When you make a purchase for your business, you face an important accounting decision: should this purchase be capitalised or expensed? The treatment of a purchase within your business’s accounts can be a complex financial decision. Should the treatment of a purchase be based on financial significance? Long-term economic impact? And what can I capitalise on within my accounts?

While the treatment of a purchase does not immediately affect the company’s cash flow, the long-term significance of either choice can greatly impact your business. Depending on the significance of the purchase, the company’s tax liability, balance sheet value, medium-term cash flow, and potential business value can all be impacted.

This article will distinguish between Capitalisation and Expensing, how these two accounting treatments should be implemented, and their financial implications on your business’s financial reporting and corporation tax return.

If you’re unsure whether to capitalise or expense a purchase, we can help. Our accounting experts are available to guide you through these financial decisions, feel free to get in touch for bespoke business tax advice.

Table of Contents

What Types Of Assets are used in Accounting?

Assets are the foundation of a company’s financial statements. They represent the economic resources owned by a business. When deciding how a purchase should be treated within your accounts, it is important first to understand the distinction between these various asset classes, as each has its characteristics and implications for financial reporting.

Fixed Assets

Fixed assets are long-term tangible resources that a company uses for business operations. Fixed assets include buildings, land, machinery, vehicles and significant related infrastructure. Typically, a fixed asset will be capitalised by a business due to the long-term use of the asset class and often high book value. Capitalising a fixed asset ensures that depreciation expenses are reflected proportionally on a year-by-year basis to reflect the total life of the asset within the business.

Fixed assets are often substantial investments for businesses, and their maintenance and acquisition costs need to be carefully planned. Any related installation, transportation and setup costs can be included in the purchase capitalisation cost.

 

Current Assets

Current assets are typically defined as resources easily converted into cash within one year. Examples of current assets include cash, stock inventory, pre-paid liabilities and any other liquid assets. The current assets account highlights the company’s short-term liquidity and ability to pay its obligations.

 

Intangible Assets

Intangible assets are non-physical assets owned by a business that provide value due to their legal rights or competitive advantages they offer. Examples of intangible assets include domains, patents, trademarks and copyright agreements.

The treatment of an intangible asset can vary depending on the significance of the purchase. Patents and domains can be acquired for relatively small sums of money but provide significant value to the business. On the other hand, intangible assets can represent a significant purchase for the business; therefore, capitalisation is an appropriate accounting decision.

Intangible assets will often be amortised over a much more extended period, as they are less inhibited by growth and asset life cycle and generally remain within a business for a longer period than fixed assets. For example, the purchase of a patent might be amortised over 20 years to reflect the period in which it provides exclusive value to the business.

 

Tangible Assets

Tangible assets are physical assets owned by a business that can be touched or seen. They can include both fixed and current assets. Examples include inventory, buildings, machinery, and vehicles.

Tangible assets can be either capitalised or expensed, depending upon their financial significance and their life period of use within the business. For example, buildings and land will typically be capitalised, while general tools for a manufacturing business might be expensed within the given accounting period.

What is Capitalising an Asset?

Capitalising is the process of recording a purchase as an asset on the business’s balance sheet. The cost of the purchase is spread out over the asset’s ‘useful life’ through a depreciation expense. This deprecation cost is then recorded as an expense in the business’s annual profit and loss account.

According to the Generally Accepted Accounting Principles (GAAP) matching principle, an expense should be recognised in the same period as the revenues it helps generate. Following the matching principle, if an asset is expected to be utilised and support the generation of revenue over numerous accounting periods, then a proportionate expense should be made for each year in which the asset meets these requirements.

By capitalising a purchase, a business can ensure that the appropriate level of cost is reflected in its yearly financial accounts, ensuring accuracy and transparency in financial reporting.

Depreciation and Amortisation

Depreciation and Amortisation are both accounting methods used to spread the cost of capitalised assets over their useful lives within the business. Depreciation applies to tangible assets, such as buildings and vehicles, while amortisation is used for intangible assets, such as trademarks and domain purchases.

  • Depreciation: There are various types of accounting depreciation methods. Examples include straight-line depreciation, declining balance or the Sum-Of-The-Years method. The method chosen depends upon the type of asset being depreciated. For instance, the value of a new vehicle will reduce at a faster rate in the earlier years of its life cycle. A declining balance deprecation method might be used to provide a true realisable value and prevent overstating on the balance sheet.
  • Amortisation: Amortisation involves spreading the cost of an intangible asset over its life period. A straight line of amortisation typically reflects a consistent value of the asset’s economic benefits. It is important to note that FRS102 states that an intangible asset should only be capitalised when the cost or value of the asset can be measured reliably.

When Should you Capitalise a Purchase?

Choosing to capitalise a purchase depends on several factors, including the purpose of the proposed asset, the amount spent, and the expected duration of benefit from the proposed asset. If the purchase is of significant value and will provide future economic benefit beyond the current fiscal year, then it can be assumed appropriate to capitalise the purchase.

It is important to note that the financial significance of a purchase will vary from business to business. For example, purchasing a £50,000 computer server might be considered an expense for one company but a capitalised asset for another.

 

What Purchases Can You Capitalise?

Generally, the following purchases are considered appropriate capitalised assets, assuming they provide long-term economic value to the business and represent a significant financial purchase.

  • Buildings and Land: This includes offices, units and properties. Initial survey costs, renovations and legal fees can be included in the capitalised figure.
  • Machinery and Equipment: This includes significant investments in heavy machinery, office equipment, fittings, and tooling that are utilised over the long term. Office chairs and desks are often written off as expenses due to their short life cycles.
  • Vehicles: This includes company-owned vans, cars, trucks and delivery vehicles. These assets must be depreciated correctly to represent their true book value.
  • Software: This includes large-scale software systems, in-house specialised software and CRMs. Increasingly external software has moved towards a SaaS expenditure model, which should be considered an expense rather than a capitalised asset.
  • Intangible Assets: This includes trademarks, patents and licenses. The purchase of assets must have a true value to be amortised.
 

Benefits of Capitalising a Purchase 

  • Long-Term Tax Relief: Capitalising a purchase in the short term can potentially increase a business’s tax obligation for the current tax year compared to expense accounting treatment due to a lower expense figure in the profit and loss accounts. However, capitalising a purchase provides expense deductions over a longer period for a business. For businesses in their earlier stages, where their tax liability might be lower, the ability to spread the asset’s cost over a period could provide more significant tax relief in the later stages when their profits are higher.
  • Transparent Financial Representation: By capitalising a purchase, a business can present the true financial cost of a purchase on a year-by-year basis, minimising distorting financial results from any large purchase.
  • Strengthened Financial Statements: Capitalising assets appear on the business balance sheet, providing enhanced financial representation. This can be useful when seeking financing, creditworthiness or seeking to sell the business.

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What is Expensing in Accounting?

Expensing is the default method of recognising a purchase, in which the cost is immediately recognised and written off in full within the expense section of the company’s annual profit and loss. The total cost of the purchase is recognised in the accounting year of purchase. An expensing treatment is typically applied to purchases that provide short-term benefits to the business and do not have a significant financial impact.


When Should You Expense a Purchase?

Any purchase that does not meet the criteria for capitalisation should be classed as an expense. The following criteria should be followed where there is uncertainty for the treatment of a purchase.

  • Low Purchase Cost: The purchase is below the business’s set threshold (typically below £500) and does not significantly impact the business’s finances.
  • Short-term Use: The purchase is used or disposed of within a year.
  • No Long-term Benefit: The purchase does not provide a lasting economic benefit or add value to an existing asset.
  • Operational and Marketing Expense: Operational and marketing costs that relate to everyday business expenses or refer to short-term marketing campaigns are classed as a business expense.

Benefits of Expensing a Purchase

Expensing a purchase offers a straightforward approach to accounting for purchases, especially for items with a short life cycle within the business or lower book value. Expensing can provide the following additional benefits:

  • Short-Term Annual Tax Reduction: By expensing a purchase, the total cost of the purchase is deducted in full for the given tax year. The company’s profits will be reduced, thus reducing any tax liabilities. This can be particularly beneficial if a business is experiencing a successful accounting period.
  • Improved Cash Flow: The potential reduction in annual taxation from a total purchase deduction could positively impact the business’s cash flow. Capital initially separated for tax payment can now be re-distributed to other company areas.
  • Simplified Accounting: Expensing a purchase avoids the need for complex depreciation calculations and asset record-keeping. This simplicity is particularly beneficial for small businesses with limited accounting resources.

What Purchases Can You Expense?

  • Routine Maintenance: General yearly maintenance costs or small repairs to an asset that do not extend its life cycle or improve its value.
  • Marketing and Advertising: An intangible expense that can be of high expenditure output but relates to short-term promotional campaigns. The cost of this purchase can be directly linked to the accounting period in which the purchase took place.
  • Rent and Utilities: Regular monthly, quarterly, or yearly payments for premises rental, rates, and other miscellaneous operating expenses. These costs can be directly linked to the same accounting period and must be expensed in the yearly profit and loss expense section.
  • Office Supplies: Consumable items such as ink, pens and paper. This purchase could include physical assets, such as printers and office chairs, that have a short life cycle and do not present a significant financial expenditure for the business.

Capitalising vs Expensing: Impact on Finances 

The decision to capitalise or expense a purchase can have significant financial implications for a business’s tax liabilities, the value of its balance sheet, and potentially its ability to attain financing. Understanding these impacts is crucial because they affect strategic decision-making and financial reporting.

 

Financial Implications of Capitalising a Purchase

Choosing to capitalise on a purchase impacts both the business’s balance sheet and income statement.

  • Higher Taxable Income in the Short Term: As capitalisation spreads the cost of a purchase over several accounting years, an ‘opportunity cost’ of lower tax from expensing the full purchase value is missed. In theory, short-term taxation reductions are minimised. Over the long term, however, the value of the purchase will reduce future taxable income.
  • Increased Balance Sheet Value: Capitalised purchases increase the asset value on the balance sheet, making the business appear more financially robust and enhancing financial ratios.
  • Aligned Financial Reporting: Spreading the cost of a purchase over its useful life period provides greater accuracy in the true financial forecast of the business. Large financial purchases do not distort the business’s accounts.

Financial Implications of Expensing a Purchase

The financial implications of expensing a purchase significantly impact the business’s profit and loss but do not affect the balance sheet.

  • Unrealised Balance Sheet: When purchases are expensed, their costs are immediately deducted from the profit and loss statement rather than being recorded as assets. These costs do not appear on the balance sheet as long-term assets. This can make the business appear less financially stable than it is. It can also be challenging to understand the realisable value of the company’s smaller financial purchases.
  • Reduced Short-Term Taxable Income: Expenses immediately reduce the business’s net profit. Taxable income at year-end is significantly reduced compared to capitalised assets.
  • Immediate Impact on P&L Statement: While an expensed purchase can help reduce a business tax liability in the short term, it can also present the business as less successful and profitable in a given year. Businesses seeking future investment must justify a lower yearly net profit.

Conclusion

The choice between capitalising and expensing a purchase is not only an accounting decision but also a strategic business choice. Business owners must take careful consideration when deciding how to treat a purchase within their business accounts.

Planning is required to understand the potential financial situation that the business might face in the future. A growing and expanding business may likely experience greater benefits from capitalised purchases in the long term. Assuming that the business’s profits increase over time, the ability to continually reduce the business’s recorded net profit through depreciation expenses helps to support future cash flow and realisable profits.

A business owner should consider the treatment of a purchase and its impact on the business’s financial strategy before proceeding with a purchase. Depending on the size of the purchase, properly accounting for the treatment of these purchases can ensure accurate financial reporting and optimise the business’s tax position.

At DS Burge & Co, we understand the complexities of future business planning. We work hard to ensure your business is fully compliant and optimised for tax efficiency.

Do you have more questions about the treatment of purchases within your business accounts? Our team is available to chat and provide expert advice on all your account needs, so please get in touch.