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Chapter 9. Goosing, Stuffing, and Faking... > Red Flag 1: Any Signs That Companies...

Red Flag 1: Any Signs That Companies Are Reducing Costs by Capitalizing Them

Corporate spending can be divided into two categories. There are the purchases of raw materials and payment of wages, rent, and advertising costs that are clearly operating expenses. These have to be offset against revenue on a quarterly basis. Then there is the purchase of some big-ticket items that are used over a number of years, such as a fleet of new vehicles for a trucking firm. The latter costs are capitalized, which means that an asset is created on the company’s balance sheet and is then written off (through an annual depreciation charge) over its productive life. This asset is going to be used to produce revenue over a longer period than a quarter or a year, and therefore the costs should be taken over a longer period to reflect that. At the same time, the annual depreciation charge is an acknowledgment that the asset will eventually be spent and will have to be replaced.


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