If a company capitalizes its costs then it means that the charges do not show up on the income statement. However, the expense will show up as a depreciation expense. The total amount can also be seen on the balance sheet accounts. This means that a company has the ability to spread the amount of its expenses over time. This means that the net income for that company will have a smoothing effect over the life of the investment or asset, and in the first year artificially inflates the net income.
Beat Box Co. manufactures and assembles stereo systems. Recently, Beat Box has just leased a new piece of equipment for its operations. Instead of the company incurring the cost all at once it has decided to capitalize the cost over time. Thus, if the entire cost of the equipment was $1,000, and it depreciates over ten years then the entire amount of expense incurred each year on the balance sheet would be $100. Note that if the amount of income was $600 for the next ten years then the amount in the first year would be a loss of $400. However, because this amount was capitalized the company will show a profit of $500 each year for the next ten years.
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