Prepaid amount capitalised?


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Hi,

In my company everyone seems to use the term "capitalized" for prepaid rent that we post. Is this correct as I seem to disagree that it is pure and simple prepaid amount. As we can only capitalize for assets which are long term in nature for eg, Fixed Assets?

Thanks!
 
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It is correct; when you purchase prepaid rent, you don't initially recognize the transaction as an expense, rather an asset; therefore, you are capitalizing the cost. Capitalization means that the cost is recorded as a balance sheet item, rather than an income statement item. It is the same exact thing as capitalizing a fixed asset.

Hi,

In my company everyone seems to use the term "capitalized" for prepaid rent that we post. Is this correct as I seem to disagree that it is pure and simple prepaid amount. As we can only capitalize for assets which are long term in nature for eg, Fixed Assets?

Thanks!
 

bklynboy

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I dont view prepaid items as being capitalized. Capitalization refers to expenditures that you will benefit over a period of time. A fixed asset is an asset that can be sold. Prepaid items cannot. Capitalization in the strict sense refers solely to assets purchased that are then depreciated/amortized. Prepaid items are different - they cant be sold, they are not assets to begin with but solely an asset since the expense needs to be recognized over the term paid.

Also, a capitalized fixed asset is not directly amortized but uses a contra asset to depreciate - different than prepaid items. Also, capitalzied assets do not have to be fully expensed (could be a slavage value) whereas prepaid items do.
 
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Capitalization refers to including the cost as a balance sheet item, rather than an income statement item. In order to be an asset, the item needs to provide future economic benefit; prepaid insurance does this. Depreciating a fixed asset and recognizing insurance expense are similar treatments; both record expenses and both reduce the net asset value. The use of contra accounts in depreciation is just a means to an end result; it has nothing to do with capitalization itself. The connection between the inability to sell prepaid items in contrast to fixed assets and capitalizing items is not apparent to me.

I dont view prepaid items as being capitalized. Capitalization refers to expenditures that you will benefit over a period of time. A fixed asset is an asset that can be sold. Prepaid items cannot. Capitalization in the strict sense refers solely to assets purchased that are then depreciated/amortized. Prepaid items are different - they cant be sold, they are not assets to begin with but solely an asset since the expense needs to be recognized over the term paid.

Also, a capitalized fixed asset is not directly amortized but uses a contra asset to depreciate - different than prepaid items. Also, capitalzied assets do not have to be fully expensed (could be a slavage value) whereas prepaid items do.
 

bklynboy

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I dont refer to prepaid as being capitalized since this implies you have an asset that was purchased. This is not the case as you have an expense that for book purposes gets reflected over time. A fixed asset is capitalized since its bringing an asset on the balance sheet that you then depreciate (you dont depreciate prepaid items). Its very different and though have similar characteristics are not the proper use of the term capitalizing when referring to a prepaid asset.
 
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I don't know what is technically correct or not but purchasing prepaid rent or insurance, for example, is purchasing an asset; an asset is brought onto the balance sheet. Also, depreciation is simply an allocation of the cost as an expense; you expense expired prepaid assets as well. You may be correct, as I do not know the actual answer, however, judging by your criteria, I would use the term capitalization.

I dont refer to prepaid as being capitalized since this implies you have an asset that was purchased. This is not the case as you have an expense that for book purposes gets reflected over time. A fixed asset is capitalized since its bringing an asset on the balance sheet that you then depreciate (you dont depreciate prepaid items). Its very different and though have similar characteristics are not the proper use of the term capitalizing when referring to a prepaid asset.
 
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