What does it mean when a company capitalizes something? To capitalize something means to recognize it as an asset on the balance sheet as opposed to showing it as an expense in the income statement. When a company spends money, in addition to cash going down, one of two outcomes need to be recorded in the financial statements to keep the balance sheet in balance, either one, it is treated as an expense in the income statement or two the transaction is recorded as a purchase of an asset with the asset being shown on the balance sheet. This second option is referred to as capitalization.

Now the company doesn't just get to decide which of these two options to use. There are accounting rules that must be followed for something to be capitalized. It has to meet the definition and recognition criteria of an asset, which at a high level is that it is expected to generate a future economic benefit for the company. Any spending that does not meet the definition of an asset has to be recognized as an expense in the income statement. So, for example, let's take the rental expense for a head office building. This monthly cost is an expense. Since there is no future benefit arising to the company from this payment, they are paying for the fact that they have used the office space, which does not provide a future benefit. So this does not meet the definition of an asset and therefore has to be shown as an expense in the income statement and cannot be capitalized. On the contrary, let's consider a company buying a machine to be used in the production of its output. This machine can be expected to produce goods in the future that the company can sell for a profit, meaning the machine is expected to generate future benefits for the company. This means that the purchase price of the machine can be capitalized and recognized as an asset on the balance sheet. The company might like this since if it's not being shown as an expense in the income statement, profits will be higher. However, this doesn't mean that it'll never impact the income statement at all. Every year as the machine is used and the company gets the benefit from owning it, its value reduces. This is reflected in the financial statements by reducing the value of the assets on the balance sheet, and also a corresponding expense called depreciation in the income statement. As the benefit of owning the machine is used up.