Knowledge Center

  • RSS Feed
  • Contact
  • Print

KNOWLEDGE CENTER >

Capitalization Policy

September 26, 2017

If your business does not have a capitalization policy or if it has not been updated in recent years, this is a critical accounting issue. A capitalization policy establishes, for book purposes, that a property purchase (1) over a minimum expenditure (e.g. $5,000, $2,500, $1,000, etc. per unit) and (2) having a useful life of one year or more be capitalized. If an expenditure meets the capitalization policy, it would be capitalized for book purposes. If an expenditure does not meet the capitalization policy, it should be expensed.

There are benefits to having a capitalization policy:

  • The business’ treatment of property additions and repairs and maintenance will become more consistent. Regardless of who is recording the entry or when the entry is recorded, a capitalization policy ensures that an item is treated the same way, every time.  
  • The business will spend significantly less on recordkeeping if the capitalization policy is followed as the business will spend less time maintaining records for each immaterial item. A capitalized asset will also be recorded on the fixed asset schedule in the year it is placed in service, depreciated each year over its useful life, and then eventually disposed of. In addition, you will have a longer list of fixed assets to maintain each year. By having a higher capitalization policy, there is less recordkeeping relating to individual assets that have smaller historical costs.

Capitalization Threshold

Previously, we have discussed the tangible property regulations and the updated de minimis safe harbor thresholds announced by the Internal Revenue Service. According to recent IRS regulations, business taxpayers can deduct, rather than capitalize, certain capital items up to a specified dollar amount based on whether the taxpayer has an applicable financial statement (AFS), which is a set of financial statements that is (1) audited financial statements accompanied by a report of a CPA firm, (2) filed with the Securities and Exchange Commission, or (3) filed with another government agency. If the business taxpayer has an AFS, the safe harbor threshold is $5,000 per item. If the business taxpayer does not have AFS, the safe harbor threshold is $2,500 per item ($500 prior to January 1, 2016).

The $5,000 and $2,500 thresholds are just what are provided for under the de minimis safe harbor rules. A business can implement a capitalization policy with thresholds that are higher or lower than these thresholds.

  • A company cannot expense higher dollar value acquisitions for tax purposes than they have expensed for book purposes. Just because you can expense up to $5,000 or $2,500 under the de minimis safe harbor rules does not mean you should necessarily max out your capitalization policy.
     
  • By adopting higher capitalization thresholds, your expenses will increase more than your assets, which may have an impact on your business’ financial ratios (less assets, higher expenses), which in turn, may lead to impacting debt covenants.

The $5,000 and $2,500 thresholds under the de minimis safe harbor rules only apply if the capitalization policy is signed and effective prior to the beginning of the fiscal year.

Useful Lives

Under U.S. GAAP, there is no predetermined useful life.  However, best practice is to establish guidelines for how long management reasonably expects a class of asset to be in use.  There are countless organizations out there that may depreciate two comparable pieces of equipment over different useful lives without thinking about it.  Your accounting professionals at BlumShapiro can assist in helping develop guidelines specific for your organization.

General guidelines that are commonly used include:

  • Land – Not a depreciable asset.
  • Land improvements – 15 years
  • Buildings – 30-40 years
  • Computer equipment – 5 years
  • Furniture and equipment – 10 years
  • Software – 3 years

These guidelines removes the guess work and discussions over how long to depreciate an asset when the depreciation schedules are being generated.

For tax purposes, the Internal Revenue Service dictates what the depreciable life of each asset should be.  Your tax professionals at BlumShapiro will assist in making those determinations.

Salvage Value

Salvage value is the estimated value of an asset at the end of its useful life when the asset can no longer be used for its intended purpose.  For example, if an organization has a fleet of vehicles, the Organization may determine that each vehicle may have a salvage value that they expect the vehicle to be worth when the vehicle is disposed (e.g. if they sell the vehicle to another organization).  When appropriate, management should make a best estimate as to what an asset’s salvage value could be at the end of its useful life.

For example, if the Organization purchases a $100,000 truck, expects the truck to have a useful life of 10 years, and expects that the truck will be worth $10,000 at the end of 10 years, then the Organization would take depreciation of $9,000 per year ($100,000 cost - $10,000 salvage = $90,000 / 10 years = $9,000). 

The impact on salvage value can be felt on net income (decreasing depreciation and net income) and on the value of the Organization’s assets (increasing net book value since less depreciation is taken).  The salvage value can also have an impact on financial ratios, such as the debt-to-equity ratio.

We have created a sample capitalization policy for reference that can be downloaded here. If you have any questions, comments, or concerns, we would be happy to assist in developing a capitalization policy that makes sense for your organization.

For more information or additional questions, please contact Thomas Pora, tpora@blumshapiro.com

How BlumShapiro Can Help

BlumShapiro is committed to helping our clients realize savings through efficient tax compliance and effective tax planning. We emphasize timely communication and a team approach to servicing our clients’ needs. Hands-on tax partner and tax specialist involvement is provided to ensure that our clients receive the most experienced and in-depth technical expertise that we have to offer. Learn about the variety of tax services offered >>

 

Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statues, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.

 

Advisors | Auditors | Consultants | CPAs - Blum Shapiro is one of the premier public accounting firms in the northeast and a Top 100 CPA Firm in the U.S. Our professionals serve businesses, individuals and organizations in Boston (MA), Hartford (CT), Cranston (RI), Shelton (CT) ,Quincy (MA) and Newton (MA) with audit, tax and business consulting services. Our firm has developed practice areas in automotive, construction, education, government, healthcare, hospitality, manufacturing, nonprofit organizations and professional service firms. New Haven CT, Fairfield CT, Norwalk CT, Waterbury CT.