What is the difference between a cost being capitalized or expensed in terms of GAAP?

Question

There are GAAP rules for what items can be capitalized and which you have to put under expenses. What is the difference?

Answer 1

The useful life of the item purchased usually determines whether it is amortized, thus becoming an asset that will be depreciated, or expensed. Computers, telephone systems, and copiers would be depreciated over 3 to 5 years, whereas heavy machinery may be depreciated over 10 to 20 years.

My boss and I were reviewing budget/income statements this week and ran across this. She couldn't understand why the program's net income was so much higher compared to the figure she arrived at by subtracting expenses from income. She'd couldn't figure out why it appeared we had $40,000 more in net income than we should. I ran her through the balance sheet and showed her that the additional expenses were added to our assets. It all added up!

Answer 2

If a purchase is consumed in the course of using it, such as printer toner or paper, it's an expense. If it is durable goods with a service life of one year or more, used in the production of income or a support role, it is an asset and must be capitalized. Service contracts are expensed even though they often have a "life" of several years. The cost must generally be amortized over the life of the contract, even if the total cost is paid up front. An exception is if the service contract is sold with the asset and it's cost is not stated separately on the invoice.

Answer 3

Costs and revenues are matched together. When you capitalize a cost a portion of it is written off in each accounting period, (amortized) against revenues associated with that cost. When you expense a cost it is all written off in the same accounting period in which it was incurred. Whether costs are capitalized or expensed depends on the industry and the methods allowed within the industry.

Answer 4

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Answer 5

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