Capital Expenditure Criteria
A capital expenditure is one that has been recorded on the accounts as an asset, so that its value might be depreciated over multiple time periods. Depreciation is the accounting procedure of allocating the decrease in an asset's value over multiple time periods, in order to reflect that asset's pattern of use. Expenditure can only be capitalized when its occurrence will be used across multiple time periods to help in the production of revenue.
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Accrual Basis Accounting
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Most accounting in the present is done on an accrual basis, meaning that costs and revenues are recognized at the time of their occurrence. Such a choice stands in stark contrast to cash basis accounting, which permits the recognition of costs and revenues only when cash is either paid out or received.
Matching Principle
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One of the core assumptions in accrual basis accounting is that costs should be matched to the same time periods as the revenues that their occurrence helped produce. This assumption, most often called the Matching Principle, says that the decreases in an asset's value incurred through its use must be allocated across the periods of that asset's use, as an expense in each of them. It is this principle that requires certain expenditures with multiple-period usefulness to be recorded as assets.
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Adding On Value
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Certain expenditures are capitalized by having their values added onto those of preexisting assets. These expenditures are capitalized because their occurrence either increased the asset's useful lifespan, improved its function, or both. Such expenditures are capitalized in this manner in order to reflect that they have added to the asset's ability to produce revenue, and therefore should have their values added onto its value, so that they can be spread out across the asset's multiple periods of usage.
Becoming an Asset
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Other expenditures are capitalized by recording them as entirely new assets on the accounts. This is done whenever the expenditures will help produce revenues across multiple time periods, but were not incurred in improving a preexisting asset. For example, the research and development costs incurred in producing a patent that will be used to produce revenues for years to come will be recorded as an asset so that its value can be expensed over the periods of its usefulness.
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References
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