Concept of Capitalisation : Some Restatements

Under (a) in "Need for, . . . . Depreciation" (vide above), the concept of matching costs with revenue was recalled. Another concept which is to be recalled in profit determination is the capital and revenue concept. Any expenditure incurred by a business will ultimately be either part of the costs of the period or as an asset to be, and will so be, maced forward to the subsequent periods. If considered as part of costs of the period, it will be taken to the P & L A/c. If considered as part of assets, it will be carried forward, and will be shown in the BS. To recall previous information, the former is "Revenue"  and the latter is "Capital". 

So, those items of expenditure which are treated as assets will not naturally constitute "cost  of the period". Then, the quantum of profit is influenced by a judgement on whether to "capitalise" (treat as an asset) an expenditure or to charge it as "cost of the period". As a corollary, and expenditure which is capitalised (i.e. an asset) also becomes part of the "cost of the period" in installment over a period of years. This concept of allowing to "become" (as in the last sentence) is the concept of depreciation. When an expenditure, which is treated as an asset, is charged off over a period of years, it is called "depreciation". 

Any expenditure which seeks to create an enduring benefit, or lasting facility, should be capitalised. The amount to be capitalised should include all costs, including the cost of putting the facility to use, i.e. to bring it to a usable condition. As examples : 

• "Cost" of a building purchased is not merely the consideration paid to the seller but includes also all legal fees, commissions, cost of alterations to make it suitable to the buyer's purposes, etc., including any value for own labour involved (say, even the buyer has himself drawn up the sale deed); 
• For a machine, besides purchase price, all incidental costs in acquiring, getting to site, installing it and energizing it and providing guard rails and meteorology would form part of the amount to be capitalised. 

The amount of expenditure capitalised will not remain undisturbed in the books of accounts, except perhaps cost of land. The cost of other assets will be charged against the revenues of various years in the form of depreciation. Depreciation effects the spreading (or distinction)  of the capitalised cost or other basic value of tangible capital assets less salvage, if any, over the expected useful life of the facility in a systematic and rational manner. It is a process of allocation, not of 

valuation.