Capitalisation: problems, advantages & standards

The decision whether to capitalise a cost of not is, ideally, a matter of deciding which of the accounting principles of accrual or prudence are more relevant or important in the circumstances. It also, like all such decisions, presents on opportunity to shift accounting profits between years, and is one of many techniques that can make profit numbers lower or higher.

The return on many expenses is uncertain, and it can be difficult to separate overheads from such alleged investments. This means that

When capitalising a cost it is also important to know that the benefits are sufficiently well defined that it will be possible to decide when expected benefits have not been delivered, so that the asset (i.e. the capitalised cost) can be impaired when necessary. This is why, for example, most accounting standards (including IFRS) allow some R & D costs to be capitalised, but not others. Costs related to developing a particular product may be impaired if the product fails (to launch or sell), whereas it is hard to establish what cash flows are related to more general research.

The abuses of capitalisation are controlled by rules in accounting standards, but more restrictive rules tend to create inconsistencies between the treatment of intangible assets that are internally developed, those that are purchased, and those that acquired through a takeover. It is very often the case that the cost of an asset may not be capitalised if developed internally, would appear on the balance sheet at cost if the asset was purchased, and at fair value if acquired through a takeover.