When should costs be expensed and when should costs be capitalized?

Costs should be expensed when they are used up or have expired and when they have no future economic value which can be measured. For example, the August salaries of a company’s marketing team should be charged to expense in August since the future economic value of their August salaries cannot be determined.

Costs should be capitalized or recorded as assets when the costs have not expired and they have future economic value. For example, on November 25 a company pays $12,000 for property insurance covering the six months of December through May. The $12,000 is initially recorded as the current asset Prepaid Insurance. On November 30 the company will report this asset at $12,000 since the $12,000 has a future economic value. (It will save making future payments of cash for insurance coverage.) On December 31 the asset will be reported as $10,000—the unexpired cost. It will also report Insurance Expense for the month of December as $2,000—the cost that has expired during December. On January 31 the asset will be reported at the unexpired cost of $8,000. January’s insurance expense will be $2,000—the amount that has expired during January.

Learn more about Accounting Principles and Adjusting Entries.

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