Capitalization policy definition
/What is Capitalization Policy?
A capitalization policy is used by a company to set a threshold, above which qualifying expenditures are recorded as fixed assets, and below which they are charged to expense as incurred. The policy is typically set by senior management or even the board of directors.
Some elements of a capitalization policy may be driven by common practice within an industry. If competitors capitalize their assets in a certain manner, a business may want to follow suit, in order to provide financial statements to the investment community that are comparable to those issued by competitors.
The capitalization policy also governs whether certain expenditures are accounted for as separate assets, or as part of a larger asset. For example, the policy could state that the roof of a building be classified separately from the rest of the structure, on the grounds that the roof may be replaced several times over the life of the building.
Another criterion for separate classification as a fixed asset is when an item has significantly different maintenance requirements from those of nearby assets. Thus, the capitalization policy could state that a group of machines clustered on an assembly line be classified as a single asset if they share common maintenance requirements, but as separate assets if they have significantly different maintenance requirements.
The policy may also state the circumstances under which leased assets are to be recorded as fixed assets, as well as the circumstances under which interest costs are to be capitalized into the fixed assets with which they are associated. The requirements for doing so are stated under Generally Accepted Accounting Principles and International Financial Reporting Standards.
What is a Good Capitalization Limit?
The threshold level set by a capitalization policy can vary considerably. A smaller business with few expenditures may be willing to accept a low capitalization threshold of just $1,000, whereas a larger business that may be overwhelmed by the recordation requirements of fixed assets may prefer a very high limit, such as $50,000. Nonprofits may prefer a low capitalization limit, so that they can keep close track of their assets. Many businesses find that a capitalization threshold of about $5,000 balances the offsetting issues of avoiding excessive record keeping and avoiding charging large items to expense as incurred.
Is the Capitalization Limit Covered by GAAP?
The Generally Accepted Accounting Principles accounting framework does not recommend or require any capitalization limit. There is no mention of it in the framework. Accordingly, when setting a capitalization limit, you should discuss the issue with your outside auditors, to ensure that they are in agreement that your proposed limit is a reasonable one for your business.
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Capitalization Policy for Non-Profit Entities
A non-profit may have special rules for the recordation of certain fixed assets that are never encountered by for-profit entities, such as donated assets, artwork, and historical treasures. In addition, nonprofits frequently set a relatively low capitalization limit, since this forces them to create records for more assets; this allows them to better track their assets.
When to Set a Low Capitalization Threshold
In some industries, such as non-profits and first responders, it is necessary to keep close track of lower-cost assets, in order to impose a higher level of record keeping than would otherwise be the case. For example, an ambulance company may capitalize oxygen delivery units that would normally be charged to expense, just to have more accurate records of where the units are located.