Capitalization and revenue are accounting concepts representing two distinct ideas, although the two share a slight similarity. Revenue represents the total value of assets brought into a company through its main line of business. Capitalization is a technique accountants use to influence expense ratios and net income. Both revenue and capitalization have to do with the way a company reports its financial situation to outsiders, regardless of the actual inflow and outflow of capital.
Revenue includes both cash income and credit sales. This differentiates revenue from cash-flow, since parts of revenue may include customer debt that will not be repaid until future periods. Accountants consider revenue to be an equity account, increasing the revenue account on the right (credit) side of the T-account to match increases on the left (debit) side of either the cash or accounts-receivable account. Revenue generally does not include accruals, such as interest income, instead focusing on proceeds from sales, royalties or other transaction-related income.
Financial statement valuations could become significantly skewed in periods in which large purchases occur, which could send false red flag signals to lenders, investors, analysts and other company stakeholders. In reality, small businesses can incur large losses in some periods due to large purchases, then experience large profits in subsequent periods. Capitalization avoids this situation on paper by spreading the expense out over several periods. While this does not necessarily represent the actual outflow of money, it brings a sense of normalcy and comparability among reporting periods.
Types of Capitalization
Depreciation and amortization are two common capitalization methods. Accountants use depreciation to capitalize the cost of physical assets, such as buildings and production machinery. Amortization is used to capitalize the discount or premium received from selling debt instruments, such as bonds. Several methods of depreciation and amortization exist to serve different situations and accounting needs. The straight-line method recognizes an equal amount per period throughout the expected life of the asset of payback period of the debt. The declining-balance method calculates new amounts for each period based on the current remaining balance and a set capitalization rate.
Both revenue and capitalization deal with the concept of accruals, or figures that change on paper without affecting real-world assets. Revenue can include interest income and capital gains, for example, if investment is a company's main line of business. Capitalization is all about accrual, forgoing the recognition of real-world expenses until future periods.