In tax and accounting, capitalization allows costs to be apportioned across multiple tax and accounting periods. In order to keep an accurate accounting of an organization, accounting principles try to allocate costs for the year in which they generate income, and in tax, the government prefers individuals to spread large expenses over multiple years because they generate income over many tax periods. In order to do this, accounting principles and tax laws require companies and investments to be capitalized which then allows tax benefits to be recovered through depreciation over the life of the asset. For example, if XYZ Co. buys a large van for deliveries in 2018, tax laws require the asset to be capitalized, and XYZ Co. can take depreciations for the asset to lower their taxes over multiple years. Capitalization is the cause of much litigation over its very complex rules and exceptions in both the tax and accounting contexts.
In finance, capitalization refers to the amount of outstanding stock, debt, and retained earnings (book value), or capitalization may refer to the market capitalization. Book value essentially refers to a company’s value if it became liquidated and can be calculated by subtracting its liabilities from its total assets. The book value allows investors to analyze the actual value of a company and its relative debt levels. Market capitalization simply means the value of all the outstanding stocks which can be calculated by multiplying the outstanding stocks by the current share price. In the market context, investors often refer to a company as over or under capitalized based on the company’s ability to make payments to creditors and investors.
[Last updated in January of 2022 by the Wex Definitions Team]