Business expenditures can be divided into either revenue expenditures or capital expenditures. Revenue expenditures are recorded on the income statement as expenses, while capital expenditures are recorded on the balance sheet as assets so their values can be either depreciated or amortized depending on the nature of the asset. Capital expenditures are capitalized, meaning they're recorded on the balance sheet as an asset, because their occurrences produce benefits for the business in multiple periods.
International Financial Reporting Standards
The International Financial Reporting Standards (IFRS) are accounting rules, standards and guidelines published by the International Accounting Standards Board (IASB). IFRS were established in 2001 and incorporated the older International Accounting Standards (IAS). International Accounting Standards relevant to the capitalization of capital expenditures include IAS 18 and IAS 38, which are concerned with revenue recognition and intangible assets.
Capital and Revenue Expenditures
Revenue expenditures are recorded on the income statement as expenses because their occurrence produces benefits in one single period and therefore their existence should only be recorded in one single period. In contrast, capital expenditures produce benefits in multiple periods, and this must be represented on the accounts. Capitalization of capital expenditures is the simplest method to solve this problem.
Capitalization is done so the values of the capitalized capital expenditures might be either depreciated or amortized across the multiple periods in which their usefulness is spent. Depreciation and amortization are much the same procedure, except that their targets differ in being tangible and intangible. In both cases, the capitalized asset has portions of its value deducted in each period of its continuing usefulness as a depreciation expense to represent that its value is being spent producing benefits for the business.
Base and Intangible Assets
Capitalization can take two forms. The capital expenditure has its value added to a pre-existing base asset because the expenditure went into increasing the usefulness of the base asset; examples of this include vehicle upgrades and building improvements. Or the capital expenditure is recorded as a new intangible asset because no pre-existing asset was augmented by the expenditure; examples of this include patents and research and development costs.
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.