Capitalization and depreciation policy procedures

Having a clear and defined capitalization and depreciation policy helps you keep your business financial reporting accurate and manage your assets effectively. The capitalization policy guides you in deciding which expenditures should be treated as capital assets.

On the other hand, the depreciation policy gives you a roadmap for spreading the costs of these capital assets over their useful lives. When you put these policies together, they help you comply with accounting standards and give you a transparent view of your financial health.

What is a capitalization policy?

A capitalization policy sets a minimum cost threshold, ensuring you view any expenditure above that as a long-term investment—or capital asset—that will depreciate over time. It helps you classify expenditures as fixed assets to depreciate, ensuring consistent financial reporting and clear separation between operational costs and long-term investments that bring value for multiple fiscal periods.

What is a depreciation policy?

You record depreciation regularly to show how an asset's value fades over time due to use, wear and tear, or becoming outdated. The depreciation policy shares an overview of the methods for calculating depreciation, the estimated useful life of assets, and how to apply depreciation. All this provides a clear and accurate picture of an asset's value throughout its lifetime.

How to create capitalization and depreciation policy templates

Creating clear capitalization and depreciation policy templates promotes consistent financial reporting and compliance. These templates help you record accurate asset values and manage long-term investments.

Steps to create a capitalization policy template

• State the policy’s goals, such as guiding financial reporting and ensuring compliance
• Set a minimum dollar amount for capitalizing assets, taking industry standards into account
• List the types of assets that can be capitalized; include specific examples
• Define the expected useful life for each asset category
• Spell out methods for recording capitalized assets, including allocation procedures
• Specify how often to review and update the policy
• Emphasize maintaining proper records to support capitalized expenditures
• Make sure all appropriate staff are trained and understand the policy

Steps to create a depreciation policy template

1. Your accounting policy should spell out the objectives, focusing on accurate asset value allocation and compliance
2. Identify the methods—straight-line, declining balance—and provide examples
3. Outline the expected useful life for asset categories based on industry standards
4. Provide guidelines for estimating the asset's expected value at the end of its useful life
5. Detail how and when depreciation will be recorded in financial statements
6. Outline procedures for assessing and recognizing asset impairment
7. Define how and when to review useful lives and salvage values
8. Stress the importance of documenting depreciation calculations and adjustments
9. Ensure staff are trained on the depreciation policy for better compliance

How are capitalization and depreciation policies related?

Capitalization and depreciation policies are closely related because they both deal with how to treat long-term assets in accounting. Also, capitalization and depreciation policies both must comply with Generally Accepted Accounting Principles (GAAP), ensuring that financial reporting is standardized and consistent across industries.

How does capitalization affect depreciation?

Depreciation policy comes into play when an asset is capitalized because now, instead of expensing the entire cost at once, the business will spread the cost over the asset’s useful life. The useful life and capitalized amount directly affect the amount of depreciation recorded each period.

For example, if you capitalize a $50,000 machine, and the depreciation policy applies a 5-year useful life, your business will record a $10,000 depreciation expense each year using the straight-line method.

How does depreciation affect capitalized assets?

The depreciation policy reduces the book value of the capitalized asset on the balance sheet over time. As you apply depreciation, the value of the asset on the balance sheet decreases, and accumulated depreciation grows. Depreciation doesn't affect cash flow, but it does affect net income and the carrying value of capitalized assets, reflecting wear and tear or obsolescence.

For example, after the first year, the machine mentioned above will show a net book value of $40,000 on the balance sheet Original $50,000 Cost - $10,000 Accumulated Depreciation

Criteria for capitalizing assets

The following criteria for capitalizing assets are a set of guidelines for when an expense should be classified as a capital asset rather than a regular operating expense. Typical criteria include:

• The asset’s cost must exceed a minimum dollar amount, or capitalization threshold, set by the business. This threshold ensures that only significant expenditures are capitalized.
• You must expect the asset’s useful life to last more than one year. Expense the asset rather than capitalizing it if it’s consumed or fully used within the current fiscal year.
• The asset must provide economic benefits to the business beyond the current reporting period
• It must be tangible, meaning it has a physical form, like real estate, equipment, or machinery. You may also capitalize some intangible assets, such as computer software or intellectual property, depending on business policy.
• Include costs directly attributable to acquiring the asset in the capitalized amount. These include purchase price, installation or setup costs, shipping and handling fees, and any costs required to bring the asset into working condition, such as training or testing.
• The business must have legal ownership or control over the asset to capitalize it. You can also capitalize leasehold improvements if your business has the right to control and use the asset.
• You must intend to use the asset for business operations rather than for sale. Don’t capitalize assets held as inventory or for short-term resale.

Items you can capitalize

For accurate financial reporting and effective asset management, you must understand which expenditures you can capitalize. These items qualify:

Depreciation procedures

When you acquire it, classify the asset into the appropriate asset category, such as buildings, machinery, office equipment, or vehicles. Each asset class should have predefined depreciation rules and useful lives. Typical criteria for depreciation procedures include:

1. Estimate the asset’s useful life based on the manufacturer’s guidelines, industry standards, historical data from similar assets, and legal or contractual limits, if applicable

2. Select the appropriate depreciation method based on business policy and the nature of the asset. You must apply this method consistently across similar assets. Common methods include:

3. Estimate the salvage value of the asset, which is what, if anything, you expect the asset to be worth at the end of its useful life

4. Use the historical cost of the asset—purchase price and all related setup costs—to determine the depreciable amount, subtracting the salvage value.

5. Depreciation begins when you place the asset into service for its intended use, not when it’s purchased. Be sure to apply depreciation in the first accounting period after you start using it.

6. Record depreciation periodically—typically monthly or annually. Track the accumulated depreciation separately from the asset account on the balance sheet, reducing the asset’s carrying amount.

7. Regularly review the asset’s useful life and salvage value to confirm it’s reasonable, especially if the asset undergoes significant changes or if its economic utility declines. Adjust the depreciation schedule as needed based on your revised estimates.

Ease your capitalization and depreciation with Ramp’s templates

Clearly defining asset capitalization and depreciation procedures ensures compliance with accounting standards. Focusing on accuracy and transparency improves decision-making, asset management, and business outcomes performance.

To simplify and optimize your capitalization and depreciation policies even further, Ramp streamlines expense categorization. With seamless integration into your accounting software, you can effortlessly track and manage capital expenditures while maintaining compliance with accounting standards.

Learn how Ramp can help automate your asset management.