Meaning and definition of Capitalized Cost
Capitalized cost can be defined as an expense that is added to the cost basis of a fixed asset on the balance sheet of a company. The capitalized costs are incurred while financing or building fixed assets. However, these costs are not expensed in the periods of being incurred, but identified over a time period through the way of amortization or depreciation.
As explained by Investopedia, capitalized costs can be referred as an attempt to follow the Matching Principle of Accounting which seeks to match expenses with the revenues. Putting another way, match the cost of an item to period of being issued, as contrasted with those when the cost was actually incurred. Since some assets feature a long life and generate revenue during that functional life, their costs might be depreciated over a long time period.
Example of Capitalized Cost
The capitalized cost can be exemplified as the costs related to construction of a new factory. The costs related to building the asset, counting labor and other financing costs, can be added to the asset’s carrying value on the balance sheet. These capitalized costs are identified in prospective time periods.
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.