Definition: Capitalization is the process of recording an expense or cost in a permanent account and systematically allocating over future periods. In other words, capitalization takes an expense, which would normally be recorded in a temporary account, and records it in a permanent account like an asset account.
What Does Capitalization Mean?
All costs that benefit more than one accounting period or fiscal year are required to be capitalized according to GAAP. This is consistent with the matching principle because revenues and expenses are matched in each accounting period.
For instance, a company vehicle will last more than one accounting period. It will probably last ten or more accounting periods. The matching principle states that the vehicle can’t be recorded as an expense in the year that it was purchased because this would not match future revenues with future expenses. All of the expense the vehicle would be recognized the year it was purchased. Instead, the vehicle is capitalized and is recorded as an asset. Since all asset accounts are permanent accounts, the vehicle will remain on the balance sheet for future periods.
The vehicle can then be depreciated each year over its useful life. Thus, capitalization matches future revenues with future expenses.
Some costs or expenses that last for future years are not always capitalized like repairs and improvements. Repairs made to the company vehicle are not typically capitalized. Instead, they are usually expensed in the current year. As a general rule of thumb, large assets purchases should always be capitalized while smaller assets and di minimis purchases are usually expensed.