When should costs be expensed and when should costs be capitalized?

Definition of Costs

In the context of the question, costs are the amounts paid in exchange for materials, products, or services. The costs could be:

  • Reported as an expense on the current period's income statement, or
  • Reported as an asset and expensed later. To defer the cost to the balance sheet is to capitalize the costs.

Examples of Costs Being Expensed

Costs are reported as expenses in the accounting period when they are used up, have expired, or have no future economic value which can be measured. For example, the June salaries for the company's marketing team should be reported as an expense in June since the future economic value cannot be measured/determined.

Another example is the amount spent to repair equipment that broke in June and was repaired in June. The cost of the repair merely restored the equipment to its same condition. Since there was no additional future economic value added, the costs of repair is reported as an expense on the June income statement.

Example of Costs Being Capitalized

Costs are capitalized (recorded as assets) when the costs have not been used up and have future economic value. Assume that a company incurs a cost of $30,000 in June to add a hydraulic lift to its delivery truck that had no lift. The remaining useful life of the truck and the lift is 5 years. The cost of $30,000 should be capitalized since it added future economic value by making an improvement to the truck. The $30,000 cost increases the company's assets, but will be reduced by depreciating the cost to expense over the next 5 years.

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