Capitalizing costs related to buildings, building improvements, and infrastructure can be challenging for many higher education institutions and public entities. Proper capitalization is essential for accurate financial reporting, indirect cost recoveries and federal audit compliance. Misclassifying these costs can lead to overstated expenses, missed tax deductions, and financial misstatements. Our experts at HCA Asset Management compiled these points as a guide to walk you through common issues businesses face with capitalization and how to avoid them.
Capitalizing Buildings: Key Considerations
The process of capitalizing a new building seems straightforward, but there are important details to consider:
- Capture All Associated Costs: Beyond the physical structure, be sure to capitalize associated costs such as engineering, design, and architectural fees. These are integral to the building and should be part of its total capitalized value. Overlooking these costs can lead to underreporting the value of your building asset.
- Review Construction Invoices Thoroughly: Construction projects often include the purchase of moveable equipment—such as furniture, equipment or other assets—that may have much shorter useful lives than the building itself. These items should be reclassified in your asset system, as they typically need to be depreciated over a shorter period. Misclassifying these as part of the building’s cost can lead to incorrect depreciation schedules.
- Consider Componentization: This accounting practice involves breaking down the building’s costs by components (such as the roof, electrical systems, and structure) and assigning appropriate useful lives to each. For example, a roof might only last 20 years, while the structure could last 50. By segregating these costs, businesses can ensure accurate depreciation and make future replacements easier to account for. When a roof is replaced, you can accurately retire only the costs associated with the original roof and capitalize the new one.
Capitalizing Building Improvements: Getting it Right
Distinguishing between capital improvements and repairs is critical for businesses to maintain compliance. Capital improvements are those that extend the life or enhance the value of your building. Examples include expanding your facility, installing new energy-efficient systems, or upgrading electrical systems. These costs should be capitalized and depreciated over time.
In contrast, routine maintenance, like patching a roof or painting, should be expensed in the current year.
Infrastructure Capitalization: Handling Complex Projects
Capitalizing infrastructure costs, such as those related to utilities, roads, or large-scale system upgrades, can be more complex than buildings or improvements. Here are a few strategies to navigate these challenges:
- Identify Capitalizable Costs: Infrastructure improvements that enhance the functionality or extend the life of the asset should be capitalized. For instance, upgrading a road to handle more traffic or installing a more efficient utility system would be classified as a capital improvement.
- Consider Componentizing Infrastructure: As with buildings, infrastructure projects can benefit from componentization. By breaking down the costs of different elements—such as pipelines, electrical grids, or transportation networks—you can assign useful lives that better reflect the reality of each asset’s durability. This leads to more accurate financial reporting and simplifies future accounting for replacements or upgrades.
How to Avoid Common Capitalization Mistakes
While understanding the basics of capitalization is essential, avoiding common pitfalls requires careful attention to detail. Here are a few key tips:
- Keep Detailed Records: Maintain comprehensive records of all costs associated with your buildings, improvements, and infrastructure projects. Having clear documentation makes it easier to determine what should be capitalized versus expensed.
- Consult with Experts: The rules surrounding capitalization can be intricate, and the stakes are high. Consulting with financial or accounting experts can help ensure that your business remains compliant with financial reporting standards and optimizes its tax benefits. While your internal team may be capable of handling day-to-day accounting, bringing in outside advisors can be valuable when managing complex capital expenditures.
- Regularly Review and Update Depreciation Schedules: As your assets age, it’s essential to revisit and adjust depreciation schedules to reflect changes in the useful life of building components or infrastructure. This ensures that your financial reporting remains accurate over time and helps avoid discrepancies when replacements or retirements occur.
Whether you’re navigating external audit requirements, managing financial reporting, or controlling fixed assets, relying on experts can help you ensure your capital asset management is handled with precision and care. Learn more about our work, and how we leverage the latest capital asset management technologies with the University of Iowa when addressing their capitalization and compliance needs.