I have been tasked with managing our timesheet system at work.
When filling out timesheets, people can select tasks which are classified as Capital Expenditure (CAPEX), such as writing code, or Operational Expenditure (OPEX), such as attending meetings.
Everyone at work keeps telling me that we want to maximize the amount of time (i.e. labour cost) which gets classified as CAPEX.
So if someone spends 4 hours writing code, but forgets to put that in their timesheet, the cost of that person for half a day defaults to OPEX, which apparently is worse for the company.
Me: How is OPEX worse?
Accountant: Because we can't write off OPEX costs. We can write off CAPEX costs
Me: What do you mean "write off"?
Accountant: $1 of CAPEX now means we have an asset worth $1. It will degrade over time (e.g. an old car is not as valuable as a new car.) So in future years we can say on paper that we lost money (e.g. 10 cents per year for 10 years). This means the company as a whole will make less profit on paper in those years, which means we pay less tax. (Since tax is a % based on profit not revenue)
At the time this explanation made sense, but the more I think about it, the less it makes sense.
Let's compare a $1M OPEX cost, vs a $1M CAPEX cost, deprecated/amortised/whatever over 10 years. Assume an effective corporate tax rate of 30%.
Year 1: We spend $1M. We aren't counting the work as an asset. Therefore our company made $1M less profit this year. So we pay $1M * 30% = $300k less tax than if we didn't spend $1M.
Years 2 onwards: No effect
Total Net Present Value (NPV) = $300k - $1M = - $700k.
Year 1: We spent $1M. We are "capitalising" it, so we are saying that we now own a $1M asset. So the net change to our companies worth is $1M - $1M = 0.
Year 2-11: We are "writing down" the value of this asset by $100k each year. So on paper we made $100k less profit each year. So we pay 30% * $100k = $30k less tax each year.
Let's assuming a NPV rate of 10%. (You can choose any positive number and the end result is the same), the NPV of the tax savings is:
(1.1^0 * $0) + (1.1^-1 * $30k) + (1.1^-2 * $30k) + (1.1^-3 * $30k) + (1.1^-4 * $30k) + (1.1^-5 * $30k) + (1.1^-6 * $30k) + (1.1^-7 * $30k) + (1.1^-8 * $30k) + (1.1^-9 * $30k) + 91.1^-10 * $30k) = $184,337
Or as code, if that's clearer:
sum([(1/1.1)**n * 30000 for n in range(1,11)])
So the NPV of choosing to spend $1M on CAPEX vs no spend is $184.337 - $1M = -$815,662
-815,662 < -700,000
So isn't the CAPEX option far worse for the company financially? It seems to me like it would be better tax-wise to never capitalise anything.
(Yes I'm ignoring the value produced by the spend, e.g. if you spent $1M renovating a store and get $1.1M more sales or whatever. That gain is the same regardless of whether or not you capitalise the cost. Therefore it doesn't affect whether or not you should capitalise.)
Or is the real reason we capitalise stuff that it looks better on the books to have high assets and high liabilities than low assets and low liabilities?
(This company was in Indonesia, but I've seen the same thing in Australia.)