CHAPTER TWO 2
Capitalization versus Expense
ONE OF THE MOST important decisions that company management must make deals with the capitalization policy. Specifically, what purchases will be expensed as incurred and what purchases will be capitalized and depreciated over time?
This is not a trivial issue. Simply saying “because we have always done it this way” is not a substitute for serious analysis. In some ways the entire process of internal control of fixed assets depends on the initial decision as to when expensing stops and capitalization starts.
The actual range that different companies use is far wider than might be imagined. In today’s environment it is unusual to find anyone capitalizing purchases of less than $500 per item, although there are firms with lower levels. Yet a significant number of companies have a policy of capitalizing all fixed assets acquired in excess of $500. At the other extreme, one large construction and engineering firm expenses everything under $25,000.
The basic accounting theory supporting the capitalization of long-lived assets, often referred to as Property, Plant, and Equipment (PP&E), is that assets which have a useful life longer than a year should have the initial cost spread over the “useful life.” By definition, for long-lived assets the useful life always is longer than a year.
By capitalizing the initial cost, ...