Difference Between Amortization and Capitalization (With Table)

The key distinction between amortisation and capitalization is that amortisation describes allocating the cost of an intangible asset over time for accounting and tax purposes. In contrast, capitalization records 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 simultaneously. 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 its entire useful life.

An amortised loan is one where the principal is repaid gradually, over time, and 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 fixed, although variable-rate loans are also available.

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

Comparison Table Between Amortization and Capitalization

What is Amortization?

The term “amortisation” refers to repaying debt in pre-determined, periodic payments that include both principal and interest. Amortisation is commonly used for mortgage and car loans but also 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 called “fixed rate” or “straight line” 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 the 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, with fixed payments such as monthly mortgage or car loan payments.

When you amortise a loan, you pay the debt in regular increments over time rather than taking on the full burden. These loans allow you to pay only the interest in the early years and then gradually increase your payment so that you are eventually 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 through depreciation. Capitalization can refer to 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 asset’s cost, the asset’s expected life, and any salvage value it might have at the end of its useful life. This information lets you properly allocate the cost over time by considering factors like inflation and market value.

Expenses are 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 used 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 immediately. However, capitalisation is necessary when the cost is high, or the expected useful life is relatively long.

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 the 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 recovery period solely applied to a certain group of assets, whereas depreciation is applied to all assets. Capitalization is an 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. The amortisation concept is employed for borrowings, whereas capitalization is used for asset-intensive activities such as manufacturing.
5. Amortisation refers to a specific situation, whereas capitalization is a more general concept.

Conclusion

Amortisation is when a company sets aside money to pay 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 exceed 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