Asset recognition criteria
/What are Asset Recognition Criteria?
Asset recognition criteria are needed to determine which assets will be included in the balance sheet. When an expenditure is made, it can either be recognized as an expense or an asset, with recognition as an expense being the default presumption. Most expenditures will be recognized at once as expenses, since they reflect the immediate consumption of the underlying expenditure. For example, an expenditure for office supplies is charged to expense as incurred.
Economic Benefits Criterion
In a reduced number of cases, it may be possible to instead recognize an expenditure as an asset, thereby deferring its recognition as an expense. The primary criterion for asset recognition is that the expenditure will result in economic benefits flowing to the owner in future reporting periods. The asset is then charged to expense over the expected number of periods during which economic benefits will be realized. One exception is the land asset, which is considered to have an indefinite life - land remains an asset in perpetuity.
For example, a company buys a machine for producing widgets for $100,000, and expects to use the machine for the next five years. Based on this information, the initial expenditure is recognized as an asset, which is then charged to expense using some type of depreciation method over the anticipated five-year period.
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Objective Measurement Criterion
Another criterion used for asset recognition is that there must be an objective way to measure the asset. For example, the purchase price of a fixed asset is an objective measurement, since the buyer is expending a specific amount of funds. However, it is not possible to objectively measure an internally-generated intangible asset, such as the value of customer relationships. Thus, given the difficulty of measurement, this type of asset cannot be recognized as an asset (unless it relates to an acquisition, in which case a portion of the purchase price is allocated to the intangible assets of the acquiree).
Materiality Criterion
Yet another criterion for asset recognition is the materiality of the expenditure. Asset tracking is time-consuming, and so is to be avoided from a clerical perspective. A business typically imposes a threshold, below which all expenditures are charged to expense, in order to reduce the number of its asset records. For example, a business sets its capitalization limit at $2,500, which means that all laptops purchased are charged to expense, even though they will clearly provide benefits over the next few years.
Note: The capitalization limit is not mentioned in the accounting frameworks at all, so you should clear a proposed capitalization limit (or change to an existing one) with your external auditors. There may be an upper threshold for this limit that they will not approve.