What is the purpose of a capitalization policy?

The purpose of a capitalization policy is to determine the criteria for distinguishing between expenses and capital items. This is essential for proper financial reporting and compliance with accounting standards. Capital items, such as buildings or machinery, are long-term assets that provide benefits for more than one accounting period, while expenses are typically short-term costs that are used up in a single period.

Establishing clear guidelines on what qualifies as a capital asset helps organizations appropriately allocate resources, manage their financial statements, and reflect their financial position accurately. By adhering to a capitalization policy, companies can ensure that their balance sheets accurately depict their assets, which is crucial for stakeholders assessing the organization's financial health.