Capitalization is an accounting procedure where a class of expenditures called capital expenditures are recorded on the accounts as assets rather than expenses. Amortization is an accounting procedure where certain capital expenditures recorded as intangible assets are depreciated across the multiple time periods of their usefulness. Amortization is a process that applies only to certain capitalized costs and is not a competitor to capitalization, which is reserved for the simple expedience of recording all expenditures as expenses.
Capitalization is used on expenditures classified as capital expenditures, as opposed to revenue expenditures. Capital expenditures are those expenditures that will assist the business in the production of revenues across multiple time periods, whereas revenue expenditures will help only in the single periods of their occurrence. Capitalized expenditures can either have their values added onto preexisting assets or recorded as new intangible assets.
Capitalization as Intangible Assets
Capital expenditures that increase either the efficiency and efficacy of preexisting assets at their intended tasks or their useful lifespans have the values of their expenditure added onto those assets. Capital expenditures that do not add to preexisting assets but will nonetheless help produce revenues across time have their values recorded as intangible assets.
Since the values of intangible assets decrease over time, both through their usage and through the expiration of their useful lifespans, it is appropriate to write off a portion of their value in each period of their use as an expense. Such a procedure, when applied to intangible assets, is called amortization.
Amortization in Practice
In practice, intangible assets have their values divided up over all of their periods of their use in order to be amortized. How this is done depends on the method used. The straight-line method allocates the same amortization to each period, whereas the declining-balance method allocates a set percentage of the asset's remaining value. Amortization is recorded as an expense in each period, and is either a direct write-off of the asset's value or accrued in a contra-asset meant to represent that asset's total decrease in value thus far.
Alan Li started writing in 2008 and has seen his work published in newsletters written for the Cecil Street Community Centre in Toronto. He is a graduate of the finance program at the University of Toronto with a Bachelor of Commerce and has additional accreditation from the Canadian Securities Institute.