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What it means to capitalize something

What it means to capitalize something

Posted May 20, 2011 18:51 UTC (Fri) by jhhaller (subscriber, #56103)
In reply to: Scale Fail (part 2) Hardware often works ... by mrjk
Parent article: Scale Fail (part 2)

Many people don't understand what it means to have a capital asset. Yes, capitalizing something does take much of the expense off the books. But it affects cash flow, as you still have to pay for the equipment when you get it. On top of that, a portion of the capitalization comes back as expense every fiscal period, as the purchase still has to come off revenue eventually. This shows up on budgets as depreciation.

Think of buying something on capital as like buying a car. There are payments every month, and your outstanding loan amount counts against your available credit. You still have to pay off the car, but not all at once. Capitalization is slightly different in that there is no one loaning the money up front, but to an organizational budget, it looks more like the loan, while corporate worries about where the money comes from, and if they can meet the payroll next month.

With capitalization, it's quite easy to get oneself into a bind, where last year you bought a huge amount of equipment, this year you fixed the software bottleneck which makes the extra equipment no longer necessary. But, your organization will be paying the depreciation on that now useless equipment until its fully depreciated or you sell it. The first organization I worked at had a seven year depreciation schedule, and everything was worthless by year four. We eventually started buying everything on expense accounts, as it allowed us to adjust to different staff and work levels. But, we were stuck with that depreciation for quite some time.


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What it means to capitalize something

Posted May 30, 2011 0:43 UTC (Mon) by giraffedata (subscriber, #1954) [Link]

With capitalization, it's quite easy to get oneself into a bind, where last year you bought a huge amount of equipment, this year you fixed the software bottleneck which makes the extra equipment no longer necessary. But, your organization will be paying the depreciation on that now useless equipment until its fully depreciated or you sell it.

And that's the whole reason buying stuff with capital dollars is often better than buying stuff for which you have to use expense dollars. You certainly won't hold onto that equipment you're not using anymore and keep paying for the depreciation. You'll sell it and get back some of what you originally spent. But if you had originally spent money on consulting instead of hardware (and the consulting wasn't capitalizable), you're stuck. The money is gone forever. That's why Management is more willing to authorize hardware purchase than consulting.

Obviously, you can do the accounting incorrectly and make it look like some decision is better when it's not -- for example, depreciating equipment over 7 years when you know it will be worthless in 4.

What it means to capitalize something

Posted May 30, 2011 10:41 UTC (Mon) by nix (subscriber, #2304) [Link]

That's why Management is more willing to authorize hardware purchase than consulting.
Not anywhere I've ever worked (though perhaps this is because ostentatiously pointless expenditure is perhaps *the* way to retain empires in the City).


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