Capitalize in Accounting

The term ‘capitalized’ in accounting means to record an expenditure as an asset on the balance sheet. Capitalization takes place when a business buys an asset that has a useful life. The cost of the relevant asset is then allocated to expense over its useful life i.e charging depreciation, etc. This means that the relevant expenditure will appear on the balance sheet instead of the income statement. The capitalizing of the expenses is a benefit for the company as the assets bought by them for the long-term are subjected to depreciation and capitalizing expenses can amortize or depreciate the costs. This process is called capitalization.

In order to capitalize any expense, we’ll have to make sure it meets the criteria stated below.

The assets exceeding the capitalization limit

The companies set a capitalization limit, below which the expenses are considered too immaterial to be capitalized. Therefore, the limit is supposed to be followed and considered as it controls the capitalization of the expenses. Generally, the capitalization limit is $1,000.

The assets have a useful life 

The companies also seek to generate revenues for a long period of time. Thus, the asset should have a long and useful life at least a year or more. Thereby, the business can record it as an asset and depreciate it over its valuable life.

Most of the important principles of capitalization in accounting are from the matching principle.

Matching Principle

The matching principle states that the expenses in the accounting should be recorded when they are incurred and not when the payment is made. This helps the business identify the amounts spent to generate revenue.

For e.g, the company bought machinery for manufacturing goods with more efficiency. It is supposed to have a useful life for a period of over 10 years. Instead of expensing the entire cost of the machinery, the company will write off (depreciated) the cost of the asset over its useful life i.e 10 years. Therefore, the asset will be written off as it is used and these types of assets are automatically used as capitalized assets.

Benefits of Capitalization

Capitalization is of course recording expenses as an asset but this indeed has benefits.

• This reduces the fluctuation of income over time as the fixed assets (long-term) are costly. For the small business owners or the small firms, it’s even greater.
• The capitalization of expenditures increases the company’s asset balance, without changing the company’s liability balance. This improves the financial ratios like the current ratio.
•  Small businesses have a provision for tax benefits related to the depreciation of capitalized assets. Section 179 of depreciation allows those business owners to depreciate certain assets quicker than others are allowed.

Meaning of Opening Stock

Opening stock is the inventory or stock of goods that are available at the beginning of the new accounting year carried down from the previous year’s closing stock which is recorded in the books of accounts.

• In simple words, Opening stock is the goods/quantity/products that are held by a business at the beginning of a new accounting period and it is the closing stock of the preceding year carried down.
• Similarly, the closing stock is the number of unsold goods that remain with the business at the end of an accounting year and is further carried down to the next year as Opening Stock.

Formula

There are 3 main formulas used for Opening Stock’s calculation. They are-

• For manufacturing companies

Opening Stock = Raw Material Cost + Work in Progress + Finished Goods Cost

• When only Sales, GP, COGS, and Closing Stock are given

Opening Stock = Sales – Gross Profit – Cost of Goods Sold + Closing Stock

• You can use this one when only limited information is provided

Opening Stock = COGS + Closing Inventory – Purchases

Types of Opening Stock

There are three types of Opening Stock or we may also say that Opening  Stock consists of these 3 elements. They are-

• Raw Materials- These are the unprocessed goods held by a business that is yet to be converted into finished goods.
• Work in Progress- These include the goods that are in process but not converted into finished goods.
• Finished Goods- These are the goods/products that have completed the manufacturing process but have not yet been sold.

Opening Stock in Final Accounts

Opening stock is a part of the Trading Account while preparing the Final Accounts. And this is how it is posted in the Trading A/c.

Trading A/c (for the year ending…)

Example of Opening Stock

Example

IKEA, the biggest Furniture manufacturer collected this data on April 1, 2021,

Timber – $300,000

Wood – $30,000

Nails – $15,000

Pre-cut Wood – $120,000

Assembled Furniture – $400,000

Now, adding them (as said earlier, Opening stock is a combination of these three.)

Opening Stock (Raw Material + Work in Progress + Finished Goods) = $865,000

Therefore, that’s how one can calculate Opening Stock.