What is the effect of capitalizing an expense?

Capitalizing an expense means that rather than recognizing the cost as an immediate expense on the income statement, the cost is recorded as an asset. This process essentially delays the recognition of the expense to future periods through depreciation or amortization, depending on the nature of the asset.

When an expense is capitalized, it's treated as an investment in an asset that will provide benefits over multiple periods; for example, equipment purchased for business operations. The associated costs are then expensed over the useful life of that asset rather than all at once. This practice aligns with the matching principle in accounting, which aims to match expenses with the revenues they help to generate, providing a more accurate reflection of a company's financial performance over time.

Consequently, the immediate financial impact is that expenses appear lower in the current period, and income can be artificially inflated. However, the effect on cash flow remains unaffected since it is a reclassification rather than a cash transaction.