Illustration 2: Should you capitalize SG&A expense? Analyzing Amazon.com

Let use consider SG&A expenses at Amazon. To make a judgment on whether you should capitalize this expense, you need to get a sense of what these expenses are and how long the benefits accruing from these expenses last. For instance, assume that an Amazon promotion (the expense of which would be included in SG&A) attracts a new customer to the web site and that customers, once they try Amazon, continue, on average, to be customers for three years. You would then use a three year amortizable life for SG&A expenses and capitalize them the same way you capitalized R&D: by collecting historical information on SG&A expenses, amortizing them each year, estimating the value of the selling asset and then adjusting operating income and book value of equity.

We do believe, on balance, that selling, general and administrative expenses should continue to be treated as operating expenses and not capitalized for Amazon for two reasons. First, retail customers are difficult to retain, especially online, and Amazon faces serious competition from other online retailers. Consequently, the customers that Amazon might attract with its advertising or sales promotions are unlikely to stay for an extended period just because of the initial inducements. Second, as the company has become larger, its selling, general and administrative expenses seem increasingly directed towards generating revenues in current periods rather than future periods to retain current customers.

Illustration 3: Capitalizing Recruitment and Training Expenses: Cyber Health Consulting

Cyber Health Consulting (CHC) is a firm that specializes in offering management consulting services to health care firms. CHC reported operating income (EBIT) of $51.5 million and net income of $23 million in the most recent year. However, the firm's expenses include the cost of recruiting new consultants ($ 5.5 million) and the cost of training ($8.5 million). A consultant who joins CHC stays with the firm, on average, 4 years.

To capitalize the cost of recruiting and training, we obtained these costs from each of the prior four years. Table 6 reports on these expenses and amortizes each of these expenses over four years.

The adjustments to operating and net income are as follows:

As with R&D expenses, the fact that training and recruiting expenses are fully tax deductible dispenses with the need to consider the tax effect when adjusting net income.

See Technical Indicators