Accountants: CapEx vs. OpEx

Disclaimer: I’m an IT guy. I have no accounting background. Please respond using small words and short sentences.

Scenario 1:

A large public corporation decides to implement a new software solution. They purchase a bunch of hardware (servers), storage devices, server software & licenses, scale up their resources knowledgeable in implementing the new solution. Say it costs them $25M for the project. Say by some miracle they get it done on budget.

I imagine that from an accounting point of view this is largely a capital expense and much of the investment can be depreciated over time. Even the consulting fees they paid to extra staff. There may be some ongoing licensing costs from year to year but I suppose those are considered operational expenses, like the various support costs of equipment, additional storage as data grows, periodic upgrades, etc…

Does that sound about right?

Scenario 2:

The same large public corporation decides to implement a new software solution. They don not purchase a bunch of hardware (servers), storage devices, server software, etc. They decide to go with a cloud based solution (like Salesforce, for example). All they pay are user license fees based on whatever solution they’ve contracted from the SaaS vendor. There is very little in the way scaling up their resources knowledgeable in implementing the new solution. Say the prjected cost is $25M for the implementation and services over the next 5 years.

Since there is really very little in the way of asset investment going on, mostly the cost is related to the SaaS licensing, is the expense considered to be largely an operational expense? And if so, is there (much) depreciation to be had? Doesn’t OpEx considered something that comes at the cost of profits in accounting terms? Don’t board members and investors like to see low OpEx margins and mind CapEx much less because it has more tax advantages?
Bottom line is, I’m wondering if SaaS models are going to become less advantagious from a P&L point of view, even if it makes sense in some cases from an IT perspective.

Enlighten me.

When you depreciate a capital asset you take the dollar amount you reduce you asset by (say $5million a year in your first example) and record it as an operating expense for the relevant period. From a cost accounting perspective you can almost think of a depreciating capital asset as a zero-profit lease to yourself.

Tax accounting and other business reasons can make choosing between purchase & depreciate and lease complicated but in essence both methods spread the cost of the project over a number of years in a very similar manner.

So when the CFO makes a statement that he’d like to reduce OpEx but doesn’t mind CapEx, what is he really saying with respect to these kinds of projects? Is he saying that SaaS models are less desirable than on-prem models?

Or is he just playing word games and saying to IT, “Reduce what you’re spending, guys!”

I guess that was more a question about motive of some CFO than a specific accounting question.

Allow me to re-phrase -

At the end of the year, when the tax accounting is done, is there really no significant difference between OpEx and CapEx expenses from a corporate P&L reporting point of view? If so, why bother distinguishing between the two when allocating dept budgets?

Even if you operated this whole setup as a lease, instead of investing in the assets yourself, the accounting would likely be substantially the same because accounting regulations require the lease to be treated as a capital asset (similar to accounting for a capital asset).

So, in other words, I don’t think pursuing a lease for this project would change your OpEx or CapEx ratios because both options would end in the same accounting.

I would interpret the CFO’s statement as “You’re spending too much on day to day expenses! We need to reduce spending. But I’m not worried about cash flow so if you have any expensive projects that will reduce costs/increase revenue in the long term I’m all for it.”

Interesting and enlightening.

Thank you both.