Why is it important that we use the accounting practice of capitalizing major as

Question

1. Why is it important that we use the accounting practice of capitalizing major asset acquisitions of items with multiple-year useful lives and then depreciating them over time? How does this improve valuation of the business on the balance sheet and ensure compliance with the matching principle on the income statement (a) when the asset is acquired, (b) in one of the middle years of use of an asset with a multi-year life, and (3) when the asset is eventually disposed of via sale to an outside party.

Explanation / Answer

It is important to capitalize major asset acquisitions of items with multiple-year because it will help one give a better image of the path the business is taking. If they were to be automatically considered expenses then this would hurt the company and make it appear non profitable in the long term. Depreciating them over time is also an important technique because you cannot always assume something will be as functional as the day you aquired it, for example a car or a tractor which would eventually break down and get used up over time, thus it's value must be depreciated over time, usually linearlly unless some unexpected market failure occurs.

(a) It improves valuation in this case because when the asset is aquired you would most likely want your business to appear profitable and functional, especially at the initial aquisition time of such multi year items, otherwise it would the defeat the whole purpose of even aquiring them.

(b) In this case valuation is improved because duting these mid life years it gives the company a sense of stability on it's balance sheet. This owuld also make things appear to be going much more smoothly rather than having it market as an expense altogether from the start.

(c) When the asset is eventually disposed of it improves valuation because if past companies had any kind of access to the balance sheet they would see that the overall effect was indeed positive and not just a complete waste of time which would highly deter and prospecting outside third parties.

Hope this helps, good luck.

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