Lesson 3 of 8 · 14 min
Expense recognition and capitalising versus expensing
Expenses follow the consumption of economic benefits: matched with revenue, charged to the period, or capitalised and spread over an asset's life, and that choice reshapes profit, cash flow classification and trends.
In short
- Three models: matching (cost of goods sold with the related sale), period costs expensed as incurred (administration, R&D, repairs), and capitalisation followed by depreciation or amortisation.
- Capitalising instead of expensing gives higher profit in the year of spending, higher operating cash flow (the outlay is investing) and higher assets and equity early on.
- Over the asset's life, total net income and total cash flow are the same; expensing simply moves profit earlier into later years, flattering growth and adding volatility.
- For recurring purchases, the profit boost from capitalising lasts as long as spending exceeds depreciation.
- Estimates (bad debts, warranties, useful lives, salvage values) move expenses too. Recognising expenses later is less conservative; unexplained changes in estimates deserve scrutiny.
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