Hi,
I wonder how these scenarios will show in the statements.
Assumptions: €100 machine purchase, Depreciation of 10 years (straight line), no salvage value, corporate tax rate of 20%. Machine purchased in the beginning of the year and no dividends are paid out to equity holders.
Capitalising scenario:
Depreciation = 10€, so net income decreases by 10€ * (1-0,2) = -8€.
Cash Flows
Depreciation is added back in in CFO so we have 2€ from CFO.
CapEx decreases CFI with 100€
PP&E is now 90€ (after depreciation the first year)
Cash is -98
Asset = -8€
Retained earnings = -8€
Balanced!
Now the question: how would this scenario look like if we would expense? Would we just have 100€ in PP&E and -100€ cash on the balance sheet? It feels wrong to skip the whole flow through the PnL and cash flow statements..
If you expensed the machine, the entire EU100 impact would fall on the income statement, instead of EU10 of depreciation:
P&L Machine expense: -EU100 Net income: -EU100 * (1-0.2) = -EU80
CFS CFO = -EU80 Net cash flow = -EU80
B/S Cash = -EU80 Assets = -EU80
Retained earnings = -EU80
Because you expensed the machine, it doesn't show up as a capital asset (i.e. PP&E) on the balance sheet anymore, and therefore does not incur depreciation. It should be treated like any other cash expense.
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