could not justify taking zero depreciation in Year 1. If they made the purchae in December, then no problem taking zero in Year 1, if that is the company’s documented policy.
Yep. thanks!!
Regarding question 3 of this blue box example1 in reading 17, why does the answer attribute the difference in total change in cash flow to taxes only? i thought the answer would be because CAP is adding back depreciation to calculate cash flow.
Think of it in terms of concepts, rather than formula:
Immediately after buying the equipment, each comapniy has equally less cash.
But come tax time, the company who fully expensed the purchase for accounting purposes deducts the full amount from their tax return in Year 1. The company that capitlaized will deduct 1/3rd in year 1. That is where the CF differnce is.