ACFE Certified Fraud Examiner (CFE) Financial Transactions and Fraud Schemes Practice Exam

When an expenditure is improperly recorded as a capitalized asset instead of being recognized as an expense, the primary effect is that assets on the balance sheet will be falsely overstated. This occurs because capitalizing an expenditure treats it as an asset rather than a current expense, which leads to an increase in total assets reported.

In terms of financial reporting, expenses that should be recognized immediately reduce net income for that accounting period, while capitalizing an expense spreads the cost over several accounting periods through depreciation or amortization. As a result, this manipulation inflates the value of assets on the balance sheet because the company reports an asset that does not accurately reflect its true economic position.

It’s important to recognize that while this incorrect capitalization can have downstream effects on net income and expenses, the most immediate and direct impact is on the balance sheet, leading to asset overstatement. This issue is significant for both auditors and financial statement users, as it can obscure the true financial health and profitability of the entity.