What is to 'Capitalize'
Capitalize is an accounting method used to delay the recognition of expenses by recording the expense as a long-term asset. In general, capitalizing expenses is beneficial as companies acquiring new assets with a long-term lifespan can spread out the cost. Companies are allowed to take expenses they incur in the current period and deduct them over the long-term life of the asset.
BREAKING DOWN 'Capitalize'
If a company capitalizes regular operating expenses, it is doing so inappropriately, most likely to artificially boost its operating cash flow and look like a more profitable company. These fraudulent practices are generally exposed in the long run. It is important not to confuse capitalize with market capitalization.
One of the most important principles in accounting is the matching principle. It says that accountants must match revenues and expenses to the period in which they occurred. This is a simple task when expensing office supplies as they are typically used within one year, but what about a computer or a car? These are assets that can bring value to the business for multiple years. Instead of expensing the entire cost of the computer or car when purchased, accounting rules allow companies to write off the cost of the asset over its useful life. In other words, the asset is written off as it is used. Most companies have an asset threshold. That is, assets valued over a certain amount are automatically treated as a capitalized asset.
An asset is a storage of value. To capitalize an expense and record it as an asset means the company plans on using the item purchased for an extended period of time in the future. An expense is capitalized when it is recorded as an asset, due to its future value, on the balance sheet rather than an expense on the income statement. Companies like to capitalize assets because it reduces expenses and increases net income even though cash flow goes down. As an example, it is not uncommon for companies to expense office supplies and capitalize computers and cars.
The process of writing off an asset, or capitalizing an asset over the life of the asset, is referred to as depreciation, or amortization for intangible assets. Depreciation deducts a certain value from the asset every year until the full value of the asset is written off of the balance sheet. The annual depreciation expense comes out of net income and is determined based on the useful life of the asset, the total cost of the asset and the salvage value of the asset.