Capitalization , Amortization, and Depreciation

Capitalization , Amortization, and Depreciation

63 Pages · 2005 · 310 KB · English

Capitalization , Amortization, and Depreciation Introduction In general, expenses are deductible if allowed by a specific code section. Capital

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Capitalization , Amortization, and Depreciation Introduction In general, expenses are deductible if allowed by a specific code section. Capital expenditures, in contrast, are not deductible; instead, they must be added to the basis of an asset. From there, they may – or may not – result in future depreciation or amortization, depending on the type of asset. For exampl e, the cost of land must be capitalized and is never subject to depreciation or amortization recovery. In contrast , five years worth of pre-paid insurance must also be capitalized; however, it may then be amortized over the five-year life. These very simple rules are subject to some controversy and require much refinement. The difference between an expense and a cap ital expenditure is sometimes obvious. For example, the replacement cost of a single shingl e blown off a roof by a hurricane is clearly an expense – and thus not subject to capitalization - for two reasons. First it is minor – and thus not worth the process of capitalization and deprecia tion. Even though the shingle itself may actually last many years, depending on the remaining life of the roof, the minor cost is not worth the accounting trouble. Second, its replacement does little to change or extend the life of the main asset – the roof. Hence it is just a short-term, mi nor repair and gives rise to the allowance of a deduction under section 162 as an ordinary and n ecessary business expense (assuming, of course, the roof was on a building used for a trade or business). For accounting purposes, we would debit an expense account – repairs – and credit a payable or

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