Advanced Valuation Issues Capitalized Expenses推荐.pdfVIP

28 Capitalized Expenses When a company builds a plant or purchases equipment, the asset is capital- ized on the balance sheet and depreciated over time. Conversely, when a com- pany creates an intangible asset, such as a brand name, distribution network, or patent, accounting rules dictate that the entire outlay must be expensed immediately. For firms with significant intangible assets, such as technology companies and pharmaceutical firms, failure to recognize intangible assets can lead to significant underestimation of a company’s invested capital and, thus, overstatement of return on invested capital (ROIC). To illustrate why and how to capitalize expenses, in this chapter we focus on one category, research and development (RD) expenses. For the purposes of measuring a company’s economic performance, any ex- pense with benefits lasting more than a year should be treated as an investment, since it has created a durable intangible asset. We recommend capitalizing RD expenses for three reasons: 1. To represent historical investment more accurately: By expensing items with long-term benefits, the accounting statements will understate the com- pany’s historical investment. This understatement of capital can ar- tificially boost ROIC in later years, making a business appear more attractive than it really is. (In the example to follow, ROIC drops from 42 percent to 13 percent when RD expenses are appropriately capital- ized.) 2. To prevent manipulation of short-term earnings: When RD is expensed, reductions in current RD flow immediately through the income state- ment, so under traditional accounting, a manager looking to meet short- term earnings targets can simply reduce RD. When RD is capitalized, however, short-term earnings are unaffected by cha