Capital Expenditure Accounting Treatment
Accounting treatment for capital expenditures can be difficult, involving many accounts and journal entries. Once an item is capitalized, it is kept separately from other expenses in the accounting records. It is also reported in a different manner. Capitalized items are usually kept in the books for longer than a year, with backup paper files containing invoices and other information kept separately from regular expenses.
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Assets
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Capitalized expenditures, recognized as assets in financial statements, generally involve large amounts of money and are for a longer duration. The balance sheet usually presents this type of expenditure in three lines, with the first one indicating the type and cost of the fixed asset. The next line shows accumulated depreciation. The third line shows the book value of the asset (cost less accumulated depreciation). Each time the asset is depreciated, the accumulated depreciation account is credited, decreasing the book value of the asset.
Expenses
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A capitalized expenditure is recognized in the income statement as an expense in stages--not all at once. Depreciation expense is calculated based on an asset's cost, life, salvage value and methodology. The amount calculated may be the same each period or may vary, depending on the methodology used. Usually depreciation calculations are performed by a computerized program. Many firms use spreadsheets such as MS Excel to keep track of depreciation expenses. Others have asset modules within their accounting systems to keep track of assets and depreciation expenses.
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Disposals
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When an asset is disposed of, a certain accounting treatment is required. You need to zero out both asset and accumulated depreciation related to the disposal; and you may have to recognize gains or losses on the transaction. Usually the journal entry to recognize a sale of an existing asset is to credit the asset, credit cash (or a receivable), debit the accumulated depreciation and debit or credit the gain/loss on asset disposal account. In a computerized integrated system, you follow the system procedures to dispose of an asset and the journal entry is created in the background automatically.
Policies
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To keep capitalization uniform and standard, many firms have policies and procedures regarding this issue. For example, it is not worthwhile to capitalize small items and then have a $10 depreciation expense in the books for years. Policies and procedures may show an amount, such as $10,000, as the minimum cost to capitalize an item. Since amounts are not the only requirement for capitalization, policies need to be more specific, such as the item being of a long-term nature and other specifications.
Considerations
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Treatment of capitalized expenditures per the Internal Revenue Service may be different from the accounting books. Depreciation amounts may differ and items that are capitalized in the books can be expensed in tax returns via section 179 of the tax code.
Many firms tag and identify capitalized expenditures, not just for accounting but for insurance purposes as well. Lists of assets are kept and are reviewed every year to identify any losses or damage that may require accounting adjustments.
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References
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