Capitalize Expense Journal Entry
Capitalized Expense is the expense that company spends but it meets the definition of capitalized as assets on the balance sheet.
Expense is the cost that company pays to support the operation which aims to make revenue for the company. Based on the accounting matching principle, the company needs to record expenses in the same accounting period in which the revenue is made. The revenue is the result of the company’s expenses, so both of them must be recorded in the same period. The benefit of expense will be consumed immediately, the company cannot carry forward the benefit to the next period. For example, company hires employees to work and brings benefits to the company. The work that employees provide to the company cannot carry forward to the next period, so the cost of employment needs to record as an expense in the current month.
On the other hand, some expenses are not only able to provide the benefit in the current period but also the future period. It is able to generate future economic benefits for the company in more than one accounting period. If we record it as the expense in the current period, it will conflict with the matching principle. So the company requires to capitalize the expense to fixed assets and depreciate over the useful life. It will delay the recognition of the expense and allocate over the period of time that matches with benefit or cash inflow.
Capitalized expense will be recorded as a stand-alone fixed asset or a part of the existing asset. If it is a standalone fixed asset, it will be depreciated over its lifetime. If it is attached with other assets, we need to recalculate the depreciation expense of the existing fixed assets.
If the capitalized expense can bring future benefit but it is less than one period, it is not necessary to capitalize as an asset. Moreover, if the amount of capitalized is too small, the company may decide to record it as an expense even it meets the definition of an asset. The company usually prepares the accounting policy to set the minimum balance to be capitalized.
Capitalize Expense Journal Entry
When the company spends on the capitalized expense, they need to record the fixed assets and credit cash or accounts payable.
The journal entry is debiting fixed assets and credit accounts payable or cash.
| Account | Debit | Credit |
|---|---|---|
| Fixed Assets – Cost | ### | |
| Accounts Payable/Cash | ### |
The fixed assets on balance sheet will be increased. If company has not yet paid the supplier, it will increase accounts payable which is the current liability. Otherwise, it will reduce the company cash balance.
At the end of the accounting period, company should calculate the depreciation expense.
Depreciation Expense = (Cost – Residual Value)/Useful life
The journal entry is debiting depreciation expense and credit accumulated depreciation.
| Account | Debit | Credit |
|---|---|---|
| Depreciation Expense | ### | |
| Accumulated Depreciation | ### |
Depreciation expense is the allocation of fixed assets to expense over its lifetime.
Capitalize Expense Journal Entry Example
ABC is a company that produces toys for retail stores in US. On 01 Jan 202X, company spend $ 50,000 to repair the machinery in the production. After the repair, the production manager estimates that it will increase the useful life of the machine for 5 years from the repaired date.
Please prepare the journal entry related to the capitalized expense.
Based on ABC’s assessment, the repair will increase the machine’s future economic benefit. So it must be capitalized as fixed assets rather than recorded as the expense on income statement. As the company is able to separate the cost and useful life, we can record it as the one fixed asset and depreciate over its lifetime.
On 01 Jan 202X, the journal entry is debiting Fixed assets $ 50,000 and credit cash $ 50,000.
| Account | Debit | Credit |
|---|---|---|
| Fixed Assets – Cost | 50,000 | |
| Cash | 50,000 |
The cost of fixed assets will increase by $ 50,000 while the cash reduce by $ 50,000.
At the end of accounting period, accountants have to calculate the depreciation expense.
Depreciation Expense = $ 50,000/5 year = $ 10,000 per year
The journal entry is debiting depreciation expense $ 10,000 and credit accumulated depreciation $ 10,000.
| Account | Debit | Credit |
|---|---|---|
| Depreciation Expense | 10,000 | |
| Accumulated Depreciation | 10,000 |
Depreciation expense will appear on the income statement and accumulated depreciation will reduce the cost of machinery.
ABC needs to record the depreciation every accounting period. By the end of the 5th year, it will reduce the cost of repairing machinery to zero. All balances are recorded as expenses over the period of 5 years.