What Determines If Your Assets Are Capitalized?
The capitalization of assets is a process a business uses to turn business equipment purchases into asset acquisitions. Capitalized assets provide additional tax benefits over simple business expenses and provide a means for a company to recoup the cost of integral equipment purchases. The criteria for determining which assets to capitalize often comes down to purchase price and how long the company intends to use the equipment.
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Asset Capitalization
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When a company capitalizes an asset, it records the asset on the business's balance sheet as opposed to its income statement. A balance sheet is a summary of a company's financial position including account balances, liabilities, assets and equity of individual company owners. By including the asset on the company balance sheet, the company counts the asset toward the overall worth of the company as opposed to simply listing the asset as a purchase in the sea of numbers that is the company's income statement.
Criteria for Capitalizing Assets
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A business usually only chooses to capitalize high-valued assets, though this is relative to the size of the business. For example, a small business may consider an $800 office computer as a capital asset, whereas a multi-million dollar corporation may only consider the computer as a business expense. The difference provides different benefits at tax time depending on the long-term or short-term tax goals of the company. Capital assets usually allow a company to stretch tax benefits over several years, allowing for additional savings.
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Leasing Equipment Strategies
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Capitalizing leased equipment also provides a company a means to move more assets from its income statement to its balance sheet. According to the AccountingCoach website, a business should capitalize an equipment leasing agreement if the lease is little more than a disguised equipment finance and purchase plan. This allows the company to report the amount owed on the balance sheet as a liability as opposed to a direct expenditure on its income statement.
Business Tax Implications
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The IRS allows a business to claim depreciation on capitalized assets when filing a federal tax return. Each capital asset depreciates at a different rate calculated using the Modified Accelerated Cost Recovery System (MACRS). A business can recoup up to the original purchase price of capitalized assets in tax deductions over a period of years. A business may only claim purchases listed in the company's income statement as expenses. The IRS only allows these deductions for one year at a time. For example, capitalized assets may depreciate over five years, providing tax deductions each of those years, whereas business expenses provide deductions for only the year of purchase.
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