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11.2 Analyze and Classify Capitalized Costs versus Expenses

Capitalized Costs vs. Expenses​

Capitalized Costs:

  • Recorded as assets
  • Depreciated over useful life
  • Match cost with periods that benefit

Expenses:

  • Recorded immediately
  • Reduce income in current period
  • No future benefit

When to Capitalize​

Capitalize if:

  • Asset has useful life > 1 year
  • Asset provides future economic benefits
  • Cost is significant
  • Asset is used in business operations

Expense if:

  • Benefit is consumed immediately
  • Cost is immaterial
  • Maintenance or repair (doesn't extend life)
  • Routine operating expense

Examples: Capitalize​

Equipment Purchase:

  • Purchase price: €10,000
  • Delivery: €500
  • Installation: €1,000
  • Total Capitalized: €11,500

Journal Entry:

223000 Equipment                   €11,500
510000 Cash (or 400000 Payable)                €11,500
To record equipment purchase

Building Improvements:

  • Renovation that extends useful life: €50,000
  • Capitalize: €50,000

Examples: Expense​

Repairs:

  • Routine maintenance: €500
  • Expense: €500

Journal Entry:

619000 Repairs and Maintenance    €500
510000 Cash                                    €500
To record routine maintenance

Small Purchases:

  • Office supplies: €100
  • Expense: €100 (immaterial, consumed immediately)

Cost Components​

What to Include in Asset Cost:

  1. Purchase Price: Invoice amount
  2. Delivery Costs: Shipping, freight
  3. Installation Costs: Setup, assembly
  4. Legal Fees: Title, registration
  5. Testing Costs: Initial testing
  6. Other Direct Costs: Necessary to get asset ready

What NOT to Include:

  1. Financing Costs: Interest (expensed separately)
  2. Training Costs: Employee training (expensed)
  3. Operating Costs: Ongoing maintenance (expensed)

Luxembourg Considerations​

VAT Treatment:

  • VAT on asset purchases is usually recoverable
  • Recorded separately (VAT Recoverable)
  • Not included in asset cost

Example:

  • Equipment: €10,000 (excluding VAT)
  • VAT 17%: €1,700
  • Total: €11,700

Journal Entry:

223000 Equipment                   €10,000
431000 VAT Recoverable              1,700
510000 Cash (or 400000 Payable)                €11,700
To record equipment purchase with VAT

Luxembourg Compliance Note​

For capitalized costs in Luxembourg:

  • Must follow PCN Class 2 requirements
  • Must include all direct costs
  • Must exclude VAT (if recoverable)
  • Must be properly documented
  • Must comply with tax rules
  • Must support asset values

Think It Through​

A business purchases equipment for €5,000 and spends €500 on delivery and €1,000 on installation. Should all these costs be capitalized? Why or why not?