What is a Capitalization Limit?

A capitalization limit ("cap limit") is the threshold above which an entity capitalizes purchased or constructed assets. Below the cap limit, you generally charge purchases to expense instead. There is no specifically required cap limit; a business should consider a number of factors before settling upon the most appropriate limit. If the cap limit is extremely low, some expenditures will be shifted into fixed assets that would normally have been charged off at once, which will make short-term profits look somewhat higher. On the other hand, these items will still be charged to expense eventually, so a low cap limit increases the depreciation expense in later years. If you set a high cap limit, there will be substantially fewer assets to record in the fixed assets register, which can reduce the workload of the accounting staff. However, if you set too high a cap limit, a larger number of big-ticket purchases will be charged to expense in the current period, which tends to make month-to-month profits vary more than operating results would normally indicate.

Setting a low cap limit will also create a larger fixed assets register on which the local government jurisdiction will be more than happy to charge personal property taxes, whereas an excessively high cap limit will yield so few reportable assets that it may trigger a time-consuming government tax audit.

Thus, there is no perfect answer. From an efficiency perspective, it is better to have fewer fixed asset records to keep track of, so I prefer a relatively high cap limit. If management wants to impose a really low cap limit in order to bolster short-term profits, explain to them that this will result in more short-term income taxes, as well as more personal property taxes, potentially for years to come; these changes result in a cash outflow in the form of tax payments that would not have been present if a higher cap limit had been used.