Expensing vs. CapitalizingComparison of Differences along with Examples

Lisa Borga

Date Published: November 16, 2021

Capitalizing and expensing are two ways for businesses to record costs on their financial statements.

These two options for adding costs allow businesses to choose whichever method is most advantageous for their business.

Capitalizing

If a business chooses to capitalize a cost, it is added as a capital expenditure.

The business can account for the cost on its balance sheet as an asset.

The asset will then be depreciated over time, and this cost will be recorded on the business’s income statement.

Therefore, since the entire cost is not subtracted from profits at the time of purchase, this method can increase a business’s profit.

Although, most companies take the useful life of an asset into consideration when deciding whether or not to capitalize the cost of the asset.

Expensing

Businesses also have the option of expensing costs.

When expensing a cost, the cost is added to the business’s income statement.

After this, the cost is subtracted from the revenue for the business to calculate the profits.

If the asset is recorded as an expensed cost, it will not be recorded on the balance sheet.

Instead, it shows up on the statement of cash flows or the income statement.

Although expensing a cost may result in lower profits for a period, it can reduce a business’s taxes since the expense can be reported sooner.

Expensing vs capitalizing

Similarities and Differences

Here are some similarities and differences between these two methods of recording costs.

Similarities

Capitalizing and expensing are both ways of recording costs on the financial statements of a business.

Also, whether a business chooses to capitalize or expense a cost will affect the business’s taxes and profits for the period.

A business and its management are free to select the operation of their choice in each instance, which means that when choosing between expensing and capitalizing, there is considerable leeway in which a company can choose.

Differences

The biggest difference between these two options is that capitalized costs will be recorded on the balance sheet.

In contrast, expensed costs will be recorded on either the income statement or on the statement of cash flows.

How these costs are displayed will also be different with capitalized costs marked as a cash outflow from investment, whereas with expensed costs, they will be marked as an outflow from operating cash.

These two cost recording methods will also affect an organization’s taxes and profits as well.

Capitalized costs can cause an increase in reported profit which in turn will result in a greater amount owed in taxes.

Expensed costs can actually cause a reduction in reported profit which would mean the company would owe fewer taxes.

How Assets Are Affected By Capitalizing and Expensing

Whether a cost is capitalized or expensed, an asset can have a significant impact on a company’s assets and, in turn, their impact on the company’s cash flow.

For instance, if a company chooses to capitalize a cost, this can raise a company’s cash flow.

This is because any increase in the value of an asset from capitalizing can then be classified as cash flow resulting from investments.

In contrast, by expensing costs, the opposite is true, and operating cash flow will be reduced.

When a cost is expensed, this will be deducted directly from a business’s revenue resulting in a reduced profit without enhancing the existing asset’s value.

Examples

expensing and capitalizing

Here are a few examples of capitalizing and expensing of costs in action:

Example 1: Capitalizing the Cost of Plant Equipment

If a basketball manufacturing plant purchases new plant equipment for $50,000 and chooses to pay all of the costs upfront, they may choose to capitalize the expense.

This is because the plant equipment is likely to have a service life of more than one business cycle, and as a result, the business can record the depreciation of the equipment every year for the remainder of the equipment’s useful life.

This may benefit the company by recording the cost on the balance sheet as an asset and only including the depreciation on the income statement instead of deducting the entire cost directly from revenue.

Example 2: Expensing Supply Expenditures

If a catering company were to earn revenue of $5,000 in the course of a single business cycle and spend $300 on supplies during the same period, they might choose to record the cost as an expense.

By doing this, the business would subtract the $300 expense from their revenue of $5,000, which will result in a profit for the business cycle of $4,700.

However, this will result in a drop in the company’s assets for the time frame, which can reduce shareholder equity.

Example 3: Capitalizing the Cost of a New Retail Location

Tubas to Go wants to open a new retail location for its business and has settled on building an entirely new structure.

In doing so, they can capitalize the cost of both the labor and materials required.

The cost of labor for building the new structure will be $6,000, and materials will be $3,000, which means a total of $9,000 to be capitalized.

Tubas to Go may choose to do this because the new location is likely to remain in use for a number of business cycles, and the operation of the location can enhance the value of assets that would benefit from its opening.

As a result, they can classify the cost of $9,000 as an asset on the balance sheet and assign the depreciation as an expense on the income statement over its expected life.

Example 4: Expensing Maintenance Costs

Jane’s Bakery earns $30,000 in revenue in a single business cycle but spends $3,000 in maintenance costs to repair a faulty oven.

Jane may choose to expense the maintenance cost because it is a one-time cost that does not raise the value of other assets.

The bakery’s profit can then be found by subtracting the cost from its revenue.

This results in a profit for the year of $27,000.

The $3,000 cost can then be recorded as an expense on the income statement, in turn reducing total assets as well as shareholder equity.

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  1. University of California " Reminder: Capitalization of Equipment Repairs and Maintenance" Page 1 . November 16, 2021

  2. Stanford University " Determine Whether to Capitalize or Expense Software Costs" Page 1 . November 16, 2021

  3. University of Rochester "GUIDELINES FOR CAPITALIZATION OF ASSETS " White Paper. November 16, 2021