Fixed Asset Basics - Purchased Items

Fixed assets can cause confusion for many self-employed professionals and small businesses.  Fixed assets are tangible property that have a useful life of more than one year which are used in business operations to generate revenues. For large businesses, the fixed assets will often be categorized as property, plant, and equipment (PP&E) on the balance sheet.  For many non-accountants, that definition and those broad categories do not help determine which purchased item should be classified as fixed assets.  Here are some additional criteria to help small businesses and their bookkeepers properly classify fixed assets.  (Note that commercial buildings and rental property will be covered in another post.)

Useful Life

Many people focus on this characteristic exclusively when deciding what items should be capitalized.  The useful life can vary significantly depending upon how the item is used by the business.  For example, a landscaper in Florida may need to replace lawnmowers annually because they are worn out, while the same mower may last for years at a seasonal 9-hole golf course in Maine.  The lawnmower is part of supplies for the landscaper, while it is a fixed asset for the golf course.

I have seen some fixed asset accounts include small tools and inexpensive furniture and office décor with single items having a cost of $100 or even less.  Many professional offices will have a small toolkit for the office, perhaps a hammer, a drill, a wrench, measuring tape and level for assembling/tightening office furniture or hanging wall art.  Those items are all durable good with a useful life beyond one year.  However, they are not used in business operations to generate revenues.  These small tools and decor are not fixed assets for accounting purposes. 

Capitalization Threshold

This consideration is often overlooked by small businesses.  Businesses which have audited or reviewed financial statements consistent with GAAP will typically have many written financial procedures and policies, including a capitalization threshold.  These businesses will often have a capitalization threshold of $5,000.  This means that the company will expense all items under that dollar value as an annual expense, even if the item has a longer useful life and is used in revenue-generating operations.

How do you determine the total cost or basis of a potential fixed asset?  You should include the purchase price, all sales taxes, all shipping and delivery charges, and any installation costs.  The total of these costs is the basis of the purchase.

Even if your small business is just you in a home office, you can have a capitalization threshold.  I recommend $2,500 as a practical threshold; you should just expense any items with a basis under that total.  Having this threshold will simplify your recordkeeping and make most of your decisions around fixed assets simple.  Most office equipment, furniture and fixtures will all be expensed using this threshold.

Bookkeeping

Items which are capitalized need to be tracked on a schedule for accounting and income tax purposes.  Each item is tracked individually, with a description, the date it is placed in service, its basis, and the method by which it is being depreciated.  Fixed assets which appear on a balance sheet are expensed over years using depreciation.  Using an acceptable method, a portion of the basis is expensed each year and the value of the fixed asset is reduced on the books by an accumulated depreciation account.  The mechanics of depreciation are not covered here and your accountant can help you determine annual deprecation on any fixed assets.

I have seen some businesses create a new fixed asset account for every single fixed asset.  This is unnecessary and creates a large chart of accounts that can be cumbersome.  If you have multiple fixed assets, pick a few salient categories and classify appropriate fixed assets into those accounts. 

Taxation

Earlier I advocated a $2,500 capitalization threshold for most small businesses.  The IRS has a de minimus safe harbor election threshold of $2,500 per invoice or item for taxpayers without applicable financial statements.  This means you can expense items with a basis under that amount and the IRS will not challenge those items in the event of an audit. 

For items above $2,500, your tax preparer does need to keep a schedule of those fixed assets as described earlier.  If your business has sufficient income, you will likely be able to expense your fixed assets using section 179 or bonus depreciation, subject to some limitation.  Your tax accountant can work with you on permitted accelerated depreciation methods for fixed assets.

Note that your local personal property tax authority may have lower threshold requirements.  You may need to include some items that you have fully expensed on your books and tax returns on a personal property tax return. 

Conclusion

For most cash basis small businesses, they should expense all single invoices or items having a basis under $2,500.  This will simplify the long-term recordkeeping required for fixed asset schedules while reducing taxable income.  For items over the threshold, consider the useful life of the tangible property.  Discuss these issues with your accountant if it is not clear if the item is a fixed asset. 

Another post will cover repairs versus improvements, another fixed asset issue commonly seen with commercial buildings and rental properties.