Capitalizing vs. Expensing | Income Variability

[allalongthewatc]

Schweser says that income variability is lower when capitalizing, as compared to expensing. Can someone please explain this to me?

 

[S2000magician]

Try some numbers:
You buy a $1,000,000 machine with a useful life of 10 years.
Your revenue each year is $150,000.
If you capitalize the cost of the machine, your annual income is $50,000 per year each year for 10 years.
If you expense the cost of the machine, your annual income is −$850,000 the first year, and $150,000 per year each year for the next 9 years.
Which is less variable?

 

[Tactics]

By capitalizing the costs, you incur a fixed depreciation expense each year (assuming straight line dep), as opposed to a high one-time operating cost.

 

[allalongthewatc]

Thanks S2000magician!

 

[S2000magician]

My pleasure.