Expensing/Capitalization question

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dind

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Hi,

According to Schweser notes, capitalizing increases assets but does not increase debt. I don't understand how this is possible.

When a firm purchases a plant for $1000, if you capitalize the asset, you add a new item under assets for $1000 in the balance sheet. But shouldn't say you also add $1000 as accounts-payable in the liabilities section ?

Since the basic equation is
Assets = Liabilities + Equity.

So if Assets increased by $1000, shouldn't Liabilties also increase by $1000 ? Unless it's the owner's equity that increases by $1000 - which I don't see.

I'm sure it's simple, but eh I am an engineer and I am new to this stuff :)

Thanks.
 
Capitalization is an accounting decision, not a financing decision. It does not affect your debts any differently than expensing. For instance, if you buy a computer for $1000.00, you can choose how to pay for it, sell a bond, sell stock, use your cash etc. That is a financing decision. Financing decisions affect your debts/equities. Your decision to capitalize, expense will affect your B/S and I/S.

If you capitalize the computer, the long term asset category will go up by $1000.00. Your expenses will go down by $1000.00 (relative to an expensed computer).

It will also have several impacts on your ratios.
 
So to answer your question, offset on equities/debts will depend on your FINANCING decision.

If you sell debt to buy it, your liabilities will offset the rise in assets

If you sell stock, your equities will offset the rise.

If you use cash, the decrease in cash will offset the rise in LT assets
 
Thanks folks,

Yes, I get it now. It's just weird that shweser kept saying that debt/equity will decrease without specifying exactly how the financing was done.

Thanks again. Back to the books.
 
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