Management Accounting: Operating, Investment & Capital Expenses

Private accounting for small to mid-sized entrepreneurial companies remains in a grey market environment that fluctuates inconsistently between GAAP Standards, Informal Internal Management Standards and Hybrid Tax Standards. Better management tools are needed.

Accounting has enough complexity when it operates with very clear and well-defined standards. Often with unclear and inconsistent standards, private enterprise accounting can be confusing and provides marginally accounting literate business owners with little of what they need to make the best business decisions possible.

Management of operating expenses, investment expenses and capital expenses are the types of issues that can confuse accountants and totally confound business owners needing accounting insight and not confusion. It is not always considered or possible in the context of internal financial statement reporting to provide the kind of insight that is the highest and best use of accounting information.

Operating expenses: In its best interpretation and most accurate tracking an operating expense should capture an expense that was an actual accounting event when it occurred or otherwise clearly allocated, regardless of whether it is good, bad or indifferent.

If a thoughtful budget plan does not exist making value judgments about an actual expense relies on good thoughtful chart of account creation.  If it is consistent it is frequently assumed to be appropriate which may or may not be the case.  Accounting illuminates, managements role is to challenge.

Capital Expenses:  In theory, a capital expense is designed to measure an expenditure that is designed to provide useful benefits over a period of time longer than one accounting period and allocate expenses though depreciation expense treatment for the life cycle of the asset.      In reality,  the life cycle is determined mostly by tax laws and may or may not accurately reflect the life cycle of the asset.  Actual expense allocation is frequently distorted.

The classification of capital assets is well intended and is generally more accurate than simply treating capital expenditures as operating expenses.  However, changing tax laws related to accelerated tax write-offs and other elements literally take a tax expert to fully process and translate the accounting treatment.  Most small business owners don’t always have that access or insight.  The bigger issue is that Capital Expense treatment ignores the bigger question as to whether the expense is meet its business objectives or not.

The original intent to provide an accurate accounting presentation of how much of a capital expenditure should be expressed in a particular accounting period is confusing at best and its value to business owners and managers difficult to process.  Its significance is often ignored and depreciation simply treated as positive cash flow or non-taxable income.  The investment objective and eventual replacement is frequently never really addressed or measured.

Investment expenses: Unlike Operating Expenses and distinct from Capital Expenses,  Investment Expenses are often simplified and viewed as normal operating expenses. They are usually categorized in the seemingly most logical time frame and account class.  However, real Investment activity that does not meet Tax or GAAP standards for Capital Expenses are very easy to be misinterpreted or misunderstood. The accounting treatment frequently provides little insight for management, financial analytical help or insight.

This confusion between the nature of these expenses can easily cover-up or lead to bad decision making and extremely short-sighted business management behavior.

One of the best examples of this type of distinction is with advertising and marketing expenditures.  Good advertising strategies will frequently engage in early investment spending that is designed to have longer term and residual benefits.  This investment spending strategy can be viewed as distorted, inappropriate or unprofitable within the context of normal financial accounting treatment.  It can lead to short-changing the value of the expenditure and the strategy which can extend beyond the accounting period. The ultimate value may never be fully appreciated or realized.   It can also lead to becoming an excuse for poor performance.

On the other hand, simply accepting investment spending as appropriate without having clarity as to what the investment objectives were and measuring its value and cost within defined parameters is a bigger challenge.  This type of investment spending requires astute accounting recognition with appropriate notes to management or financial statement consumers so investment elements are recognized and their outcome measured.  When that occurs, good accounting can become a great management and financial analysis tool.

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