When Expenses are Capitalized as Assets

Booking something as an asset or an expense is not always black or white. There are many gray areas in accounting. It’s easy to know that a car or a building is an asset, but what about routine repairs to that car or building? When is it an expense, and when should those repairs be added to the cost of that asset (capitalized)?

As discussed with prepaid assets and unearned revenue, such routine repairs would always be considered an expense if it would only affect the current period of time. For instance an oil change would always be an expense, since it affects the car right then to help it run better. It could conceivably increase the useful life of the automobile but not increase its worth.

Improvements are Assets not Expenses

On the other hand if the engine died and had to be replaced, this would probably increase the car’s life as well as its worth. So the engine expense would be capitalized. The best self check is to ask yourself if the expense only affects the current period of time or if it will be an ongoing use for a year or more. Is the cost an improvement or merely a repair or maintenance charge?

Since an oil change has to be done every few months, it is obviously a current period expense. But a new or rebuilt engine would logically be expected to last for several years. So that expense would be added to the cost of the car.

Capitalize Expense only after Cost Threshold has been Reached

A major gray area of capitalizing assets is that some companies have a minimum dollar amount spent before they will capitalize. This spares having to frequently update their fixed assets and depreciation schedules. The threshold varies from company to company. While some have it as low as $500, others will go as high as $2,000. It all depends on the size and budget of the company in question.

So even if the expense should be capitalized, if it’s lower than the company’s cost threshold, it wouldn’t be. It’s definitely important to remember that when deciding whether an expense should or should not be capitalized. Keep in mind though that these non-capitalized expenses should be kept track of. An audit trail for costly repairs makes good sense.

Overstated Assets Will Increase Income Tax

Just remember that if an expense is or is not capitalized will ultimately affect not only the income statement, but the balance sheet as well. If an improvement is expensed, this will understate the balance sheet and overstate expense. Or if an expense is capitalized, the balance sheet will be overstated and expense will be understated, which could negatively impact income tax.