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. Learn more here.
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.
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.
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.
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:
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 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.