We have capitalized several internal software development and equipment upgrade costs over the last three years to show higher EBITDA. How do we defend these capital expenditures when a buyer's forensic accountants try to reclassify them as operational expenses?

Question

Tyler Smith · Accepted Answer

Capitalization policies are a primary target during financial due diligence. Owners often capitalize internal labor and maintenance costs to boost their reported earnings, but a buyer's Quality of Earnings team will aggressively review these transactions. If they reclassify these as operating expenses, your EBITDA drops, and your purchase price will be adjusted downward. To defend your capitalization decisions, you must have institutionalized accounting policies and granular documentation. You cannot simply estimate the time your team spent building internal software or upgrading machinery. For every capitalized project, you must show detailed time-tracking records, clear project scopes, and invoices that prove the investment created a new, long-term asset rather than just maintaining current operations. This aligns with standard GAAP rules for internal-use software development. If you cannot produce this level of detail, do not attempt to capitalize these costs. It is far better to run a clean, conservative P&L than to have a buyer uncover weak accounting records during due diligence, which damages your credibility and invites deeper scrutiny of your entire operation. Use your exit runway to clean up these classifications and establish a rigorous capitalization policy today.