# software as capital

Jordan Hayes jmhayes at j-o-r-d-a-n.com
Sat Aug 28 13:12:02 PDT 1999

From dhenwood at panix.com Sat Aug 28 12:57:37 1999

If software were depreciated rather than expensed, reported

earnings would be higher.

Only today; tomorrow, they would be lower. In the long-term, it's the same. You can't depreciate what you didn't pay for -- despite this wacky idea of "capitalizing new ideas" ... can you imagine getting a deduction (depreciation is a current expense, and thus deductible) for something you didn't pay for? Sure, you paid the person who had the idea -- but payroll already is an expense.

Maybe an example is useful. Say you have a company that buys \$9k of software in year 1 and has \$2k of revenue the first year, increasing by \$2k per year over three years: \$4k the second year, \$6k the third. \$12k total. If software is expensed immediately, you have "profits" that look like this:

Year 1: (\$2k - \$9k = -\$7k) Year 2: (\$4k - \$7k loss carry-forward = -\$3k) Year 3: (\$6k - \$3k loss carry-forward = \$3k)

In that third year, you show a \$3k profit and pay tax on it. If your accounting period were three years long instead of one year, you'd have one big "year" that looked like (\$12k - \$9k = \$3k).

I.e., it's the same.

On the other hand, if you depreciate it over three years, you have books that look like this:

Year 1: (\$2k - \$3k = -\$1k) Year 2: (\$4k - \$3k - \$1k loss carry-forward = \$0k) [you just broke even!] Year 3: (\$6k - \$3k = \$3k)

These numbers are contrived to give the exact same answer in both cases, but it's easy to see how capitalization vs. expense is just a question of how long your reporting period is. In the real world, capitalization does nothing but raise tax revenues. Since it takes longer to write it down than it did to spend it, you show profits in the interim that get taxed sooner than you're done writing it off -- of course those taxes are deductible against future earnings, so you'll eventually "get it back" (in the form of additional expenses incurred in future accounting periods, which of course depresses earnings) but you get it back more slowly than you gave it to the government.

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I find it curious that Greenspan would make this comment.

/jordan