Difference Between Amortization and Capitalization (With Table)

The key distinction between amortisation and capitalization is that amortisation describes the process of allocating the cost of an intangible asset over a period of time for accounting and tax purposes, whereas capitalization is the process of recording an expense as an asset to be depreciated, amortised or evaluated for impairment.

Amortization vs Capitalization

The main difference between Amortization and capitalization is that amortisation is applied exclusively to a certain group of assets, but capitalization is applied to all assets at the same time. The accounting approach of capitalization is one of the most common. It involves an expense that increases the asset’s worth and must be paid throughout the asset’s entire useful life.

An amortised loan is one where the principal is repaid gradually, over time, and usually at a fixed rate. This contrasts with a revolving credit facility like a credit card, which operates under an “interest only” model. The interest rate on an amortised loan is usually fixed, although there are also variable rate loans available.

Capitalized assets are intended to be long-term assets used in the course of doing business, rather than short-term assets used primarily for resale. Capitalized costs include direct material and labor expenses related to purchasing or building an asset, as well as indirect overhead expenses such as utilities, depreciation and insurance that are related to the asset.

Comparison Table Between Amortization and Capitalization

Parameters of ComparisonAmortizationCapitalization
DescriptionAmortization is a term that refers to the process of deducting capital expenditures over a period of time.In addition to the stock on the balance sheet, capitalization includes long-term loans granted to the firm.
FinanceIn finance, the term “amortisation” has two meanings. It first displays the payment schedule, and then it reflects the intangible asset’s cost expense.Capitalization is a quantitative examination of a company’s capital structure in finance.
UseThe phrase amortisation refers to a certain situation and is a borrowing idea.Asset-intensive industries, such as manufacturing, require capitalization.
HistoryIn 1830, the term “amortisation” was first used.In 1851, the term “capitalization” was first used.
ExampleAmortization is used in a variety of ways, including auto loans and home equity loans.If a corporation buys anything, the cost isn’t incurred; instead, it’s capitalised as a fixed asset on the balance sheet.

What is Amortization?

The term “amortisation” refers to the practise of repaying a debt in pre-determined, periodic payments that include both principle and interest. Amortisation is commonly used for mortgage loans and car loans, but it is also used for student loan debts and other types of personal loans.

When you purchase a home with an amortising loan, your monthly payment of principal and interest remains fixed throughout the life of the loan. Amortising loans are often called “fixed rate” or “straight line” loans because your monthly payments stay the same. In contrast, some other types of loans do not have amortisation schedules; instead, they require you to make fixed monthly interest payments until you pay off the loan in full at the end of its term.

The amortisation schedule (or table) breaks down each payment into how much goes toward interest and how much goes toward principal. As your debt decreases with each payment, less money goes toward interest and more goes to principal — until all that’s left is the final, full principal payment. This means that you’ll be making more progress paying down your debt earlier in the life of an amortising loan than later, since more of each payment will go to complete your past loan.

To amortise a loan means to pay it off over time, usually with fixed payments such as monthly mortgage or car loan payments.

When you amortise a loan, you are paying the debt in regular increments over time rather than taking on the full burden at once. These types of loans allow you to pay only the interest in the early years and then gradually increase your payment so that eventually you are paying both principal and interest.

What is Capitalization?

The process of documenting an item in a permanent account and allocating it consistently over time is known as capitalization. The cost of an asset is allocated over its useful life, usually through depreciation. Capitalization can be used to refer to both tangible assets, such as machines and equipment, and intangible assets, such as patents.

The process of capitalization requires that you have accurate information about the cost of the asset, the expected life of the asset, and any salvage value it might have at the end of its useful life. This information allows you to properly allocate the cost over time by taking into consideration factors like inflation and market value.

Expenses are usually recorded when they occur but some expenses are incurred over several accounting periods. For example, software licenses may be valid for multiple years or machinery might be in use for decades before needing replacement. In these cases, the costs should be accounted for over the entire period that they are used rather than all at once.

Sometimes a business needs to purchase items for its operations. When the cost of an item is relatively low compared with its expected useful life, the company can expense the full cost of that item immediately. However, when the cost is large or the expected useful life is relatively long, capitalization is necessary.

The result over time is that part of the total costs become depreciation expenses, which are deducted each year from current earnings to reflect the decrease in value of assets.

Main Differences Between Amortization and Capitalization

  1. Amortization and capitalization are two terms used in finance that have distinct definitions. The term “amortisation” has two different interpretations. First, it indicates the payment schedule, and second, it reflects the intangible asset’s cost expense, whereas capitalization is a quantitative evaluation of a company’s capital structure.
  2. Amortization is a type of recovery period that is solely applied to a certain group of assets, whereas depreciation is applied to all assets. Capitalization is a sort of accounting technique that includes a cost that increases the asset’s value and must be incurred throughout the asset’s entire useful life.
  3. Amortization is a term that refers to the process of deducting capital expenditures over a period of time. In addition to the stock on the balance sheet, capitalization includes long-term loans granted to the firm.
  4. For borrowings, the amortisation concept is employed, whereas capitalization is used for asset-intensive activities such as manufacturing.
  5. The phrase amortisation refers to a specific situation, whereas capitalization is a more general concept.

Conclusion

Amortisation is the process by which a company sets aside money for paying off an intangible asset over time. This can include patents, copyrights and trademarks, as well as goodwill.

Capitalization means adding an expense to the balance sheet rather than deducting it from income. For example, interest on debt may be capitalized and added to the cost basis of an asset when constructing a building or other fixed asset. Capitalization occurs when interest costs are greater than straight-line depreciation expenses in a given period.

References

  1. https://api.taylorfrancis.com/content/chapters/edit/download?identifierName=doi&identifierValue=10.4324/9781315547947-13&type=chapterpdf
  2. https://www.sciencedirect.com/science/article/pii/0165410195004106