When an entity improperly capitalizes expenses, what is one potential consequence?

When an entity improperly capitalizes expenses, it typically reports certain costs as capital expenditures rather than as immediate expenses. This accounting practice can lead to the overstatement of assets on the balance sheet because capitalized costs are added to the value of an asset rather than being expensed in the current period. As a result, the financial statements may reflect a stronger asset position, leading analysts and investors to view the company as more financially robust than it actually is.

Capitalizing expenses rather than recognizing them immediately affects the income statement by postponing the recognition of expenses, which can also lead to distorted profit margins. However, the main impact related to the capitalization of expenses is the appearance of assets, making them seem more favorable on the financial statements, even if the underlying economic reality has not changed.