What is Capitalize

To capitalize is to record a cost/expense on the balance sheet for the purposes of delaying full recognition of the expense.  In general, capitalizing expenses is beneficial as companies acquiring new assets with long-term lifespans can amortize the costs.

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Capitalize

BREAKING DOWN Capitalize

One of the most important principles of accounting is the matching principle. The matching principle states that expenses should be recorded for the period incurred regardless of when payment (e.g., cash) is made. Recognizing expenses in the period incurred allows businesses to identify amounts spent to generate revenue.  For assets that are immediately consumed, this process is simple and sensible.  However, large assets that provide a future economic benefit present a different opportunity. For example, a company purchases a large delivery truck for daily operations.  This truck is expected to provide value over 12 years. Instead of expensing the entire cost of the truck when purchased, accounting rules allow companies to write off the cost of the asset over its useful life (12 years). In other words, the asset is written off as it is used. Most companies have an asset threshold, in which assets valued over a certain amount are automatically treated as a capitalized asset.

Capitalization Benefits

Capitalizing assets has many benefits.  Because long-term assets are costly, expensing the cost over future periods reduces significant fluctuations in income, especially for small firms.  Many lenders require companies to maintain a specific debt to equity ratio.  If large long-term assets were expensed immediately, it could compromise the required ratio for existing loans or could prevent firms from receiving new loans.  Also, capitalizing expenses increases a company's asset balance without affecting its liability balance.  As a result, many financial ratios will appear favorable.  Despite this benefit, it should not be the motivation for capitalizing an expense.

Depreciation

The process of writing off an asset, or capitalizing an asset over its life, 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 the balance sheet.  Depreciation is an expense recorded on the income statement; it is not to be confused with "accumulated depreciation," which is a balance sheet contra account.  The income statement depreciation expense is the amount of depreciation expensed for the period indicated on the income statement.  The accumulated depreciation balance sheet contra account is the cumulative total of depreciation expense recorded on the income statements from the asset's acquisition until the time indicated on the balance sheet.