When Does Capitalization Begin on an Asset?
Asset capitalization rules allow companies to record certain costs as an asset rather than an expense. The costs must directly associate with an asset purchased or owned by a company. Accounting regulators allow for capitalization, because the costs actually bring value to the firm. The asset will most likely benefit the company for more than the current period, bringing additional value to the firm.
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Capitalization Policy
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A company can begin asset capitalization once it purchases an asset or when making purchases for currently owned assets. Certain costs fall under capitalization. Freight and handling, shipping insurance, setup costs and test runs are all costs a company can capitalize. Most of these costs are the result of purchasing and setting up an asset, although major adjustments to currently owned assets can result in cost capitalization.
Recording Entries
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Accountants record entries to identify each cost capitalized with an asset. The entry will debit the asset account and credit cash or accounts payable. Accounts payable receives a credit if the company purchases the item on credit, delaying cash payment. This entry retains all transaction information on the balance sheet. This does not affect the company's profit, only its true economic wealth.
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Purpose
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Capitalization policies increase an asset's historical cost basis. The cost basis represents the total asset amount a company can depreciate over time. Depreciation expense reports the use of an asset for each month. Companies use depreciation to create a smoother reporting for net income. Expensing asset costs immediately will result in a significant profit loss. This can distort accounting statements, because the company will continue to use the asset for a long time.
Considerations
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Land and land improvements are two distinct categories under asset capitalization rules. Land does not typically lose value; therefore, depreciation does not apply to land. Improvements to land, however, are depreciable in most cases. Companies will need to capitalize all land improvements in a separate asset account and then depreciate the cost for these items over time.
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