Capital assets constitute items such as land, buildings, or office and manufacturing equipment. It also includes loan fees, some interest expenses and intangible property like copyrights. A business expects these items to contribute to company profit for years, the principle of matching income and expense requires spread the cost over the useful lifetime of the asset. Generally accepted accounting principles, or GAAP, recognize differing expectations of the useful of the different types of assets.
Physical assets such as buildings or heavy equipment obviously have extended lifetimes and receive capital asset treatment. The balance sheet reports the cost of these items at their purchase price. In general, if a repair or overhaul extends the life of the asset, that cost becomes a capital item. GAAP recognizes two acceptable methods for recording such capital expenses. One adds the cost of the repair to the capital accounts as a new item. The other reduces the accumulated depreciation by the amount of the expense. This method preserves the item cost at its historical value; but increases the total value of capital assets. Normal repairs as a result of operations do not qualify for treatment as capital assets.
Capitalizing Interest and Loan Fees
If a company constructs an asset such as a building or a piece of equipment over time, and finances that construction; the interest charged on the loan during the construction period becomes part of the cost of the asset. Similarly, some of the costs of obtaining long-term loans, such as a mortgage used to purchase a building, become capitalized assets. As with other assets, recording annual amortization costs spreads the cost of these assets over a number of years.
Intangible assets include intellectual property such as patents, copyrights, trademarks, licenses, goodwill and other property that does not physically exist. All of these items contribute to the future income of the business, so therefore they require treatment as assets. As the nature of modern business has changed, the value of these assets has grown in proportion to the physical assets of many businesses. Determining the value or useful life of these assets requires a subjective judgment by company management.
Evolving Methods of Capitalizing Assets
The Sarbanes-Oxley Act, passed by Congress in 2002, called on the Securities and Exchange Commission to investigate the possibility of moving U.S. accounting from a rules-based system to a principles-based system such as the international financial reporting standards, or IFRS. In February 2010, the commission issued statements expressing continued support for such a transition.
IFRS and GAAP differ in their treatment of capitalized assets on a few points. Notably GAAP does not permit reevaluation of assets to market value, whereas IFRS permits this recognition. IFRS requires depreciation of components of large capital assets separately. Interest during construction also receives different treatment. Comparing capital asset valuations between the two systems requires knowledge of these differences.