Loading the player...

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.

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.  

RELATED TERMS
  1. Accumulated Depreciation

    Accumulated depreciation is the cumulative depreciation of an ...
  2. Fully Depreciated Asset

    A fully depreciated asset is a property, plant or piece of equipment ...
  3. Depreciation

    Depreciation is an accounting method of allocating the cost of ...
  4. Depreciated Cost

    Depreciated cost is the original cost of a fixed asset less accumulated ...
  5. Group Depreciation

    Group depreciation combines similar fixed assets into a pool ...
  6. Historical Cost

    Historical cost is a measure of value used in accounting in which the ...
Related Articles
  1. Investing

    Reading the Balance Sheet

    Learn about the components of a company balance sheet - aka the statement of financial position - and how it relates to other financial statements.
  2. Investing

    How to Evaluate a Company's Balance Sheet

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

    Recoverable Depreciation: How it Works

    Recoverable depreciation is a concept used in many insurance policies and claims.
  4. 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.
  5. Investing

    Analyzing Google's Balance Sheet

    We take a look at Google's balance sheet to learn about the health of the company and how well it is run.
  6. Investing

    The difference between CAPEX and current expenses

    Learn the difference between capital expenditures, or CAPEX, and current expenses, and find out why they are treated differently on income taxes.
RELATED FAQS
  1. What is the relationship between accumulated depreciation and depreciation expense?

    Understand the relationship between accumulated depreciation and depreciation expense. Learn how each one is accounted for ... Read Answer >>
  2. When should I use depreciation expense instead of accumulated depreciation?

    Distinguish differences between depreciation expense, which is reported on the income statement, and accumulated depreciation ... Read Answer >>
  3. Why is accumulated depreciation a credit balance?

    Accumulated depreciation is the cumulative depreciation of an asset that has been recorded. Accumulated depreciation increases ... Read Answer >>
  4. Does accumulated depreciation affect net income?

    Accumulated depreciation is a running total of the depreciation expense that has been recorded over the years. However, it ... Read Answer >>
  5. How does depreciation affect cash flow?

    Depreciation is a non-cash accounting charge doesn't directly affect cash flow, but there are certain tax situations whereby ... Read Answer >>
  6. What are typical forms of capital assets within a manufacturing company?

    Learn the typical forms of capital assets for a manufacturing company, such as land, buildings, equipment, goodwill and trademarks. Read Answer >>
Trading Center