As an investor, one of the most important things you can do is really, truly understand how the companies work when you've invested in them. For example, how they apply their fixed asset capitalization policy can be helpful when you're looking at business expenses. Read on to better understand this and how it affects you.
What is a fixed asset?
A fixed asset, strictly speaking, is any sort of asset that has a long useful life. Instead of having a relatively short life and being considered more or less used up within the year, fixed assets are good for many years -- maybe even many decades in the case of some kinds of equipment, most buildings, vehicles, and so forth.
When an asset is considered a fixed asset, it's expensed differently than a regular asset, which is generally expensed all at once. The fixed assets have only a portion of their acquisition costs expensed out every year, based on the expected life of the asset, along with annual maintenance costs.
What is a fixed asset capitalization policy?
A fixed asset capitalization policy is an internal accounting policy within a specific company or organization that explains how to capitalize fixed assets and what it takes for an asset to qualify as a fixed asset. Technically, once an asset is put on the balance sheet, it's capitalized, but the fixed asset capitalization policy decides if fixed assets are treated as such and expensed over time or if they're treated as shorter-term assets and expensed all at once.
For example, a Fortune 500 company might purchase a new copy machine for $25,000 that year, which is, by definition, a fixed asset. But for a business of that size, it might not make sense to designate such a small purchase as a fixed asset, so it would instead be treated as a regular asset and expensed all at once. A new multimillion-dollar facility, however, would definitely be considered a fixed asset, and the fixed asset capitalization process within the company would apply.
What kinds of companies need fixed asset capitalization policies?
Every company should have a fixed asset capitalization policy, even if it's a very small company with few fixed assets. The purpose of a fixed asset capitalization policy is to remove any confusion about what qualifies as a fixed asset for that company and how it is handled in accounting.
This helps to reduce confusion, increase consistency within the company's accounting team, and ensure that assets are being treated the same across years or decades. Changing how you're expensing the same item halfway through its life will certainly look suspicious, even if it doesn't somehow trigger an audit.
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Why do fixed asset capitalization policies matter to investors?
Although investors won't benefit directly from a fixed asset capitalization policy, it's important that every company has one, especially a company that's publicly traded. Without a fixed asset capitalization policy, keeping balance sheets consistent from year to year is impossible, and accounting departments may not file tax returns consistently.
Since fixed asset capitalization policies can explain a number of different ways that fixed assets are to be managed -- from grouping smaller fixed assets together in specific ways to determining just how to deal with long-life fixed assets across multiple decades or years -- they really are a vital part of business accounting.
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