Accounting Ratios

Capitalisation of Expenses

We penalise companies which have a high level of capitalised intangible assets relative to pre-tax profits. Bloomberg’s definition of the acquisition of intangible assets includes patents, copyrights plus research and development. This data is only available for the last financial year, and so we have not collated it for 2010 to 2015, the methodology used for other red flags.

While there is some logic to the concept of capitalising costs to develop projects with long lead times, the amount capitalised can be subjective and used to manipulate reported profits. It’s worth bearing in mind that under US GAAP, companies are generally not allowed to capitalise expenses, although they can acquire intangible assets. Capitalising expenses can lead to companies with identical assets booking different values on these owing to the amount capitalised. Only about 4% of companies capitalise expenses as intangible assets, with the highest incidence rates in I.T. and software sectors, as Figure 131 shows, and in Japan and Switzerland, as Figure 132 shows. A red flag is programmed to trigger when capitalised expenses exceed 10% of pre-tax profit.