Loading the player...

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.

Capitalization Example

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.

Depreciation

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.

RELATED TERMS
  1. Business Asset

    A piece of property or equipment purchased exclusively or primarily ...
  2. Declining Balance Method

    A common depreciation-calculation system that involves applying ...
  3. Replacement Cost

    The cost to replace the assets of a company or a property of ...
  4. Depreciation

    1. A method of allocating the cost of a tangible asset over its ...
  5. Straight Line Basis

    A method of computing amortization (depreciation) by dividing ...
  6. Expense

    1. The economic costs that a business incurs through its operations ...
Related Articles
  1. Investing

    Reviewing Assets On The Balance Sheet

    A firm uses its assets to generate sales and bottom-line profits for shareholders. A healthy company will continually grow its assets, which stems from leftover profits that are reinvested back ...
  2. Investing

    Explaining amortization in the balance sheet

    Read to find out more about amortization, an important way to account for the value of intangible assets.
  3. Investing

    Reading the Balance Sheet

    Learn about the components of the statement of financial position and how they relate to each other.
  4. Investing

    How to Evaluate a Company's Balance Sheet

    Asset performance shows how what a company owes and owns affects its investment quality.
  5. Taxes

    Deferred Tax Asset

    A Deferred Tax Asset is an asset on a company’s balance sheet that may be used to reduce taxable income. It is the opposite of a deferred tax liability, which describes something that will increase ...
  6. Investing

    Depreciation: Straight-Line Vs. Double-Declining Methods

    Appreciate the different methods used to describe how book value is "used up".
  7. Investing

    Cash Flow on Steroids: Why Companies Cheat

    Pressure to be the best can sometimes push corporations to cheat. Learn how they do it and how to spot it.
  8. Investing

    Intangible Assets Provide Real Value To Stocks

    Intangible assets don't appear on balance sheets, but they're crucial to judging a company's value.
  9. Managing Wealth

    6 Asset Allocation Strategies That Work

    Your portfolio’s asset mix is a key factor in its profitability. Find out how to achieve this delicate balance.
RELATED FAQS
  1. What is the difference between amortization and depreciation?

    Learn the difference between amortization, depreciation, and depletion and how companies use these accounting methods to ... Read Answer >>
  2. Exploring The Differences Between CAPEX And OPEX?

    In this article, we'll teach you the differences between a company's capital expenditures and its operational expenses. Read Answer >>
  3. What is the difference between carrying value and market value?

    Understand the difference between carrying value and market value. Learn when a company uses carrying value to value an asset ... Read Answer >>
  4. What is the difference between current assets and fixed assets?

    Learn what current assets and fixed assets are, examples of current and non-current assets, and the differences between these ... Read Answer >>
  5. What are some examples of the main types of capital expenditures (CAPEX)?

    Learn about different expenses with acquiring assets that are considered capital expenditures and should be depreciated over ... Read Answer >>
  6. Why is it that under some circumstances, capital expenditure cannot be tax-deducted ...

    Understand the meaning of capital expenditures, and learn what the implications are for companies resulting from tax laws ... Read Answer >>
Hot Definitions
  1. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  2. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  3. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  4. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  5. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  6. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
Trading Center