Chapter 1.1® - Capital Assets & Amortization of Tangible & Intangible Assets, Cost of Capital Assets, Accounting for Lump Sum Asset Purchases
Capital assets are used in the day to day operations of a Corporation and have a useful life of more than 1 accounting period (usually 1 year). Capital assets are divided into 2 groups:
Property, plant and equipment (also known as fixed assets) include assets such as land, buildings, equipment, machinery, leasehold improvements and natural resources. On the other hand, intangible assets lack physical substance and include assets such as patents, leaseholds, copyrights and trademarks. A very popular example of a trademark is Coca Cola. Goodwill is also an intangible asset but it is shown separately on the balance sheet from Capital Assets.
For You to Know: An important note about Capital assets is that they are used in daily business operations to help generate revenue. This makes them different from inventory, which is an asset that is not used in daily operations but rather held for the purpose of resale. A corporation that purchases a digital camera for the purpose of resale lists its digital cameras on the Inventory section of its Balance sheet. But if this same firm purchases a digital camera for the purpose of using it in daily operations to generate revenue, would classify this asset as a Capital Asset.
It is also important to note that Capital assets have a useful life of more than 1 accounting period or year which makes them different from “Current Assets” that have a useful life of 1 year or less. Accounting for Capital assets involves measuring capital assets and matching their costs of depreciation/amortization to periods benefitting from their use (income statement item). The 3 main issues involved with accounting for capital assets include:
Cost of Capital Assets
To be consistent with the Cost Principle of Generally Accepted Accounting Principles (GAAP), Capital assets are always recorded at cost including all normal & reasonable expenses necessary to get the asset in place and ready for its intended purpose. For instance, the cost of a factory machine includes the invoice cost it was acquired at, minus any purchase discounts for early payment, plus freight, unpacking costs, sales taxes (PST) as well as cost of assembling the asset. Further costs of capital assets also include the cost incurred to install and test a machine before placing it in use for its intended purpose. Examples of such operations include building a foundation for the machine, electrical setups or adjusting/configuring the machine before it is ready for work. All these are examples of capital expenses.
Lump Sum Capital Asset Purchases
Purchase of lump-sum Capital assets, also known as a basket purchase, is the purchase of capital assets in a group, with 1 single transaction and 1 lump-sum buying price. For instance, a company could purchase land appraised at $500,000, land improvements (parking lots or driveways) at $150,000 and a building appraised at $2 million for a total of $2 million. If this happens, accountants allocate the cost of the purchase among the different types of assets acquired based on their relative and total market values.