A capitalization policy categorizes assets and sets dollar limits for purchases that can be recorded as assets instead of expenses. This improves a company’s financial picture and economic wealth. Depreciation is also part of the policy, representing the use of assets over time.
A capitalization policy is part of a company’s asset acquisition process. National accounting guidelines allow companies to record large item purchases as assets rather than expenses. There are often two standards for a capitalization policy. First, the item must last more than 12 months, which automatically classifies it as a long-term asset rather than a current asset. Second, purchases must exceed a certain dollar limit, such as $3,000 United States Dollars (USD), but this dollar amount can change based on a company’s guidelines.
Companies capitalize assets because it improves their results. Spending a large asset purchase can result in a significant loss of income on the income statement for the current period. Recording it as an expense also makes the item appear worthless for the foreseeable future; However, this is inaccurate as the company expects the item to last longer than 12 months. The capitalization policy corrects these defects and presents a better financial picture of the company’s assets. The assets also enhance the economic wealth of the company, improving the economic wealth of the company.
A company’s capitalization policy generally groups assets into certain categories. Groups can be production equipment, computers, software packages, leased equipment, manufactured equipment, or long-term repair and maintenance of current assets. All costs associated with these items have specific dollar amounts that comply with the capitalization policy. Companies can update the policy for inflation, which naturally increases the cost of items purchased by the company. Department managers receive policy updates to ensure all future asset purchases meet company requirements.
An accounting department typically requires an authorized form as part of the capitalization policy. The form may or may not be part of a company’s management team’s authorized purchase order. These people approve all purchases requested by employees. Along with the purchase order authorization, accountants often need an authorized form that allows them to capitalize the asset. Incorrect capitalization of purchases is a major problem of financial impropriety.
Depreciation is usually part of a company’s capitalization policy. Although the company may record the purchase price, and the costs to set up the assets, such as shipping and installation charges, should represent the use of the asset. Depreciation is the financial input that represents the use of capitalized assets. Each year, accountants record an expense that indicates the use of the asset. The entry credits a contra asset that reduces the value of an asset as listed on the company’s balance sheet.
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