GAAP stands for generally accepted accounting principles. These principles are the guidelines for how financial statements are prepared by accountants and cover all facets of a business operation. Capital improvements are made in the course of operating a business and are an important financial consideration, as a company depreciates and recovers that investment for accounting purposes.
Capital improvements are expenditures designed to better a building or equipment (capital assets) used for business purposes. The improvement is intended to extend the productive life of the business asset. Capital improvements are different than repairs for accounting purposes as capital improvements can be depreciated but the cost of repairs cannot.
Depreciation is the process by which companies report the decline in value of the assets used in the business. Accounting principles provide for a systematic way to report the depreciation as well as a schedule by which assets must be depreciated. Companies use a depreciation schedule until the asset no longer is used for the business or its value has been completely depreciated.
When capital improvements are made to a business asset, the cost of the improvement is added to the asset’s basis. The basis equals the amount that originally was paid for the investment plus the cost of any improvements. Basis is an important concept since it is the point by which capital gains or losses are determined when the asset is sold. It also is the point by which the asset is depreciated.
GAAP Accounting Treatment of Capital Improvements
Accounting filings list all of the capital assets that are depreciated on a depreciation schedule. The schedule denotes the asset’s basis, the recovery period, which is the amount of time the asset is expected to be used for business, and the projected value of the asset at the end of its useful life. There are several depreciation methods available under the GAAP accounting rules. GAAP depreciation methods are different than the depreciation methods used for tax purposes.
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