Business expenses are divided into two categories, each of which is accounted for differently. Current expenses are those which keep a business running on a day-to-day basis. Examples of current expenses are the payment of sales taxes, the purchase of office supplies or payroll expenses. Current expenses are paid in the accounting period in which they are incurred. Capitalized expenses, however, relate to the purchase of capital assets or expenses related to the improvement of these assets. Capitalized expenses are not accounted for in the period in which they were purchased. These items are placed on the balance sheet as an asset and depreciated (also called amortized) down in value on a monthly or yearly basis via a clearly defined depreciation method. The depreciation expense is recorded on the income statement.
Purchases of Property, Plant and Equipment should be capitalized on a company's financial statements. Property, Plant and Equipment is a very broad name for items that a company purchases that will be classified as an asset and will provide benefit for more than one accounting period. Examples of PP&E include land, buildings and production machinery.
Major repairs to production equipment should be capitalized. The repair to the asset will extend the useful life of the piece of equipment, which is an allowable reason to capitalize an expense. Companies should be careful, however, to not capitalize the maintenance cost of a piece of equipment. Maintenance costs are related to the mundane processes that keep the machine in running order, such as lubrication and preventative maintenance.
Improvements to a piece of land or a building are expenses that should be capitalized, as the improvements will cause the value of the asset to be increased and may lengthen the time that the asset can be used. Examples of land improvements include the installation of utilities, drainage systems and lighting systems. Building improvements, such as major office renovations, should also be capitalized. Small maintenance projects should not be capitalized, however, but should rather be expensed as a period cost.