To Expense or Capitalize Fixed Assets: That is the question.

Deciding whether to expense or capitalize fixed assets is one of the most difficult concepts for business owners to grasp.  Pretend for a moment you buy a vehicle to be used solely for business.  You know it can’t be expensed, so you record it as a fixed asset.  Easy, right?  But what if you buy a computer, rightly record it as a fixed asset, but then later need printer to go with it.  Should that printer be expensed, or should it also be capitalized?  Things can get fuzzy quickly.

Accounting standards are great at telling people how to capitalize a fixed asset, but they often don’t provide a lot of guidance on exactly which assets to capitalize and how to depreciate the ones you do capitalize. As a business owner, you obviously have a lot of expenses, so how do you decipher the rules?  Here’s a bit of guidance.

Understanding Capitalization (or, “How to know what your accountant is talking about.”)

To capitalize an asset is to put it on your balance sheet instead of “expensing” it. So if you spend $1,000 on a piece of equipment, rather than report a $1,000 expense immediately, you list the equipment on the balance sheet as an asset worth $1,000. Then, as time goes on, you amortize (depreciate) the asset over its useful life, taking a depreciation expense each year and reducing the balance-sheet value of the asset by the amount of the expense. The process of capitalization essentially allows your company to spread the cost of the asset over its useful life and avoid drastic impacts to the income statement in the period the asset was purchased.  

When we say, “fixed asset”, we’re talking about an item that is used by a company in the operation of business. Fixed assets are usually expensive in nature and do not include inventory for resale or repair or spare parts inventory. Typically, an item is not considered to be an asset to be capitalized unless it has a useful life of at least one year. Additionally, fixed assets are generally thought be items that are new or replacement in nature, rather than for the repair of an item.  Examples of fixed assets include:

  • Purchase price of the item and related taxes
  • Construction cost of the item, which can include labor and employee benefits
  • Import duties
  • Inbound freight and handling
  • Interest costs incurred during the period required to bring an asset to the condition and location necessary for its intended use
  • Site preparation
  • Installation and assembly
  • Asset startup testing
  • Professional fees
  • The cost of major periodic replacements (e.g., a new roof)

Writing Your Capitalization Policy

It’s a smart idea for your business to adopt its own customized fixed asset capitalization policy.  This will be used as a guide in determining the level expenditures should be capitalized.  Issues to consider include the size of your business, the use of your customary capital items, your level of revenues and expenses, and compliance needs — both tax depreciation report and property tax (if applicable).  This policy can also be helpful in the construction of a capital asset budget for future periods by identifying which items should be capitalized. And, perhaps most importantly, the written policy provides a defense in the event a financial audit is conducted on the company.

Most accounting organizations set minimum purchase thresholds for an item to be considered a fixed asset. The purpose of the capitalization threshold is to prevent the business from placing immaterial expenses on the balance sheet instead of recognizing them as an expense in the period incurred. There is no set value for a capitalization threshold, but the Internal Revenue Service indicates that most items with a useful life of more than one year should be capitalized.  

Does this mean that the $25 keyboard you purchased for the above mentioned PC should be capitalized and depreciated over the next five years?  Not necessarily.  Here are two things to keep in mind:

  1. The de minimis rule: The de minimis rule allows you to expense any item that may be potentially capitalized so long as said expense (or the sum of related expenses) does not significantly distort your bottom line.  In other words, these expenses do not make up a large percentage of your total expenses, subsequently providing you with extraordinary low income.  A good rule of thumb is they should be less than 0.1% of your gross receipts for the year, and/or 2% of your total depreciation and amortization expense for the year.
  2. The economic useful life: If the items purchased are used for one year and have no value after 12 months then they may be expensed. The only consideration here is timing; buying in December and consuming in January is frowned upon by IRS.  But, if those expenses do not distort your bottom line, you could argue for the deduction.

These two areas are a good place to start when determining when to expense and when to capitalize.  Still, a written policy is your best bet to ensure consistency and defend yourself should IRS contest your expenditures.

Even with these guidelines, deciding whether to expense or capitalize can be tricky.  Never hesitate to contact us for clarification.

Comments

  1. I have a question. Can you re capitalise depreciation?, I.e. If a server is purchased and amortised over 5 years. If then I am working on a project for 1 year to develop a software application, with the server dedicated to the development, am I able to capitalise the cost of the use of the server in the development of the new software, this would be in the form of 1 years depreciation charge?

    • Rachel Coughtry says:

      Thank you for reaching out! Given the very specific nature of your question, we’ll have one of our accountants reach out to you personally.

  2. Question, can equipment that was purchased as an upgrade be capitalized from the date of receipt even though it’s been sitting in storage and hasn’t been installed yet? Or would it have to be capitalized after it’s been installed and in use for it’s intended purpose?

    • Adam Boatsman says:

      You can’t recapitalize for tax purposes under the majority of circumstances. For general accounting practices, depreciable lives are, at the end of the day, an accounting estimate. While you can extend and then recalculate the useful life of an asset and recalculate depreciation, it is not common to do so unless the asset is significant (e.g. a bulldozer, or another piece of heavy equipment that represents significant capital expenditure).

      Thanks for your question!

      • Sean DeChant says:

        Question-

        If we have a vehicle that has been fully depreciated, but significant repairs need to be made in order for it to pass inspection and be used, can we capitalize the cost of the repair even though the vehicle is fully depreciated?

        Thanks!

        • Matthew Jameson says:

          Good afternoon and thank you for your inquiry.

          To answer your question, it must first be determined that these repairs will extend the life the of asset (vehicle),and in this case it sounds as it would. The next question you must ask is, are the expenses greater than our capitalization policy, if not we would want to expense them as repairs, and again it sounds as if they are “significant” enough to be over that threshold. And the final question one would want to ask is that is there a tax advantage to expensing the expenses out right. This question I cannot answer with the information given, however it is determined that there is no tax advantage, you may certainly capitalize these repairs. You would simply want to set them up as their own specific assets, i.e., not giving depreciable value back to the vehicle.

          Again thank you for your questions and please let us know if there is anything else we can help with in the future.

  3. Are there any rules around capitalizing internally developed software? Specifically, are there rules that say you HAVE to capitalize instead of expense the cost. I would rather expense the cost and not capitalize it. I know there is some management discretion in this area, some companies capitalize travel related to a project others don’t, some capitalize annual bonuses for employees dedicated to the project, others don’t. I have been through SOP 98-1/ASC 350-40 and didn’t find an answer.

    • Adam Boatsman says:

      Hi Mike. For tax purposes, you can capitalize or expense R&D for the purposes of calculating the associated tax credit – it is our experience that expensing and taking the simplified credit yields a better tax answer in most cases.

      With respect to capitalizing for book purposes, at the end of the day it is a management estimate. For many of our clients that have outside investors or are otherwise seeking additional sources of capital we will advise them to capitalize expenses directly attributable to their software that is revenue generating (e.g. Not a payroll or expense reporting system) and that major releases of functionality would qualify, not minor updates or fixes). If you look at comparatives for publicly traded companies that are in the business of selling SaaS (if that is your business) you will often find that in the footnotes they have disclosed the amount of software they are capitalizing. If you are not in the software business, unless you are seeking outside investment it may not be worth your time.

      Thanks for your question!

  4. Muhammad Kamran says:

    Dear Team,

    How do you consider capitalization of items in bulk and individual? Such as all bulbs, lights installed in newly constructed building is capitalized. however, when you replace it subsequently, what will be the accounting treatment. Similarly, in same replacement, what if its a gradual replacement on need basis or replace all of them with new improved say LED lights.

    regards,

    Kamran

    • Adam Boatsman says:

      Thanks for your question, Kamran. Typically a company will create a capitalization policy that includes a monetary value and an assumed useful life duration. This is used for major purchases and renovations. Routine maintenance would usually be expensed. Even replacement / upgrade to LED would typically be handled on an expensed basis unless you are also installing new bezels / housings / wiring, in which case may companies would capitalize.

  5. How would you treat the upgrade of a piece of equipment which is currently not working, and the upgrade contains a computer, with the total cost being about $160K. I was planning on capitalizing this upgrade as a component of the original equipment and begin depreciation when it is placed into service. Is this correct? It is actually replacing the old computer, but it probably is better than the old was just because of the technological advances. Thanks.
    Nancy

    • Hi Nancy! Since your question involves specific tax advice we’ll have someone reach out to you personally. Thanks for reading and commenting.

  6. Russell Smith says:

    If a company purchases an used asset, should it still capitalize it? Example, an owner-operator buys a 10-year old semi truck which has high mileage. Some would say its already past its useful life, although it still has economic life to it. Let’s say the owner-operator finances his purchase with a lease. Would the same rules apply that set apart a capital lease from an operating lease or not?

    • Adam Boatsman says:

      Hi Russell,

      Whether the asset is used or not it should be capitalized – on the assumption that it meets the company’s capitalization policy (ex. all fixed asset additions purchased above $2,000 are capitalized). It’s useful life would be either management’s estimate or GAAP useful life.

      Please email me if you have any questions specific to your business. I’d be happy to help.

  7. How can I capitalize previous months expenses?

    • Rachel Coughtry says:

      Thanks for your question! The answer to that question varies a bit. Given the specific nature of your question, we’ll have someone reach out to you shortly via email.

  8. Rob Clark says:

    Can you capitalize travel to a foreign country to oversee and assist in the installation of a fixed asset in the country in which it will be placed into service?

    • Rachel Coughtry says:

      Hi Rob!
      Thanks for your question. This question actually came up in this thread, though for a software company. I’ll have someone reach out to you directly to get a better idea of your business and whether it would be right for you.

    • Richard Blum says:

      Hi Rob,

      I would think that the travel expense would be a deductible ordinary and necessary business expense of the owner of that fixed asset.

      Thanks!

  9. can we capitalise expenses on rented shop

  10. Hi.. if my capitalisation limit is $2000.. i have bought 2 items.. a macbook $2500 and a multiport adaptor $100 in a single receipt.. do i capitalise both as one asset or capitalise the macbook and expense the multiport adapter?

    • Adam Boatsman says:

      I would capitalize the MacBook and expense the multi port adapter.

      Thanks for reading!

    • Adam Boatsman says:

      If you made improvements to the rented shop that meet your capitalization policy you can capitalize those expenses over the life of the lease. For example, if you made $25,000 worth of upgrades over a 5 year lease, you would capitalize $25,000 and depreciation $5,000 / year.

      Thanks for your comment!

  11. Is it o.k. for the policy to set the threshold for the cost of an individual item, even if the items were bought in bulk? For instance, if our capitalization policy is $5,000, and we buy 100 chairs at $300 for a total of $30,000 on the invoice, is it o.k. that we expense them all under Gaap? (It’s a nonprofit company, so I’m not worried about tax).

    • Rachel Coughtry says:

      Hi Jane!

      Thank you for your question! Since your question is so specific, I’ll have one of our accountants who specializes in non-profits reach out to you personally.

      Thanks!

      • I had the same question regarding buying multiple items that are not over threshold individually but are in total. Also a NFP.

        • Adam Boatsman says:

          Yes, you can group items, provided doing meets your organization’s written capitalization policy. I would encourage you to work with a professional experienced in nonprofit work to come up with a written policy if you haven’t done so already. We’d be happy to discuss this with you.

  12. In general, are there a accounting procedures to fix an improperly stated depreciation, or to “accelerate” the remaining depreciation by expensing it? In my particular case it’s a relative who capitalized real property improvements on a 15 year schedule (should have been 27.5) that also could have been expensed.

    • Rachel Coughtry says:

      Hi Bryce,
      I have forwarded your question to one of our accountants. You should receive an email shortly addressing your question.

      Thanks for reading!

  13. Hi! could you advise should be capitalize replacement cost of parts of equipment that was replaced due to obsolescence of spare parts for such parts on the market. the replacement was done to prevent fall down of operation due to unavailability of spare parts, Even if the equipment is currently deemed “fit for purpose”.

    • Adam Boatsman says:

      Hi Mira,

      It depends on the company’s capitalization policy, but generally an aggregate repair of over $5,000 would likely be capitalized.

      Thank you for your question!

  14. What if you buy items in bulk? A chair that is $200 wouldn’t be capitalized but if we bought 10 of them at $2,000 would you group them and capitalize them as a lot?

    • Adam Boatsman says:

      Hi Ali,

      That’s a reasonable thing to do, provided it meets your company’s written capitalization policy. You would also determine useful life using either management’s estimate or GAAP useful life estimates.

      Every company is different. I’d be happy to have one of my associates reach out to you personally. Feel free to email me as well.

  15. Question
    If company purchases motherboard,to be capitalised or not?

  16. Could you please explain me the capital work in process? the asset which would be capital after some time.
    For example: if we are making an office building, it requires to complete over 8 months. The material purchases is in installment. How can we handle this type of asset. Can we capitalized it when we purchase or we can convert it to Capital at completion of the building?

    • Carrie Dyckman says:

      The capital work in process is a “holding” account within property and equipment on the balance sheet. This holding account is meant to capture the costs incurred while constructing an asset that will be depreciated in the future. In your example, the material purchases would be recorded in the capital work in process account upon receipt of the invoice. All future invoices related to the construction of the office building will be recorded in this account. Upon receiving the certificate of occupancy, the total dollar amount incurred on the office building that is recorded in the capital work in process account should be moved to a depreciable asset account and depreciated accordingly.

      If you are constructing an office building, it would benefit you to have a cost segregation study performed. The purpose of the study is to segment the building between personal and real property assets for tax reporting purposes. By doing this, you’d benefit from the use of accelerated depreciation.

      We’re more than happy to speak with you more at any time.

  17. Hi,
    I own a party rental business and made big purchases for rental items to rent out for my business. I didn’t know what I was doing…but I entered these expenses as “fixed assets”. No knowing to meaning behind it. So after that fact a filed my taxes…can I fixed this issue? Inventory items shouldn’t be listed as “fixed assets…right?
    I need advice and help!

    • Jim Stephens says:

      If it’s something that is being rented, then it is correct to be fixed assets. It wouldn’t be inventory. Feel free to email me with additional questions.

      Thanks!

  18. If I am looking to replace leased warehouse lights with LED fixtures with a material cost of $25k and install cost of $5k – for a total of $30k – can I capitalize/depreciate this investment?

  19. Are items purchased using service charge income, to refurbish an area, required to be capitalised.

  20. Can I capitalize 300 Ipads @ $500 a unit?

  21. Hello.
    ‘Installation of special shelves’ on delivery truck, is it capitalized or expensed? Thanks.

  22. Nsayama Mutakwa says:

    Hi if a school buys theatre chairs which are not fitted, and are still in boxes, can you capitalize them?

    • Jim Stephens says:

      It depends on the dollar amount. Most people would want to expense the chairs and not capitalize. The decision would also depend on the tax status of the school. If it’s a private school, it’s also likely a nonprofit of some sort, and therefore not eligible to take Sec 179 deductions.

  23. Edna Auxtero says:

    When constructing a building, are the penalties paid due to legal liabilities with suppliers including cost of rework capitalized or expenses?

    • Jim Stephens says:

      My understanding without doing any research is that the penalties would be non-deductible expenses.

  24. Hi,

    In aug 17, my company purchased 08 picture frames which cost $1025, it exceeds the threshold for capitalization limit ($500). So should I capitalize the expense as fixed assets?
    We also purchased one frame in apr 17 and sep 17 which only cost $198 and $240 accordingly. These costs were expensed into income statement.
    So should I only capitalize 08 picture frames which cost more than $500?
    Thanks & Best Regards,
    Cindy

    • Jim Stephens says:

      I would expense them all. If you have an internal policy that fixed assets are capitalized if the cost is over a certain amount (like 1500 or 2000) you can expense and not capitalize. We often tell people $2,500.

  25. Part of the property is sinking and the ground needs to be relevelled. Is this cost to be capitalised?
    Also the surveyors fees for this ground relevel project, can it be capitalised as well?

    • Jim Stephens says:

      I would think this would be capitalized as it extends the useful life of the property, but it depends on how much it would cost.

  26. Hi,  Thanks for the article and answering so many Questions.  Hopefully you will answer one more…  Laptops/computers that are purchased and capitalized as assets.. would the software installed on the laptops (firewall security, Windows etc) be capitalized as part of the original cost of the computer or is the software expensed seperately.  

    • Scott Colston says:

      There is support for either position when it comes to the treatment of installed software on the laptops, as long as there is a way to determine the price allocated to the software and laptops separately:

      1. If the desire is to capitalize the software, then do not break out the software from the computer, and capitalize the full price of the purchase as one asset. The useful life of the software would be the same as the useful life of the computer purchased (3 years) – caveat to this statement: if the software is a one-year license for use of the software, then the useful life would be one year and you would expense the software purchased.

      2.If the desire is to expense the software, break out the software from the computer, expense the software and capitalize the computer.

      Thank you so much for your question, and if you have any other questions, please don’t hesitate to ask.