Accounting: What the Numbers Mean 9th Edition by Wayne W McManus, Daniel F Viele, David H Marshall

Exercise 82

Capitalizing versus expensing—effect on ROI Early in January 2010, Tellco, Inc., acquired a new machine and incurred $100,000 of interest, installation, and overhead costs that should have been capitalized but were expensed. The company earned net operating income of $1,000,000 on average total assets of $8,000,000 for 2010. Assume that the total cost of the new machine will be depreciated over 10 years using the straight-line method.

Required:

a. Calculate the ROI for Tellco, Inc., for 2010.

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b. Calculate the ROI for Tellco, Inc., for 2010, assuming that the $100,000 had been capitalized and depreciated over 10 years using the straight-line method. (Hint: There is an effect on net operating income and average assets.)

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c. Given your answers to a and b, why would the company want to account for this expenditure as an expense?

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d. Assuming that the $100,000 is capitalized, what will be the effect on ROI for 2011 and subsequent years, compared to expensing the interest, installation, and overhead costs in 2010? Explain your answer.

Step 1 of 5

Capitalizing versus Expensing-Effect-ROI

Capitalizing versus Expensing : When a company procures an asset that provides benefit for more than a financial year, it is capitalized in the balance sheet of the company. It is capitalized as a fixed asset relatively than writing it off immediately to the current year’s profit and loss. The fixed asset is next depreciated above a number of years to allocate the cost across the point that it is useful for the company. The charge of depreciation hits the profit and loss like an expense.

ROI : It is a measure to evaluate the effectiveness or performance of an investment in terms of its returns or benefits.