A core engine driving the AI earnings expansion relies on a simple accounting mismatch

GPU depreciation has become a much debated topic in corporate accounting and AI finance. If you are auditing, investing in, or managing an enterprise with heavy AI infrastructure, you cannot view GPUs as standard IT hardware. Because high-end AI processors represent massive capital expenditures, how a company depreciates them directly swings corporate profitability by billions of dollars. The friction between rapid technological obsolescence and standard financial reporting creates several major accounting risks.

One is where Cloud startups and specialised AI infrastructure firms use their existing GPU fleets as collateral to secure massive debt to buy more GPUs. If the market value of those underlying GPUs drops faster than the periods over which they are depreciated, it could trigger financing defaults and a structural crunch across the tech lending ecosystem.

However, more worrying is the mathematically valid argument that aggregate S&P 500 earnings are structurally distorted - or "inflated" - by the accounting loop between Nvidia and its mega-cap tech clients. This phenomenon stems from standard accounting principles meeting an unprecedented capital expenditures boom. It creates what short-sellers and macro analysts call a "circular liquidity loop" or "capitalised profit extraction".

The core engine driving this earnings expansion relies on a simple accounting mismatch:

Revenue hits a balance sheet instantly, but the matching expense is kicked down the road. For example, a Hyperscaler spends $10 billion of cash buying Nvidia GPUs and capitalises these as assets avoiding any immediate impact to net income. Nvidia then recognises $10 billion as immediate revenue, and a 75% profit margin converts this into $7.5 billion gross profit.

This process drives up the aggregate earnings for the S&P 500 because the multi-billion dollar purchase is not deducted from the current quarter’s earnings. The net result is that for every $10 billion spent on hardware the S&P Index sees a significant boost in net income from Nvidia, while the buyer’s current net incomes remain largely insulated, suffering only a fractional hit via the current quarter’s depreciation expense.

To make their own bottom lines look even better, the major Hyperscalers have universally extended the estimated useful life of their cloud infrastructure to 5.5 or 6 years. Prominent investors, such as Michael Burry, have openly warned that understating depreciation by extending the useful lives of compute equipment - especially chips on a rapid 2 to 3 year technology cycle - is a mechanism that artificially boosts corporate profits. If these chips face rapid economic obsolescence, S&P 500 earnings are overstating corporate health by billions of dollars.

Index-wide earnings growth looks incredibly robust, but a significant portion of that growth is just client cash being converted into Nvidia's immediate net income. If you are tracking S&P 500 valuations, looking at standard P/E ratios can be highly misleading right now. Aggregate index earnings look incredibly healthy, but they are dependent on Hyperscalers keeping their CapEx taps wide open. The moment Big Tech feels pressure from shareholders to curb infrastructure spending, Nvidia’s immediate net income is likely to contract sharply, unwinding the artificial lift that has buoyed the broader index. Then, such aggressive depreciation accounting policies will greatly exacerbate problems for the Hyperscalers.

About the author 

Jo Welman had a career in the City spanning 45 years and worked in a wide variety of financial sectors. After graduating from Exeter University in 1979 with a degree in economics, Jo spent ten years at Baring Asset Management where he managed a range of UK and US pension funds and unit trusts, investing across multiple sectors including bonds, international equities, commercial and residential property and private equity.

In 1989 Jo became Managing Director of merchant bank Rea Brothers’ institutional and private wealth investment management division. Over the following decade Jo launched a series of specialist investment trusts and funds in a variety of industry and property sectors, before forming a joint venture with reinsurance broker Benfields (now Aon Benfield) and raising one of the first limited liability corporate capital vehicles for the Lloyds insurance market in 1993. As part of his long-standing involvement in the insurance industry, Jo co-founded the Benfield Re-Insurance Investment Trust plc (Brit) in 1995. Following the sale of Rea to Close Brothers in 1999 Jo became Chairman of Brit Insurance Holdings Plc and in 2001, in partnership with Brit and Benfields, he co-founded specialist asset management firm, EPIC Investment Partners (EPIC).

Jo continues to provide corporate finance and investment advice to entrepreneurs and private investors. He sits on the board as a non-executive director of ARK Syndicate Underwriting.

“Feet up by the pool”

Jo does not receive any remuneration for his EPIC commentary. Instead, EPIC is pleased to promote the latest edition of his book “Feet up by the pool”.

Profits from sales of the book go to The Money Charity, a charity that shares Jo’s objective to help fill in some of the worrying gaps in the school curriculum. These omissions leave many young adults lacking in the financial awareness that they need to survive in a world where they will rely on their own savings if they are ever to stop working. Even if they earn the right to a full State Pension, today this amount hardly covers council tax and utility bills, and so they need to save and build up a sum of capital amounting to around twenty times their desired retirement income. A frightening number.

As Jo eloquently says, “If we can do our bit to raise awareness of the impending UK saving and pensions crisis, the exercise will have been worthwhile.”