software as capital

Roger Odisio rodisio at
Mon Aug 30 20:18:31 PDT 1999


You disagree with Doug that expensing an asset lowers reported earnings compared with depreciating it. You expressed surprise that Greenspan would say essentially the same thing--"The important point, however, is that decisions about which items to expense will have important consequences for reported earnings". You deny this. You say there is no effect on earnings, save for a possible benefit of reporthing earnings earlier rather than later.

You reach this conclusion by simply looking at one group of assets *in isolation* and compare the income stream to expenses for the asset life. By in isolation I mean without any other assets entering the books during the life of the given group. Of course your conclusion is correct in that case.

But that's not the right way to look at it. I asked you to consider a firm with multiple assets *of different vintages*, which continually buys new units and retires old ones, in which the new units themselves may have different expected lives than the ones being replaced. Add to that the new units bought to increase capacity. It should be easy for anyone who has looked at company books to see that expensing that equipment reduces earnings compared to depreciating it.

You replied with bombast, "this is just bad math", and more assertions based on your asset-in-isolation example. You said expensing understates profits today, of course. "But tomorrow *you have no deduction*, so the profits that you would have stated in a previous period (but instead understated, due to the immediate expensing) now come out." A clearer statement of your mistake could not be made: you have no deduction tomorrow because, in your example, you are following the original group of assets in isolation to the end of their life, rather than considering the situation as it actually exists, where there are new assets and new deductions *all the time*.

Let me make this concrete. If your were correct that there is no effect on earnings from expensing compared to depreciation, you would expect capitalists to be indifferent to IRS depreciation rules concerning asset life. That is, they would have no preference for accelerated depreciation (expensing being the ultimate acceleration of depreictaion into one year). But of course they do want accelerated depreciation, whenever they can get it. Capitalists are always trying to convince Congress to accelerate the writoff of one asset or another. What is the argument they use? If you accelerate depreciation it will help investment in that industry. How? Yep, by reducing reported profits, leaving them more investable funds that show up as the depreciation part of cash flow (profits plus depreciation), but are really profits (as they were considered before the depreciation was acclerated). Leaving aside whether such depreciation changes do result in more investment, the capitalists, and Greenspan, at least understand what you do not: accelerated depreciation, and of course expensing, benefits them by reducing reported earnings over time.


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