What Are the Criteria for Capitalization of Fixed Assets?

Fixed assets must be capitalized and depreciated over time.
Fixed assets must be capitalized and depreciated over time. (Image: Hemera Technologies/AbleStock.com/Getty Images)

Fixed assets -- also known as capital assets -- can make up a large part of a company's balance sheet, especially for manufacturers and other equipment-intensive businesses. Because fixed assets can last many years into the future, accounting for them correctly is important, and U.S. generally accepted accounting principles (GAAP) require that they are capitalized and depreciated over time.

What is a Fixed Asset?

A fixed asset is different than an expense in that it will have value to a company beyond the current year. Because it has a long life, GAAP requires that it is capitalized as an asset on the balance sheet and the total cost brought into expenses over time. Another important criteria is that a fixed asset is tangible, meaning that it can be seen and felt. Examples are buildings, equipment, office furniture and signage. Assets with a long life that are not tangible include patents, goodwill and customers lists. These types of assets are reported separately from fixed assets.

Useful Life

In order to decide whether something is a fixed asset and over how long it should be depreciated, you must first find its estimated useful life. There are many ways to determine the useful life of a fixed asset. You can look at the average life of other similar assets or can review the warranty period on the asset. Also consider whether the asset is likely to be outdated in a few years. A computer, for example, may physically last longer than five years, but may only be useful to a company for two or three before it needs to be upgraded.

Inclusions in Capital Cost

The total cost of a fixed asset to be capitalized is more than just the purchase cost. Include any non-recoverable sales taxes or fees paid related to the purchase. Also include any costs to install the asset or make it ready for use. For example, if a piece of equipment costs $25,000 and a team had to come in and install it for $5,000, the total capital cost is $30,000. Also, if you required any accounting or legal services to give advice surrounding the purchase, these costs should also be capitalized.

Salvage Value

When estimating the total useful life of an asset, you must also estimate how much it will be worth when you are done using it or replace it. If you will sell off your old computers for $100 each when you buy new ones, then $100 is the salvage value of each computer. When determining how to depreciate the fixed assets over time, subtract the salvage value from the total. On other words, you will not be depreciating the total cost of the asset, but only the portion that will not be recovered on sale.

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