Accounting for Your Key Assets

In the world of bookkeeping, capital assets play a crucial role. They are the backbone of a company's financial health and future growth. Understanding what capital assets are, how they are accounted for, and how they impact a company's financial statements is essential for anyone involved in bookkeeping or financial management.

Capital assets, also known as fixed assets, are significant pieces of property such as homes, cars, investment properties, stocks, bonds, and other types of assets that a person or business owns. In the context of bookkeeping, capital assets are typically the large pieces of property that a company owns that have a useful life of more than one year.

Definition of Capital Assets

Capital assets are long-term assets that are not sold in the regular course of business operations. They are used or have the potential to be used to generate revenue, and their benefits are expected to be realized over a long period of time, typically more than one year. Capital assets can include property, plant, and equipment (PP&E), investment property, intangible assets, and financial assets.

Capital assets are important because they are a key factor in determining a company's overall net worth. They are also critical for long-term strategic planning. For example, if a company plans to expand its operations, it may need to invest in new capital assets such as buildings or machinery.

Types of Capital Assets

There are several types of capital assets, each with its own characteristics and accounting considerations. The main types of capital assets include tangible assets, intangible assets, and financial assets.

Tangible assets are physical assets that can be touched. They include items such as land, buildings, machinery, vehicles, and equipment. These assets are typically depreciated over their useful life.

Intangible assets, on the other hand, are non-physical assets such as patents, trademarks, copyrights, business methodologies, goodwill, and brand recognition. These assets are typically amortized over their useful life.

Financial assets include investments in bonds, stocks, or other types of financial instruments. These assets are usually valued at market value on the balance sheet.

Tangible Capital Assets:

• Land

• Buildings

• Machinery and Equipment

• Vehicles

• Furniture and Fixtures

Intangible Capital Assets:

• Patents

• Trademarks

• Copyrights

• Goodwill

• Software

Accounting for Capital Assets

Capital assets are accounted for differently than regular operational expenses. They are capitalized rather than expensed, which means that their cost is recognized over the period of their useful life rather than at the time of purchase. This process is known as depreciation for tangible assets and amortization for intangible assets.

The cost of a capital asset includes the purchase price and any other costs necessary to bring the asset to its intended use. For example, shipping costs, installation costs, and taxes may be included in the cost of a capital asset.

Depreciation and Amortization

Depreciation and amortization are methods of allocating the cost of a capital asset over its useful life. Depreciation is used for tangible assets, while amortization is used for intangible assets. Both methods reflect the decrease in value of an asset over time due to wear and tear, deterioration, or obsolescence.

There are several methods of depreciation and amortization, including straight-line, declining balance, and units of production. The method chosen depends on the nature of the asset and the company's accounting policies.

Depreciation Methods

• Straight-Line Depreciation: Spreads the cost evenly over the asset's useful life.
• Declining Balance Depreciation: Applies a higher depreciation rate in the early years of the asset's life.
• Units of Production Depreciation: Allocates depreciation based on the asset’s usage or output.

Impairment of Capital Assets

Impairment occurs when the carrying amount of a capital asset exceeds its recoverable amount. The carrying amount is the amount at which an asset is recognized after deducting any accumulated depreciation and accumulated impairment losses. The recoverable amount is the higher of an asset's fair value less costs to sell and its value in use.

When an impairment loss occurs, it is recognized in the income statement and the carrying amount of the asset is reduced. This can have a significant impact on a company's financial statements.

Impact of Capital Assets on Financial Statements

Capital assets have a significant impact on a company's financial statements. They are included in the balance sheet, and their depreciation or amortization is reflected in the income statement. Changes in capital assets, whether through purchases, sales, depreciation, or impairment, affect the company's financial position and performance.

On the balance sheet, capital assets are included in the non-current assets section. They are usually presented at their carrying amount, with the accumulated depreciation or amortization deducted. This presentation shows the net book value of the capital assets.

Impact on the Income Statement

On the income statement, the depreciation or amortization of capital assets is included in operating expenses. This expense is deducted from revenue to arrive at operating profit. Therefore, the higher the depreciation or amortization, the lower the operating profit.

Impairment losses on capital assets are also included in the income statement. They are usually presented as a separate line item before operating profit. An impairment loss reduces both operating profit and net profit.

Impact on the Cash Flow Statement

On the cash flow statement, purchases of capital assets are included in investing activities. They represent cash outflows, as they involve spending cash to acquire new assets. Sales of capital assets, on the other hand, represent cash inflows.

Depreciation and amortization are non-cash expenses, meaning they do not involve any cash flow. However, they are added back to net profit in the operating activities section of the cash flow statement, as they are deducted in the income statement but do not affect cash.

Capital Assets in Canadian Bookkeeping

In Canadian bookkeeping, capital assets are subject to the rules and regulations set out by the Canada Revenue Agency (CRA). The CRA has specific rules for how to classify, depreciate, and dispose of capital assets.

The CRA classifies capital assets into different classes, each with its own rate of depreciation, known as the Capital Cost Allowance (CCA). The CCA rates are set by the CRA and vary depending on the type of asset.

Capital Cost Allowance

The Capital Cost Allowance (CCA) is the method used in Canada to calculate the depreciation of capital assets for tax purposes. The CCA is a percentage of the capital cost of an asset, and it is deducted from income to reduce taxable income.

The CCA rates are set by the CRA and vary depending on the type of asset. For example, buildings are depreciated at a rate of 4%, while vehicles are depreciated at a rate of 30%.

Disposition of Capital Assets

When a capital asset is sold or otherwise disposed of, the transaction must be reported to the CRA. The difference between the sale price and the book value of the asset is considered a capital gain or loss for tax purposes.

If the sale price is higher than the book value, a capital gain is realized. If the sale price is lower than the book value, a capital loss is realized. Capital gains are taxable, while capital losses can be used to offset capital gains.

Bookkeeping Entries for Capital Assets

1. Recording the Purchase:

   • Debit: Capital Asset Account

   • Credit: Cash/Accounts Payable

2. Depreciation Expense:

   • Debit: Depreciation Expense Account

   • Credit: Accumulated Depreciation Account

3. Disposal of Assets:

   • Debit: Accumulated Depreciation Account

   • Debit: Cash (if applicable)

   • Credit: Capital Asset Account

   • Credit: Gain on Sale (if applicable)