Capitalization, in financial accounting, describes when costs are recorded as assets on a company balance sheet instead of being listed as expenses on the income statement. The capitalization approach acknowledges that some expenses produce benefits that extend beyond the current accounting cycle. Thus, "capitalizing" an expense enables a company to distribute its cost over multiple periods through depreciation or amortization instead of reporting the full expense right away.

For an expense to qualify for capitalization, it must generally deliver economic benefits to the company in future periods, and those benefits should last beyond a single 澳洲幸运5开奖号码历史查询:accounting period. Assets like property, equipment, software development costs, patent acquisitions, and major repairs that extend an asset's useful life represent common 澳洲幸运5开奖号码历史查询:capitalized costs.

Capitalization can also allude to a firm's capital structure and the costs of the corporation's stock, long-term debt, and retained earnings.

What Is Capitalization?

When a business spends money on something that it considers a fixed or long-term asset, that item can be capitalized: The cost moves onto the balance sheet as an asset instead of being recorded as a business expense on the income statement. The capitalized cost is then systematically reallocated to expenses through 澳洲幸运5开奖号码历史查询:depreciation or amortization schedules for tangible and intangible assets.

Suppose a manufacturing company purchases a new piece of equipment for $100,000, and it has an expected useful life of 10 years. The company adds the $100,000 cost to its balance sheet as an asset. It then records $10,000 annually in depreciation expense (based on 澳洲幸运5开奖号码历史查询:straight-line depreciation with no salvage value), steadily converting the capitalized asset into incremental expenses recognized ꦜthroughout its useful life.

This has implications for a company's financial reporting:

• Impact on the balance sheet: When a company capitalizes assets, it will result in a temporary increase in total assets, which could affect its figures for 澳洲幸运5开奖号码历史查询:return on assets.
• Effect on income statements: When costs are capitalized, company profits appear higher in the short run because expenses are distributed over time instead of taking an immediate hit.
• Changes to cash flow statements: Capitalization impacts both the income statement and balance sheet without altering the real cash outflow. The cash flow statement records the full cash payment under 澳洲幸运5开奖号码历史查询:investing activities when the asset is acquired.
  

Different regulators have their own guidelines for recognizing capitalization. U.S. generally accepted accounting principles (GAAP) include detailed rules for specific asset categories, while the international financial reporting standards (IFRS) adopt a more principles-based approach.

The cost of expenditures must satisfy the asset definition criteria before any framework allows capitalization. Consider leased equipment, where capitalization converts an operating lease to a 澳洲幸运5开奖号码历史查询:capital lease by classifying the leased asset as a purchased asset included on the balance sheet. The Financial Accounting Standards Board (FASB) requires all leases of more than 12 months to be capitalized to reflect the lessee's rights and obligations.

Note that financial statements are at risk of being erroneous or manipulated if a cost is capitalized incorrectly. When a cost is improperly expensed, 澳洲幸运5开奖号码历史查询:net income in the current period will be lower than it should be. The company will also pay lower taxes in the current period. If a cost is instead incorrectly capitalized, net income in the current period will be higher th🌼an it should be, and assets on the balance sheet will be overstated.

Capitalization and Capital Structure

Capitalization can alternatively describe a company's 澳洲幸运5开奖号码历史查询:capital structure—i.e., the composition of its long-term or permanent funding. This meaning of capitalization includes the proportion of financing a company is exposed to via its equity stock, long-term debt, and 澳洲幸运5开奖号码历史查询:retained earnings. It represents how a business finances its overall operations and growth using different sources of funds.

A company's capitalization structure reveals the mix of funding sources it relies on:

• Equity capital consists of common stock, preferred stock, and retained earnings. This form of corporate ownership doesn't require the company to make fixed repayments to equity holders (although it may pay 澳洲幸运5开奖号码历史查询:dividends).
• Debt capital includes long-term financial instruments such as bonds, debentures, and term loans. Companies must repay their debt along with interest.
• Hybrid securities combine elements of both debt and equity, such as 澳洲幸运5开奖号码历史查询:convertible bonds.

Highly capitalized companies tend to have strong equity positions relative to deb🅷t, making them more resilient during economic downturns.

The weighted average cost of capital (WACC) represents the combined cost of all funding sources, essentially setting the minimum profit target a company needs to hit to keep its investors happy. Savvier businesses try to balance their f𒀰unding mix carefully to cut costs while maintaining financial flexibility and managing risk.

When a company can't generate enough earnings to cover what it costs to finance its operations, it's undercapitalized. This means struggling to make interest payments to bondholders or dividend payments to shareholders. On the flip side, overcapitalization happens when a business has more capital than it needs because profits are so high. While this might sound like a good thing, it actually creates inefficiencies—like paying for resources that sit idle or missing prospects to invest elsewhere. Finding the right balance is crucial for long-term business success.

Capitalization Ratios

澳洲幸运5开奖号码历史查询:Capitalization ratios in fundamental analysis evaluate a company’s capital structure. If a company relies too much on equity capital, for instance, it may have a higher overall cost of capital since equity typically demands greater returns than debt, and it misses the tax advantages that come with interest expense ded🃏uctions. Meanwhile, if a company relies too much on debt financing, it risks problems making its required interest and principal payments.

Also known as 澳洲幸运5开奖号码历史查询:leverage ratios, capitalization ratios include the following:

• 澳洲幸运5开奖号码历史查询:Debt-to-Equity (D/E) = Total Debt ÷ Shareholders' Equity
• 澳洲幸运5开奖号码历史查询:Long-term Debt to Capitalization = Long-Term Debt ÷ (Long-Term Debt + Shareholders’ Equity)
• 澳洲幸运5开奖号码历史查询:Total Debt to Capitalization = Total Debt ÷ (Total Debt + Shareholders' Equity)

The Bottom Line

The accounting practice of capitalization matches expenses to their related revenues, which for many companies provides a more accurate representation of a business's true financial status. The right capitalization methods must be used to preserve the integrity of financial statements.

Capitalization can also refer to a company's capital structure and how it finances its operations through equity, debt, and hybrid securities.