How capitalised costs are treated in Quality of Earnings analysis: identifying over-capitalisation, making QoE adjustments, and the impact on EBITDA.
Capitalised costs are a recurring area of scrutiny in Financial Due Diligence. When a company capitalises costs that should be expensed, it inflates EBITDA artificially — which, when multiplied at the deal multiple, can have a significant valuation impact. FDD analysts need to understand the accounting rules, identify over-capitalisation patterns, and make the appropriate QoE adjustment.
When a cost is capitalised, it is recorded as an asset on the balance sheet rather than as an expense in the P&L. The asset is then depreciated over its useful economic life, spreading the cost over multiple periods.
Capitalising is appropriate for assets that generate future economic benefits: property, plant, equipment, internally developed software (under certain conditions), and qualifying development costs (IAS 38).
Over-capitalisation occurs when a company capitalises costs that do not meet the accounting criteria for capitalisation — or where management has significant discretion and applies that discretion aggressively to flatter EBITDA.
Common examples:
Review the accounting policy note in the statutory accounts. What is the company's stated policy for capitalising software, development costs, or other items?
Build a schedule showing the amount capitalised each year. A rising trend in capitalisation with no corresponding asset productivity story is a warning sign.
If peer companies in the same sector expense similar costs, and this company capitalises them, the EBITDA comparison is misleading. A QoE adjustment may be warranted to create a like-for-like basis.
The typical adjustment is to treat the capitalised cost as if it had been expensed:
A software company capitalises €2m per year of development costs. The FDD team determines that €800k of this relates to maintenance (which should be expensed) and €1.2m to genuine new functionality.
The QoE adjustment reduces EBITDA by €800k. At an 8x multiple, this reduces EV by €6.4m.
Interviewers ask about capitalised costs because it combines:
A candidate who can discuss this fluently demonstrates exactly the depth of thinking TS teams value.
Capitalised costs are a subtle but material QoE risk. Analysts who can identify over-capitalisation patterns, quantify the adjustment and defend it clearly are a genuine asset to any FDD team.
The Transaction Services Interview Programme (€119.99, one-time) covers capitalised costs and all major EBITDA adjustment categories with worked case studies. Get started today.
Hundreds of candidates prepared their interviews with this programme. Those who landed the role have one thing in common: they worked the cases before walking into the room.
