Definition
1. Convert Income into Principal Amount
Capitalize can mean to convert a schedule of income into a principal amount known as the capitalized value by dividing the income schedule by a rate of interest.
2. Issue Securities for Capital Expenditures
Although less common, capitalize can also refer to the issuance of securities to finance capital expenditures.
3. Record Capital Outlays as Asset Additions
In accounting, capitalization involves recording capital outlays as additions to asset accounts rather than as expenses. This treats substantial expenditures on long-term assets as investments in the business.
4. Convert Lease Obligation
Capitalization can also refer to the practice of converting a lease obligation into an asset/liability form, known as a capital lease. This involves recording the leased asset as if it were owned and the lease obligation as if it represented borrowed funds.
5. Turn to Economic Advantage
To capitalize is also to turn something economically advantageous—for example, selling umbrellas on a rainy day.
Examples
- Capitalizing Income: A company might capitalize regular income from rentals by calculating its present value based on a specific interest rate.
- Issuance of Securities: A corporation issues bonds to fund the construction of a new manufacturing plant.
- Capital Outlays: Spending $100,000 on new machinery is recorded not as an expense but as an addition to the company’s machinery assets.
- Capital Leases: Leasing office equipment and recording it as if the company owns it, with the corresponding lease liability.
- Economic Advantage: A vendor increases sales by selling ice cream on a hot summer’s day.
Frequently Asked Questions (FAQs)
Q1: What is the purpose of capitalization in accounting? A1: Capitalization in accounting allows businesses to spread the cost of an asset over its useful life, which helps in accurate profit measurement and reduces tax liabilities.
Q2: How does a capital lease differ from an operating lease? A2: A capital lease treats the leased asset as an owned asset, adding both an asset and liability to the balance sheet. An operating lease treats lease payments as operational expenses and does not impact the balance sheet in this manner.
Q3: What types of expenditures are capitalized? A3: Expenditures on significant long-term assets, such as property, plant, and equipment, are capitalized. Routine repairs and maintenance are generally expensed.
Q4: Can businesses capitalize employee training costs? A4: Generally, employee training costs are expensed as they occur, but in some specific instances, if the training significantly enhances the economic value of a major project, it might be capitalized.
Q5: What are capitalized earnings? A5: Capitalized earnings are a method to determine the current value of a company based on the assumption that future earnings can be estimated and discounted back to their present value.
Related Terms with Definitions
- Capital Expenditure (CAPEX): Funds used by a company to acquire or upgrade physical assets such as property, industrial buildings, or equipment.
- Depreciation: The process of allocating the cost of tangible assets over its useful life.
- Amortization: The spreading of the cost of an intangible asset over its useful life.
- Operating Lease: A lease where the asset does not appear on the company’s balance sheet; payments are considered operating expenses.
- Present Value: The current value of a future sum of money or stream of cash flows given a specified rate of return.
Online References
Suggested Books for Further Studies
- “Principles of Accounting” by Weygandt, Kimmel, and Kieso
- “Intermediate Accounting” by Kieso, Weygandt, and Warfield
- “Accounting for Non-Accountants” by Wayne Label
Fundamentals of Capitalization: Accounting Basics Quiz
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