CFA Latest CFA Level 1 Discussions Capitalization of expenditures as a cash flow, can’t really understand the logic behind the solution

Capitalization of expenditures as a cash flow, can’t really understand the logic behind the solution

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    • tingwuwang
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      the question:

      Which of the following statements is most likely true with respect to capitalizing
      expenditure?
      A. Capitalization decreases cash outflows from investing activities.
      B. Capitalization increases cash inflows from operating activities.
      C. Capitalization increases the total asset turnover of the company.

      the solution’s logic is that capitalized expenditures are investing cash outflows and not operating cash flows. so by the solutions capitalizing it would result in an increase in operating cash flows and decrease in investing cash flows (whaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaat?????).
      can someone explain to me why this is the case?

      thanks so much in advance!

    • Sophie Macon
      Keymaster
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      Hey @tingwuwang, let me try:

      Expenditure capitalization always results in cash OUTflow, it is just a matter of where this is classified under cash flow statements (operating vs. investing).

      So if I capiltalize an expenditure, that means instead of it registered as a cash outflow in operating activities, it is being reclassified under cash outflow in investing activities. And therefore the total cashflow of operating activities will increase (to remove the cashoutflow being reclassified to investing activities), and total cashflow of investing activities will decrease (as it now has to deduct cash flow due to this expenditure).

      Does this make sense?

    • tingwuwang
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      @sophie so you’re essentially saying that all they’re doing there is moving the cash flow from under operating to investing, and since it’s a negative amount it will have an inverse impact of the direction of the movement, i.e. increasing from operating and decreasing from investing?

      that actually makes more sense! thanks sophie! 😀

    • Sophie Macon
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      yup @tingwuwang, that’s how I interpreted the question. Glad it’s useful.

      Keep calm and carry on, you guys are all doing great!

    • lawnm0wer
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      Also, keep in mind that when you capitalize CF, you take it off of the income statement, which increase net income. Since it net income is part of the calculation regarding CF from operations, higher net income equals higher CF from operations, all else being equal.

    • DigitalWizard
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      If your investment flows are already negative then capitalizing will indeed increase flow, making it more negative, or even more outflow. Same with operating, I think keeping inflow and outflow instead of just saying “cashflow” and assuming it is positive to the company.

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