What is the correct capitalization limit?
Tuesday, June 8, 2010 at 3:06PM A capitalization limit ("cap limit") is the threshold above which an entity capitalizes purchased or constructed assets. Below the cap limit, you generally charge assets to expense instead. There is no specifically required cap limit; you should consider a number of factors before settling upon the most appropriate limit.
If you set the cap limit extremely low, then you'll shift some expenditures into fixed assets that you would normally have charged off at once, which will make short-term profits look somewhat higher. On the other hand, you'll still need to charge these items to expense eventually, so a low cap limit increases your depreciation expense in later years.
If you set a high cap limit, then there will be substantially fewer assets to record in a fixed assets register, which can greatly reduce the work load of the accounting staff.
However, if you set too high a cap limit, then 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 your 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. I prefer having 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 earnings, then 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.
Related Topics
What does capitalize mean?
What is a capital expenditure?
What is capitalized interest?
When do I stop assigning costs to a fixed asset?
Which costs can I assign to a fixed asset?
Reader Comments (1)
Very useful, thanks.