For example, the purchase of a photocopier involves capital expenditures, and the annual paper, toner, power and maintenance costs represents operating expenses.The key thing to remember is that a capital expense is supposed to convert cash into an asset.
Second, application: most enterprise information system builds these days are funded as capital expenses. Money is spent, and at the end of the day the organization places an entry on the balance sheet saying "System Z is worth X million dollars".
Third, contention: this common IT accounting practice is bullshit.
The reason it is bullshit is that the asset has to be placed on the books with a value, some dollar figure that represents what it is worth. This isn't just some made up number, it's important. This number is a component of the total asset value of the organization, and if you are adding up the value of the organization, it will be added in along with the cash, the real estate, the fixtures, all the other things that we know do have value.
Does the enterprise information system have value? How much? Where does that number come from?
Is the information system value a re-sale value? No. Unlike the photocopier from the Wikipedia example, the enterprise information system has no value outside the organization that built it: it's sui generis, custom-built for the purposes of one organization.
Is the information system value a replacement cost? No. Governments build things like bridges and highways that don't necessarily have a re-sale value (who is going to buy them?) but still have a provable value in terms of their replacement cost. If it takes $100M to build a bridge, it's a fair bet that it'll take $100M to build a second one just like it. Is this true of enterprise information systems? If I build a billing system and it costs me $1M, will it cost you the same thing to build a second one? If you have access to my source code and specifications, you could probably build an even nicer one for 1/10 the cost or less, since you wouldn't have to spend any time at all discovering the requirements or doing data cleansing. There's no expense in materials and relatively little of the labor value ends up embodied in the final product--the system value is not the replacement cost.
Is the information system value durable? No. Long-lived public infrastructure may not be re-sellable, but it often has a useful life span reckoned in multiple decades. Given that, it's fair to say that the cash involved in building it has not been spent, but has been converted into a fixed asset. Do enterprise information systems have that kind of durability? Do I even have to ask?
Does the information system value reflect a one-time acquisition cost? No. The $3B (gulp) Port Mann bridge newly opened on BC's Lower Mainland will have an annual maintenance cost of perhaps $30M a year, %1 of the capital cost. The asset is built, and we get to keep using it almost for free (except for the tolls to cover the loan, ha ha!). Is this true of enterprise information systems? In my experience, information systems budget 10-20% of build cost for expected annual maintenance. So, it's very different again.
Is there any case at all to be made that enterprise information systems can be treated as assets, and hence budgeted as capital expenses? Yes. But it requires that the asset value be assessed very conservatively (the whole build budget is not indicative of final value), and that the value depreciate very quickly (the system has a relatively short lifespan, years not decades).
But rapid asset depreciation is just as hard on a balance sheet as operating spending is! Build a $100M system and depreciate it at 10% a year, all you've done is concentrate $100M of IT spending into a very short period of time and spread out the depreciation over a decade.
So, skill testing question for all you IT practitioners out there. Who will get the better results:
- the manager who spends $100M in one year on a system build and depreciates his asset over the ensuing decade? or,
- the manager who spends $10M a year over a decade in incremental system enhancements and improvements?
Accounting for enterprise information systems as capital expenses is a mistake. It's dubious from an accounting perspective, because the "asset" on the books isn't re-sellable, doesn't hold its value, and doesn't cost nearly its book value to replace. And it's dubious from a practical perspective because it forces system development and maintenance into an incredibly risky and inefficient spending pattern.
Don't do it if you can help it.
5 comments:
Interesting perspective on maintenance vs. capital IT expenditures. I do think enterprise systems have resale value though. A company obviously can't sell their system outright, but I believe system value comes into place when a company is acquired.
Of course, the system may have little value if it is poor, but the market determines that. If you bought a company and knew you had to replace its system then your offer would reflect that cost. Likewise, if the system performed its function that price would be included in the cost, or real value.
Basically what you are proposing is the replacement value, but a market-determined one:
(value of company w/ system) - (value of company w/o system) = (value of system)
However, a value that depends on the system being integrated in the company is not a great one: I can't break up the company and realize any value in the system. Heck, in most acquisitions the first order of business is replacing the systems of the acquired company with the ones of the parent.
In any event, my final contention is that even if you can value your system, somehow, it depreciates so fast that you'd have been better off just ignoring any fleeting balance sheet value and concentrating on maintaining and upgrading it with operating dollars. Because the real value is in supporting the profitable operations of the company, not in the system itself.
You seem to complexly state "because information isn't physical, it has little monetary value" beyond it's use.
It overlooks that the acquisition and deployment of an "information system" (for whatever that means) is an investment by the company to be used to generate profits (or fulfill mission).
For example, the IRS includes a wide range of costs that can be considered Capital Expenses such as startup costs, patents, franchise rights, etc.
http://www.irs.gov/publications/p535/ch01.html#en_US_2011_publink1000208608
However, IANACpa applies
@Andrew, I'm far too much the internet boy to argue that only atoms have value.
You can put anything you want onto your balance sheet, and I'm not saying putting enterprise information systems there is not allowed (as you note, it is!) I'm saying it's ill advised.
So, the CIO goes to the CFO and says "You're going to give me $5M to build a system and when I'm done you'll have a $5M asset on the books". And the CFO says "awesome!". Has the CIO been 100% truthful? Is the system worth $5M? You can put anything you want on your books ("goodwill" anyone?) at almost any value, but at some point things get reviewed and the values that were wrong are "written down" (see "Instagram, acquisition of"). Then shareholders, or citizens, get angry (one hopes).
So, I'm not saying anything about atoms or bits, I'm saying that (a) capital accounting for enterprise systems builds is common, but (b) the values we usually ascribe to enterprise information systems (the build costs) in book-keeping are dubious at best and (c) building systems in punctuated bursts in order to get access to capital dollars doesn't lead to the best outcomes so (d) maybe we shouldn't build information systems with capital dollars. If we can help it. Which we probably can't, because the culture of capital dollars is so ingrained.
(Special BC government note: in BC, capital dollars are "guilt free" dollars, while operating dollars are "evil, deficit increasing" dollars, so the gov't fire-hoses capital dollars around with glee, but counts every operating paper-clip with a jaundiced eye. We have a special relationship with capital that has led to some really outstanding work in the field of IT boondoggling.)
Maybe a better way to account for EIS systems is to think of their acquisition like hiring employees.
AFAIK, no business says that it cost $1 million to hire our current work force therefore our employees have a capital value of $1 million. So maybe we should think of the cost of these EIS's as just a cost of doing business. Either they provide value in-excess of their cost or they don't.
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