To capitalise or to expense, that is the question?

To capitalise or to expense? Why is an asset purchase capitalised on the balance sheet and depreciated when it is an expense that has been incurred? It is a common and excellent question. It is not about accounting sorcery or trying to deceive the taxman. The reason is logical and transparent. Suppose the NFP buys expensive equipment, such as a new vehicle. In that case, it is an investment that will continue to operate and benefit the entity over an extended period. The NFP treats this purchase as a long-term investment when acquired, showing as a capitalised asset for the financial year. As the vehicle ages, the NFP will depreciate it over time in line with its useful life.

“It is not about accounting sorcery or trying to deceive the taxman. The reason is logical and transparent.”

Your NFP buys the new vehicle for $50,000 and immediately enters it as an expense. This will skew your financial reporting, likely causing you to show a large loss in the month of purchase. The balance sheet could appear unhealthy as cash decreased when the vehicle was paid for and because it was expensed instead of capitalised there is no corresponding increase in assets to recognise that you have purchased something that adds value to your service. It does not reveal the proper health of the organisation.

Capitalising the vehicle and recognising that it is an asset makes it clear on your financial reports that you have invested in something you believe will benefit your NFP beyond the current period.

Depreciating assets also provide an accurate picture of the organisation’s financial health. Taking the vehicle example further, we have already confirmed that by capitalising it, we are recognising it as something that will bring the organisation future benefits. We must also acknowledge that it will lose value as it ages and is used. Depreciation reflects this in the balance sheet, showing the vehicle’s real value as it is used year on year.

Your NFP has purchased a $50,000 vehicle, has capitalised it, and expects it to have a useful life of 5 years. Each year, it will recognise $10,000 in depreciation to reflect that the vehicle is declining in value. In doing so, the balance sheet accurately reflects that a vehicle still exists but is worth less than it was the day you purchased it. At the same time, your Profit & Loss will take up the $10,000 depreciation cost to acknowledge that your NFP is using a vehicle it paid for in a previous period.

“Capitalising the vehicle and recognising that it is an asset makes it clear on your financial reports that you have invested in something you believe will benefit your NFP beyond the current period.”

As a general rule, think of capitalisation and depreciation like this:

When the NFP makes a significant asset purchase, such as a vehicle, you’d expect it to last more than a year. This will be capitalised at purchase and depreciated as the asset ages.

When unsure, ask yourself: Will this purchase assist the organisation over the year or more? If yes, it is more than likely a capitalised asset. Most organisations have a capitalised asset policy to help guide this decision making. This policy provides a framework to determine when a purchase should be capitalised and will generally have a dollar amount or limit attached to it. An effective capitalised asset policy should be tailored to reflect the size, complexity, and nuances of your NFP.

Check with us at Accounting For Good. We’re more than happy to provide qualified advice if you’re unsure, and our team can develop a capitalisation policy or review your current one if required.

At Accounting For Good, we work with NFP organisations with a turnover of $1M or more.

Contact us for a free consultation if your organisation needs expert financial guidance. Let us handle your accounting needs so you can focus on what matters most—serving your community and driving positive change.