Sometimes it’s obvious whether something is an asset or an expense. A car is an asset; paper clips are an expense. But what about those lower priced but important items?
How about a laptop? That new drill? An asset is an item used in the operation of the business for at least a year or the “buy/sell/receive payment” cycle of the business, whichever is longer. The total cost of the asset should include any expenses required to put the item into service: shipping, labor to install, inspections, and any improvements like a new set of tires for a truck. The acronym BAR is a useful tool in determining what to include: betterment, adaptation, restoration.
Whether something is classified as an asset has some consequences for the business; it effects tax liability, net worth, and the ability to get a loan. The IRS suggests $2,500 or $5,000 as the capitalization threshold (the cost at which an item should be classified as an asset). But a business can choose a different threshold. That threshold should be put into writing and remain consistent; never use one threshold for tax purposes and different one for lenders.
Why does it matter how we classify these items? Let’s say I run a small part-time business that brings in $1,000 a month and I buy a laptop for $1,100. I can call that an expense, but the accounting would show that I lost money that month. It’s not an accurate picture of that months’ profit, and that can have an effect on business decisions. You might want to list it as an asset and let your tax preparer expense the item at year end.
Which brings us to the depreciation schedule. This is where we expense a portion of the asset each month or once a year. I like to depreciate assets monthly. Monthly depreciation will provide us a much more accurate financial picture of your business. And that allows for better decisions.