Capitalizing vs. Expensing Costs: Cash Flow, Taxes, and Deferred Tax Liabilities

Comparing a Firm that Capitalizes Costs with One that Expenses Them

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Question

While comparing a firm that expenses costs with one that capitalizes them:

I. The capitalizing firm always shows higher cash flow from operations.

II. The cumulative difference between the cash flow from operations increases over time.

III. The capitalizing firm pays lower taxes in the first year.

IV. The capitalizing firm recognizes higher deferred tax liabilities.

Answers

Explanations

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A. B. C. D.

B

Expensing charges the entire cost to CFO while capitalization leads to a charge against the investing cash flow. Over time, depreciation reduces the tax payments. Hence, the cumulative difference in the CFOs increases over time. The expensing firm reports lower income in the first year and hence, pays lower taxes.

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