How to Capitalize Costs and the Effects on the Balance Sheet
Capitalization of a cost records it on the balance sheet, rather than the income statement. By doing this, your company increases the amount of long-term assets on the balance sheet and reduces the expenses for the current period, thereby delaying the reduction in net income. It allows the company to spread the expense over a longer period of time than if it made an immediate, one-time recording to an expense account at the time of the purchase. Your company benefits from spreading the cost of the equipment over the useful life, or amount of time the company makes use of, the asset.
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Instructions
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Add together the cost of the asset, freight and any installation costs you incur. Record this amount, the total cost to purchase the asset, as a debit to the asset account "property, plant and equipment" account in the general ledger and a credit to accounts payable. Record a depreciation expense each year for the estimated useful life of the asset using an approved modified accelerated cost recovery system by debiting the depreciation expense account. Credit the "property, plant and equipment" account for the amount of the depreciation expense in the same journal entry to reduce the amount on the balance sheet.
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Record any interest expenses related to the production of an asset that takes a significant amount of time in the "property, plant and equipment" account in the general ledger. Record the amount you pay in interest as a debit to the interest expense account each month, or every time your company makes a payment, and a credit to cash. Include the interest expense in the cost of the equipment and depreciate it over the life of the asset.
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Record the value of leased equipment in the general ledger account under "property, plant and equipment." Record the lease payment as a debit to the appropriate expense account each month and a credit to the "property, plant and equipment" account.
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Tips & Warnings
Depreciation is a tax deductible expense, which means that your company can reduce its tax liability by a portion of the total depreciation expense for a tax year.
Make sure to understand generally accepted accounting principles regarding what costs are acceptable to capitalize, so that neither the balance sheet nor the income statement contains misstatements of financial information.
