Capitalized Cost
Candlefocus EditorCapitalized costs are also referred to as capital expenditures or simply CAPEX. These costs are added to the balance sheet as an “investment,” and the associated asset is then depreciated or amortized over time. In this way, the full cost of the asset may be recognized as an expense but spread out over multiple accounting periods, thus reflecting its expected full life.
Because capitalized costs are assets, they have a more significant effect on the balance sheet than an expense. An increase in a company’s assets affects its net worth, whereas an expense adjustments has no effect. For example, a company that purchases a computer for $2,000 would recognize it in the accounts as an asset, rather than simply expensing it and decreasing the company’s income. As such, it is important for companies to properly determine when to capitalize expenditure.
In general, the criteria for capitalizing expenditure is when the benefits of an asset extend beyond the current period. This is usually the case for tangible assets, such as property or equipment, that are expected to generate a benefit for the company over multiple periods. Intangible assets, such as software, may also qualify if they are purchased for long-term use or are expected to bring value to the company.
Within these guidelines, companies may still have flexibility in deciding which expenditure should be capitalized. For example, employee salaries and bonuses may be capitalized if the employee is hired specifically to build the asset. In addition, companies may have a threshold for which costs are expensed, versus those that are capitalized. It is important for companies to adhere to their established guidelines when deciding which expenditure to capitalize.
Overall, capitalized costs are a way to match the timing of an expenditure with its expected benefit. In this way, the full cost of an asset is spread out and expensed over time, rather than expensed as an immediate expense. Although companies have some freedom in deciding which expenditure to capitalize, they should maintain a consistent policy to ensure accuracy and compliance.