When undergoing an audit, one question the auditors may ask is “does the company have a fixed asset capitalization policy?” While having a written capitalization policy in place will make your auditor happy, it will also help simplify the accounting for fixed asset purchases.
Establishing a capitalization policy helps keep the treatment of property additions, repairs and maintenance consistent. It can also save time and reduce the amount of recordkeeping. Sometimes when certain assets are purchased, it isn’t clear whether they should be depreciated over their useful life, or simply expensed entirely in the current period. Having a policy in place simplifies this scenario for certain assets with small costs or short useful lives. For example, the policy may state “only assets with a cost of greater than $5,000 and useful life that extends beyond 12 months are to be capitalized.” This would eliminate the need to consider whether or not a $4,000 purchase should be added to the company’s fixed asset listing and get depreciated. Additionally, the policy can simplify the fixed asset addition process for assets that will be capitalized by providing guidelines on the useful lives that should be established for each type of asset.
If your business has “applicable financial statements” (meaning statements that are audited for other than tax reasons, like a filing with a creditor), the IRS de minimis safe harbor election allows anything with a cost under $5,000 (as substantiated by invoice) or useful life less than 12 months to be expensed. The threshold for taxpayers with non-applicable financial statements is $2,500 per invoice or item (as substantiated by invoice). Because of financial reporting implications, smaller entities may want to have a smaller threshold. Auditors may consider a $4,000 transaction, for example, to be material and would evaluate if such transactions being expensed may cause a material misstatement in the financial statements. Furthermore, all entities need to consider if a large-scale purchase of individual items below the de minimis safe harbor election could be material to the financial statements. For example, purchasing 100 units of an item that is $4,000 a piece could be material to the financial statements. Accordingly, the IRS de minimis safe harbor election cannot be used to trump appropriate accounting under U.S. GAAP for material items.
It is important to note that to take advantage of this de minimis safe harbor election, the capitalization policy must be in-place and consistently followed. Your auditors may review repair and maintenance accounts, as well as fixed asset additions, to ensure items are being expensed or capitalized in accordance with the company policy.