what is capitalization?

Posted on 2011-05-02
Last Modified: 2012-05-11
hi guys

can you please briefly explain the concept of capitalization?
I am adquiring some machineries and need to know how to capitaliza, i putting some money down and a loan for the balance.
let's say
5 machines, @ $2500  - I am putting $500 down per each and the balance to be paid in equal monthly fees with no interest for 1 year,(monthly $167)

thanks for your help
Question by:titorober23
    1 Comment
    LVL 89

    Accepted Solution

    Captilization is the method for accounting for assets for the purpose of amortiztion (depreciation). You create asset accounts in a ledger one of which is a Capital Account (say Machines) and the other of which is an Amortization Account (say Machine Depreciation).

    When you purchase the capital, you make a Bill (in Quickbooks: Vendors -> Enter Bills) that puts the machines $2,500 into Machines and then sets up an Accounts Payable entry to pay for it (like any other payment).

    Now you pay the Bill according to your schedule above (Vendors -> Pay Bills). Because the time frame is short, you can leave the amount in Accounts Payable and leave the Bill open until it is paid.

    The key point here is that the deferred payments (loans and interest in some cases) has nothing to do with Capitilization.

    Now, once per year (normally) at year end, you record an entry to your Depreciation Expense account and the other side is Machine Depreciation (in this case). So you are expensing the amount of depriciation (amortization) that is applicable for the current year. You do this every year until the asset is fully depreciated. You probably want your accountant to do this for you.

    Why do you capitalize in the first place?
    (1) The tax rules do not allow you to expense high cost, long life machinery and other assets. You are required to epxense them over time.
    (2) Depreciation is a non-cash expense. So if you are profitable, your bank account grows because of the non-cash expense. By the time you have fully depreciated the asset, you have crreated sufficient cash (within reason) to purchase a new machine to replace the old one.

    ... Thinkpads_User

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