Answer:
Share an analysis of the accounting challenges or accomplishments the organization seems to have faced with its categorization of expenses versus capitalization.
I would like to share a real life incident which happened recently. One of our Client which is into FMCG business paid $120,000 for online marketing of a newly launched product "X" to a firm for next 3 years. The expected life of the product is 10 years. Company's management said that we will capitalize the marketing expense and amortize it over next 10 years. Since, the life of the product is 10 years.
However, our view was that the company should amortize the marketing expense in 3 years. Although, the company would earn from the product "X" for the next 10 years but since the future benefit of the amount expended will be recovered in 3 years.
2. Describe the potential effects of capitalization and expenses. Some areas worth examining are the net income, stockholders' equity, cash flow from operations, assets reported on the balance sheet, and financial ratios.
When expenses are capitalized, then Net profit, Shareholder equity increases as expenses are reduced. Whereas, assets of the company increases as when expenses are capitalized they become asset. However, they are amortized in the ratio of future benefit in the corresponding years.
However, there is no impact on cash flow from operations. as this transaction has no effect on cash inflow or outflow.
3. Analyze at least two perceived needs of the organization at the time and justify the reasons for your claims (e.g., are assets expensed versus capitalized in aneffort to lower taxes, or are more loans/investments secured in an effort to
increase business value).
No, when expenses are capitalized, the tax outgo of the company increases as expenses are reduced and thus profit increases.
On the other side, if more and more loans are taken by a company, its business value diminishes as the company becomes more and more leveraged.