Question

Explain the concept of capitalizing expenses. How does this relate to the definition of an “asset”?

Answer 1

The capitalizing concept is the concept of not recognizing full expenditure in a particular period. We allocate the expenditure on the basis of the useful life of an expenditure. For example, XYZ Ltd bought a machine for $100mn. Its useful life is 10 years. Therefore, we will not expense all $100mn in 1 year. Rather we will allocate the expenditure of $10mn for 10 years.

An asset is something that provides future economic assets. By capitalizing on an expenditure we are agreeing that a particular expenditure has a useful life of more than 1 year and therefore, it is an asset. Hence, capitalization creates assets and this is how capitalizing expenses and assets are interlinked.

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