The Republic of Iraq

Ministry of Higher Education and Scientific Research

Mosul University /College of Engineering

Capitalized Cost

Report submitted as a part of the final exam requirement for

)Economy&counting(

For the 3rd stage /Electronic and Communication in

Electrical Engineering

Provided by

YAZEN FIRAS FADHEL

Supervision by

MONIM ABDULWAHD

2019-2020
Introduction: -
A Capitalized Cost is the cost incurred in the purchase and financing of fixed assets. It
includes not only the price paid for an asset but also the expenses incurred on its
installation and transportation. A capitalized cost is added to the fixed assets and is
shown on the assets side of the balance sheet. These costs are not deducted from
revenues during the period in which these are incurred, but, however, the deductions are
made over a period of time in the form of depreciation, depletion, and amortization.

Initially, a capitalized cost is recorded as assets and thereafter is treated as an expense.

The expenses that can be capitalized by the companies are acquisition and installation
of assets, labor charges incurred in building an asset, interest paid on finance taken for
the construction purposes, materials used to construct an asset, transportation cost
incurred in bringing the asset to the site, etc.
By capitalizing these expenses, a firm gets a clear picture of a total amount incurred on
investment in assets and helps in determining the revenue earned over a period of time.
The expenses reduce the net income, so a company capitalizes more and more of
expenses thereby having more profits. But however, more profits attract more.
Taxes, so a small company does not capitalize more expenses and try to maintain a
balance between the costs incurred.
Understanding Capitalized Costs: -
When capitalizing costs, a company is following the matching principle of accounting.
The matching principle seeks to record expenses in the same period as the related
revenues. In other words, the goal is to match the cost of an asset to the periods in which
it is used, and is therefore generating revenue, as opposed to when the initial expense
was incurred. Long-term assets will be generating revenue over the course of their useful
life. Therefore, their costs may be depreciated or amortized over a long period of time.
For example, expenses incurred during construction of a warehouse are not expensed
immediately. The costs associated with building the warehouse, including labor costs
and financing costs, can be added to the carrying value of the fixed asset on the balance
sheet. These capitalized costs will be expensed through depreciation in future periods,
when revenues generated from the factory output are also recognized.

How to calculate Capitalized Cost: -

One of the most effective ways of determining the true cost of an asset is calculating the
capitalized cost. Besides, it is also helpful in evaluating the long-term overall cost of a
product, service, or investment. The estimation of capitalized cost is helpful to
consumers and businesses for projecting future costs and liabilities. However, the only
drawback to this method is that it demands a lot of data collection for prediction of
trends as well as long-term investment costs.
The key steps involved in calculating the capitalized costs are:-
1. Determine the time period as well as the duration of time to be used for
calculation of capitalized cost. Collect all the data for the specified period, and
you will get the concluding numbers readily available.
2. Sum up the concluding salvage value with the capital gains thus obtaining the
final profit.
3. Sum up the straight costs, maintenance, and any total loan interest for the specific
period thus obtaining the final cost.
4. Subtract the final profit from the final cost thus obtaining the capitalized cost for
the particular transaction for the determined period.
Special Considerations:-
Capitalizing Software Development Costs Out of the three phases of software
development—Preliminary Project Stage, Application Development Stage, and Post-
Implementation/Operation Stage—only the costs from the application development
stage should be capitalized. Examples of the costs a company would capitalize include
salaries of employees working on the project, their bonuses, debt insurance costs, and
costs of data conversion from old software. These costs could be capitalized only as
long as the project would need additional testing before application.

Important topic about Capitalized Cost: -

In accounting, the cost of an item is allocated to the cost of an asset, as opposed to being
an expense, if the company expects to consume that item over a long period of time.
Rather than being expensed, the cost of the item or fixed asset is capitalized and
amortized or depreciated over its useful life.
Typical examples of corporate capitalized costs are expenses associated with
constructing a fixed asset and can include materials, sales taxes, labor, transportation,
and interest incurred to finance the construction of the asset. Expenses associated with
intangible assets can also be capitalized; these include trademarks, filing and defending
of patents, and software development.

1. Capitalization Eligibility:
To capitalize cost, a company must derive economic benefit from assets beyond the
current year and use the items in the normal course of its operations. For example,
inventory cannot be a capital asset since companies ordinarily expect to sell their
inventories within a year.
Because capitalized costs are depreciated or amortized over a certain number of years,
their effect on the company's income statement is not immediate and, instead, is spread
out throughout the asset's useful life. Usually, the cash effect from incurring capitalized
costs is immediate with all subsequent amortization or depreciation expenses being non-
cash charges.
 2. Capitalized Costs for Fixed Assets:

Companies often incur expenses associated with the construction of a fixed asset or
putting it to use. Such expenses are allowed to be capitalized and included as part of the
cost basis of the fixed asset.
If a company borrows funds to construct an asset, such as real estate, and incurs interest
expense, the financing cost is allowed to be capitalized. Also, the company can
capitalize on other costs, such as labor, sales taxes, transportation, testing, and materials
used in the construction of the capital asset. However, after the fixed asset is installed
for use, any subsequent maintenance costs must be expensed as incurred.

3. Capitalized Costs for Intangible Assets:

Companies are allowed to capitalize costs associated with trademarks, patents, and
copyrights. Capitalization is allowed only for costs incurred to defend or register a
patent, trademark, or similar intellectual property successfully. Also, companies can
capitalize on the costs that they incur to purchase trademarks, patents, and copyrights.
Companies are allowed to capitalize on development costs for new software
applications if they achieve technological feasibility. Technological feasibility is
attained after all necessary planning, coding, designing, and testing are complete, and
the software application satisfies its design specifications.

4. Current Expensing:

When a company cannot demonstrate a link between costs and future revenues, such
costs must be expensed immediately. In the case of software development, any
associated costs incurred prior to achieving technological feasibility are expensed.
Research and development cost is another example of current expensing due to the high-
risk profile and uncertainty of future benefits from such costs.
 5. The Bottom Line:

Cost and expense are two terms that are used interchangeably in everyday language.
However, in accounting, the two terms are separate. A cost is an outlay of money to pay
for a specific asset, whereas an expense is money used to pay for something regularly.
The difference allows for capitalized costs to be spread out over a longer period, such
as the construction of a fixed asset, and the impact on profits is for a longer time frame.

Examples of capitalized costs: -

Many different costs can be classified as capitalized costs. They include:
• Materials used to construct an asset
• Sales taxes related to assets purchased for use in a fixed asset
• Purchased assets
• Interest incurred on the financing needed to construct an asset
• Wage and benefit costs incurred to construct an asset
• Demolition of a site to prepare it for new construction
• Transport costs incurred to bring a purchased asset to its intended location
• Testing costs incurred to ensure that an asset is ready for its intended use
• Many different costs can be classified as capitalized costs. They include:
• Property, plant & equipment (PP&E)
• Buildings
• Construction costs for building an asset (materials, labor, transportation, sales tax,
and interest)
• Intangible assets can also represent capitalized costs as well. Some examples
include:
• Trademarks
• Patents
• Software development
• Copyrights
Conclusion: -
When high dollar value items are capitalized, expenses are effectively smoothed out
over multiple periods. This allows a company to not present large jumps in expense in
any one period from an expensive purchase of property, plant, or equipment. The
company will initially show higher profits than it would have if the cost was expensed
in full. However, this also means that it will have to pay more in taxes initially.
Capitalizing costs inappropriately can lead investors to believe that a company’s profit
margins are higher than they really are. Surprising or unrealistic profit margins
combined with sudden drops in free cash flow (FCF), increases in capital expenditures,
and rapidly growing fixed or intangible assets recorded on the books are all warning
signs that a company may be capitalizing costs inappropriately.
Resources: -
1. https://businessjargons.com/capitalized-cost.html
2. https://www.accountingtools.com/articles/what-is-a-capitalized-cost.html
3. https://www.readyratios.com/reference/accounting/capitalized_cost.html
4. https://www.withum.com/resources/expense-vs-capitalize-costs-benefits-cost-
segregation/
5. https://www.investopedia.com/ask/answers/062515/what-are-typical-examples-
capitalized-costs-within-company.asp
6.
https://corporatefinanceinstitute.com/resources/knowledge/accounting/capitalize
d-cost/