InformationWeek

January 12, 1998

Expensing Vs. Depreciation

he rule requiring that software projects be capitalized deals with a basic aspect of accounting: how costs are recorded. One way is to treat an expenditure as an expense. Expenses-electricity, phone calls, interest, rent-are anything that is essentially used up in the period in which the cost is incurred. Since profit equals revenue less expenses, recording an item as an expense immediately reduces profit by that amount, excluding taxes.

The other way to record a cost is to "capitalize" it as an asset-something that is used or consumed over a period of time, as a building or equipment (including computer hardware) is. But most assets don't last forever. So once an asset starts being used, a company must depreciate the asset over its projected useful life. That means that every year an expense, called depreciation, is recorded, reducing the asset's value for accounting purposes until it is zero.

Whether a cost is expensed immediately or capitalized, the c ompany actually pays for the asset at the same time and the total amount of expense recorded is the same. Depreciation merely lets companies delay recording the expense and then apportion it over the asset's useful life. That means the negative impact on earnings is also delayed and spread out over time.

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