Written by: Jessica Dorsett, CPA

In our accounting classes, we learn about fixed assets.  Problem is the book examples were way too theoretical and simple.  It’s important to start out simple when learning, I get it, I was there and you have to start out slow.  However, in real life, it’s NEVER cut and dry.  Here are a few items to think about when you think you might have a fixed asset to record.

The text book says to look for these major characteristics of a fixed asset:

• “Used in operations” and not for resale (basically, not inventory)
• Long-term in nature and usually depreciated
• Possess physical substance

Easy enough, but then there are other factors to consider:

• What is the company’s capitalization policy?  Meaning, at what dollar limit do you record an asset rather than expense it?  A common limit for small businesses is $1,000.  Therefore, if you buy a desk for $500, you will expense it because it doesn’t meet the capitalization threshold, even though everything about it says “fixed asset”.
  • What if I bought two desks at the same time for a total of $1,000? It depends on your policy.  While it needs to be reasonable, you have some flexibility when creating your capitalization policy.  However, make it as clear as possible so that your bookkeeper doesn’t have to second guess every purchase.
• Did you buy the asset or lease the asset? If you paid cash, no worries.  If you took out a loan, still no worries (see warning in next point).  If you are leasing the asset, then you have to look a little closer.  You must determine if you entered into an operating lease or a capital lease.  If you entered into a capital lease, you treat it as if you purchased the asset like you would with a loan.  If it’s an operating lease, then you don’t record the asset.
• I took out a loan to buy an asset. When you buy an asset with a loan, you only record the asset for the purchase price (which may be the principal amount of the loan if you didn’t have a cash down payment or trade in).  You do not include future interest payments.  Interest payments are period costs and are expensed when paid. The only time you include interest with the cost of an asset is if you are constructing the asset yourself with loan money (see next point).
• I’m making my own asset, rather than buying it already made.  You need to include the cost of labor and materials – that is a given.  In some circumstances, you might include overhead.  If you took out a construction loan, then you have to include some interest costs.  BE CAREFUL with the interest costs, this can be a difficult calculation.

Then you have the tax consequences.  When you capitalize the asset, the cash goes out, but you don’t get the immediate tax deduction for the purchase.  The exception is with the Section 179 expense which allows you fully depreciate (or in a sense, expense) an asset in the year of purchase if certain requirements are met.

Written by JessicaDorsett

I am a CPA with Polito Eppich Associates, LLP, a public accounting firm in Vista, California. Our principal focus is with closely held companies and their owners, but we also serve private investors, non profits and other high net worth individuals. Our primary market is San Diego County and surrounding counties, however, we have clients in LA and as far north as Bakersfield and San Francisco. I graduated from the University of San Diego with a bachelors in accountancy. My primary focus with the firm is running the audit department. However, I enjoy doing tax returns to mix it up!