Hi Chuzz,..Re:.the invested capital (capital plus long-term debt) is reduced making it appear that subsequent growth is stronger than it really is.
Alan addressed these issues in an Aug. 17 speech at Jackson Hole.<g>
Software that is embedded in capital equipment, and some that is stand-alone, is currently being capitalized and consequently amortized against current and future earnings. But a substantial portion of software spending is expensed, even though the equity prices of the purchasing companies are clearly valuing the software outlays as contributing to earnings over their useful economic lives--the relevant criterion for capitalizing an asset.
There has always been a fuzzy dividing line between what is expensed and what is capitalized. This has historically bedeviled the accounting for research and development, for example. But the major technological advances of recent years have exposed a wide swath of rapidly growing outlays that, arguably, should be capitalized so that the returns they produce would be more accurately reflected as earnings over time. Indeed, there is even an argument for capitalizing new ideas, such as different ways of organizing production, that enhance the value of a firm without any associated outlays. Some analysts judge the size of undercapitalized outlays as quite large.1
The important point, however, is that decisions about which items to expense will have important consequences for reported earnings. In general, if the trend of expensed items that should be capitalized is rising faster than reported earnings, switching to capitalizing these items will almost always accelerate the growth in earnings. The reverse, of course, is also true.
bog.frb.fed.us
Cheers,
Lee |
