A major issue faced by nonprofit organizations is the preservation of their tax-exempt status. These agencies must demonstrate that, even if their expenses do not exceed their revenue, their managers and directors do not receive any personal gain from the group's positive net income. An accounting method that these agencies use to stay within federal and state guidelines is capitalization, which enables the agencies to classify the purchase of capital assets as expenses.
A nonprofit agency employs a capitalization policy to set a spending amount for capital asset purchases. Purchases above that amount are recorded as fixed assets, while those below that level are classified as expenses. For large purchases of fixed assets, capitalization allows nonprofit agencies to spread the amount of the purchase over several years and record the depreciation each year, rather than recording the total purchase price as a large one-time expenditure.
An organized capitalization policy enables nonprofit agencies to standardize their accounting practices for large capital expenditures. The policy should include which assets are suitable for capitalization, such as buildings, equipment, computers and software, and what dollar amounts each type of asset must meet to qualify for capitalization. The policy can also outline the procedures behind the capitalization and depreciation for each type of qualifying asset, including which depreciation methods will be used in the capitalization process.
A major part of developing a capitalization policy is the creation of a plan for how to deal with capital asset investments. A capitalization plan assists agencies in identifying the array of needs that a capital investment should cover and in making intelligent decisions about how to meet those needs. The plan outlines what the agency requires for its capital assets, and the policy gives the managers the methods and processes to carry out those tasks.
Although nonprofit agencies are exempt from filing income taxes, they are required to file financial statements. Nonprofit agencies should include their capitalization policy with their financial statements to show the dollar amounts and methods they use to capitalize fixed-asset purchases. Also, the financial statements should include the group's policies involving time limitations on endowments of durable assets. The agency can also attach records of each durable asset purchased, including a description, date purchased, seller's name and original cost.