Should my company capitalize and amortize the costs of sets and costumes?

Capital assets generally include items of significant value that are owned for longer than a year, and used in operations. Spending on production can vary widely from show to show and company to company. If you are spending significant sums in these areas, it’s worth exploring this issue.

Let’s take the example of an opera company that has adopted an accounting policy of capitalizing its sets and costumes and amortizing them over 7 years, based on the fact that it draws from a “canon” of works, and therefore remounts shows from time to time.

One way to look at capital assets is as a deferred expense. You pay all the bills in Year 1, but (through amortization) you recognize the expense over the estimated useful life of the asset (in this example 7 years), so that each year of use bears its proportional estimated share of the cost (in this example 1/7 per year).

The argument in favour of capitalizing and amortizing sets and costumes would be that you expected to use them actively over the estimated 7 years, either in your own shows or as rental properties. 

Let’s work through the accounting effect, step by step. In the first year of adopting this policy, you would record your sets and costumes as assets, not expenses. This would have the effect of improving your bottom line. You would of course need to record one year of amortization expense – that is, 1/7th of the purchase price. The remaining 6/7ths of the expense would be postponed to future years. 

Onward to Year 2, and a new year of programming with (potentially) a new group of directors and designers. Will those artists be content to reuse Year 1’s sets and costumes? It seems likely that, in most cases, while they may reuse some “stock” items, they would prefer to create something new and different. In that instance, the company would incur new expenses for set and costume purchases. Once you set up an amortization policy, you need to follow it -- so you would amortize Year 2’s production items in the same way. Financially, the result would still feel pretty sweet, because in this year you recognize the cost of 1/7 of Year 1 purchases plus 1/7 of Year 2 purchases... but you can see where this is heading.

By the time you hit Year 7, the bottom-line advantage has disappeared because you've got seven active amortization cycles. You're also saddled with a certain amount of extra bookkeeping – and, more importantly, production expense becomes difficult to interpret. Imagine looking at the Year 7 income statement. You know for a certainty what your box office revenue was, but because related expenses and revenues are no longer matched within a fiscal period, it becomes trickier to interpret the financial result. The set and costume expense in Year 7 does not capture the cost of Year 7 shows, but rather 1/7 of the costs for each of the previous seven years.

The real "bottom line" to this story is that you can't out-run expense. You need to recognize it sooner or later. Our opera company might have been tempted to adopt the amortization policy as a gambit to improve the bottom line at a point when things weren't going well – but over the longer haul this approach doesn't put you any further ahead.

Now – let’s look at the other side of the coin. If you expense sets and costumes during the year of the show for which they were created, expense recognition is clear. That's very helpful for the purpose of evaluating financial results. But, it's also true that companies, especially larger companies in the opera and ballet worlds, DO remount productions and rent productions to other companies. If you don't amortize the cost, those future uses have no cost attached to them – and the financial statements for those years could be seen as misstated by the amount of expense that perhaps should have been attributed to them.

Expensing items in the year of the production means that companies may own a lot of stock – sets, costumes, props, etc. – that's not acknowledged on the balance sheet as an asset. However, that is how the set and costume expense is typically handled, in the experience of Young Associates staff. 

The question for management is which treatment best reflects the company’s financial results? And, which treatment best applies generally accepted accounting principles (GAAP) such as cost-benefit and materiality? Managers need to evaluate whether the advantage of matching revenue and expense recognition outweighs the possible misstatement of future bottom lines. 

This would be an excellent topic to discuss with your accountant.

Click here for more q and a's on capital assets. 

At what point would our accumulated surplus be so large that we’d be in trouble with the Charities Directorate?

The Charities Directorate of the Canada Revenue Agency does, indeed, have rules around accumulation of property. The particular rule that charities are probably thinking about if they’re worried about the size of their accumulated surplus is the disbursement quota (DQ). The purpose of the DQ is to establish a minimum requirement for spending on charitable activities, with reference to the wealth that a charity has accumulated. As long as you maintain an appropriate level of charitable activity – measured through your spending – you are compliant with this rule.

CRA provides guidance about its spending requirements here. Note that there are separate rules for charitable organizations, which exist to deliver charitable programs and services, and foundations, which exist to support charitable programs and services.

Young Associates works with many smaller charitable organizations. Most groups in this category are unlikely to have accumulated property at a level that would cause non-compliance with the CRA. However, this is an issue that may involve complex legal and financial concepts. If you have concerns, it is wise to discuss your situation with a professional.

CRA defines its requirement for charitable organizations as follows:

If the average value of a registered charity's property not used directly in charitable activities or administration during the 24 months before the beginning of the fiscal period exceeds $100,000, the charity's disbursement quota is:
3.5% of the average value of that property.

The interpretation of this hinges on what property is not used directly in charitable activities or administration. CRA lists real estate and investments as examples. 

A charity, for instance, may hold long-term investments such as units in a mutual fund, and use the resulting interest revenue in its operations. However, the principal sits intact for multiple years, not directly used for charitable activity. (This is distinct from the case of a charity that places short-term investments to earn some interest revenue before the investment matures and the principal winds up in a chequing account, available for spending.)

A charity may also own a building that it doesn’t currently occupy; this may be the case for institutions such as hospitals, universities and churches, which may have considerable real estate holdings and needs that change over time.

Once you have identified property that meets CRA’s definition of “not used directly in charitable activities or administration,” you must calculate its average value over the two years before the start of the current fiscal year. CRA provides some latitude in how the average may be calculated. If your organization needs to make this calculation, the method for assessing value and calculating the average over time would be a good topic for discussion with your CPA.

Last step: calculate 3.5% of the average value. That yields the amount your organization is obliged to spend on its charitable activities or administration during the current year. 

Let's say your charity owns an investment portfolio, and you determined that its average value over the last 24 months was $100,000. Your DQ for the current year would therefore be $3,500.

You can see that this is actually a pretty low bar to jump over! Most organizations with the capacity to build a $100,000 investment portfolio would have operations that demanded more than $3,500 in program and admin spending. CRA’s rule is set at a level that catches inactive charities, but that is unlikely to cause compliance issues for most charities that are actively carrying out their mandates. 

I understand that assets and equity both have to do with the value in my organization. Why don’t they match?

Assets are items that your company owns. These can be tangible or intangible, and they can be current or capital. See the glossary for more detailed definitions.

Equity, also known as Net Assets, represents the organization’s residual value – the amount of value left over after Liabilities have been subtracted from what you own.

If your organization had no liabilities, then its assets would equal its equity. This may be the case for very tiny organizations, but otherwise rarely happens. Most organizations accrue liabilities in the normal course of day to day operations.

For instance, if you open a credit account with a supplier, they will invoice you for goods or services and allow you a period of time – often a month – in which to pay. For that month, you are officially in debt, although you aren’t in any trouble! Your balance sheet needs to show that the supplier has a claim on a portion of your assets. You own a certain amount of cash, receivables and other assets… but your organization’s residual value is lower by the value of the outstanding debt.

What’s the difference between holiday pay and time in lieu?

‘Holiday pay’ and ‘Time in lieu’ are actually very different. Holiday pay is pay for ‘standard’ holidays, either public or at least consistently recognized by the employer. Time in lieu is paid time off in exchange for overtime work.

Holiday pay is pay for days that an employee doesn’t have to work, because they are public holidays. In Ontario, these days are: New Year’s Day, Family Day, Good Friday, Victoria Day, Canada Day, Labour Day, Thanksgiving Day, Christmas Day, and Boxing Day. Public holidays vary in different jurisdictions. Also, some employers choose to provide holiday pay for days which are not official public holidays, but are frequently observed. For example, in Ontario, employers often acknowledge Civic Holiday the first Monday in August. Public holiday pay is based on the previous four weeks of work, and can be calculated here. The calculation i:s (regular wages from 4 weeks previous + vacation pay from 4 weeks previous) / 20. You add up the last month of earnings and divide by 20 because there are 20 working days in a normal month.

In the entertainment field — and others — it’s not uncommon for employers to ask their staff to work on a public holiday. Employees have the option to agree in writing to work the day and receive either public holiday pay plus premium pay for the hours worked on the holiday OR their regular rate plus holiday pay on a ‘substitute’ day off. In this case, the holiday rate would be calculated on the four weeks previous to the substitute holiday, not the original holiday. Some jobs do not entitle employees to take public holidays off. More details on public holiday pay in Ontario can be found here.

‘Time in lieu’ is paid time instead of overtime pay. The Employment Standards Act sets out rules on overtime pay; in most cases it is time-and-a-half (1 ½ times regular pay) for hours worked beyond 44 in a week. An employee and employer can agree in writing to time in lieu, also sometimes called ‘banked time’. In Ontario, if an employee has agreed to bank overtime hours, the employer must provide 1 ½ hours of paid time off for each hour of overtime worked. The time off must be taken within 3 months or, if an agreement is made in writing, within 12 months. If employment ends before the employee takes the paid time off, the employer must pay him or her overtime pay instead.

Find more information on paid time off in Ontario here.

What are the repercussions of not taking time off?

First, a reminder of how and when vacation time is earned: Employees earn their vacation time upon completion of a year of work (the Ontario Ministry of Labour calls it a “12-month vacation entitlement year”), and each subsequent 12-month period. If the employer deviates from the standard entitlement year, the employee is entitled to their minimum vacation time as well as a pro-rated amount of vacation time for the ‘stub period’ which precedes the start of the first alternative vacation entitlement year.

The Ontario Ministry of Labour dictates that vacation time earned (whether based on a completed entitlement year or stub period) must be taken within 10 months. The employer has the right to schedule the employee’s vacation time and/or ensure vacation is scheduled and taken.

Upon obtaining written agreement from their employer and the approval of the Director of Employment, an employee can give up some or all earned vacation time. The employer is still obliged to issue the employee vacation pay. You can give up vacation time, but you do not give up your right to the remuneration associated with that time.

You can learn more about vacation time from the Ontario Ministry of Labour website or by visiting the labour website applicable to your region.

What is vacation pay versus regular pay?

Vacation pay is remuneration for time off! The Ministry of Labour, through the Employment Standards Act, allows for 2 weeks of paid vacation per year worked. This is the legal minimum — and many employers offer their employees more than the standard 2 weeks, often to reward long service with the company.

The 2-week amount is often expressed as 4% of your regular pay. (Out of 52 weeks in the year, you work 50 and go on holiday for 2; the 2 weeks is 4% of the 50.) If you’ve worked less than a full year, the amount of paid vacation you receive is pro-rated accordingly. So, summer students, for instance, would receive vacation pay amounting to 4% of their summer earnings.

Visit this Q & A for methods on calculating vacation pay. Vacation pay is treated in the same manner as regular pay in terms of tax, EI, and CPP deductions.

Visit the Ministry of Labour website for more information on vacation pay in Ontario, or find a comparable government resource for your location.

How do I calculate vacation pay for my staff?

There are 2 methods to calculate vacation pay: you can include vacation pay in each paycheque, or your can pay it out in a lump sum when employees take their holiday (or when their contract ends). For our examples, let’s assume an employee receiving the Employment Standards Act minimum of 2 paid weeks per year worked, or 4% of earnings.

Method 1 – Pay with each cheque:

Vacation pay can be rolled into regular pay, so the employee receives it as they earn it. This means that the employee has to do their own saving-up for time off. This method is often used for part-timers, temporary and hourly-paid staff.

Example: An employee earns $1,000.00 per pay cheque. The employee has vacation paid on each cheque, therefore s/he receives $1,000.00 in pay + 4% ($40.00) for a total of $1,040.00 of gross pay each pay period

Method 2A – Pay with holiday – Salary:

Salaried employees get “paid vacation”, which means they receive their normal salary without interruption even when on vacation. There is no change in the rate or frequency of their pay; they just get paid time off. In the payroll records, 4% vacation pay is accrued each week. That is, the employer sets aside the vacation pay amount as money owing to the employee for their holiday. Since the process is seamless for both the employer and the employee, the accrual process may be omitted: if the employee gets their regular pay, the requirements have been fulfilled!

Method 2B – Pay with holiday – Non-Salary:

Part-time, casual and hourly-paid staff often have an irregular stream of earnings. From the employer’s viewpoint, the accounting is the same: you accrue 4% of each week’s earnings, setting it aside as an amount owed to the employee. However, when the employee takes time off, their vacation payout will not correspond to a normal paycheque — so from their point of view vacation pay is a lump sum.

Example: The employee is about to take her/his annual vacation, and no vacation pay has yet been paid. Therefore, the employer bases vacation pay on the employee’s total gross pay since the last time s/he took vacation. In this case, the employee has earned $13,978.65 in gross earnings since his or her last vacation. 4% of those gross earnings warrants vacation pay of $559.15.

Visit the Ontario Ministry of Labour website (or a comparable website for your area) for more information on vacation pay.

We were audited by the Canada Revenue Agency but we don’t understand or agree with the outcome. What recourse do we have?

The results of your audit should be contained in a formal letter from the Canada Revenue Agency (CRA). It should advise you on the procedure for filing an appeal: the contact information, the time limit by which you must file, and the required documentation. Or, you can contact the CRA’s Business Window at 1-800-959-5525 for assistance.

If you’re in doubt about the findings of the audit, consider this. If you file an appeal, you can always withdraw it – but if you don’t file by the expiry of the time limit, you will be considered to have accepted the audit results.

This is a great example of a case where you should seek expert professional advice on your particular situation. Many accounting and legal practices have tax experts on staff, or can evaluate whether you would benefit from discussing a tax appeal with a specialist.

When it comes to my financial statements, what is “real”?

This question came from the Executive Director of a small organization – and she asked it repeatedly, with a great deal of very genuine concern! The issue, it seems – and this is a common concern for non-financial folks – was understanding the nature of accrual accounting.

“Real,” in her terms, meant that money had changed hands. Even in the days of electronic transfers, cash in the bank still feels indisputably legit and tangible! However, non-cash transactions can be just as “real” as those involving money. For example, they may record agreements or management estimates that provide the basis for measuring financial results.

Accounts receivable and grants receivable are amounts owed to you by clients/customers and funders. A state of obligation exists when you have delivered work, and the promised payment is due. This state of obligation felt real to the Executive Director, because she was well aware of the costs her organization had incurred, and the urgency of collecting the receivable amounts.

By the same token, accounts payable were not questioned: the state of obligation between the organization and its suppliers was evident, because the organization had received goods or services for which it hadn’t yet paid, and the invoices were sitting in the “bills to be paid” file.

Prepaid expenses and deferred revenues posed a challenge. In both of these cases, money actually has changed hands – but those transactions are not recorded on the income statement as expenses and revenues; rather, they are recorded on the balance sheet as assets and liabilities (respectively). Eventually, when the obligations are satisfied, these items will be recognized as expenses and revenues. Read on…

A prepaid expense item is an asset – something you own. It arises when you have paid for goods or services ahead of time. A classic example would be a rent deposit. Often, when a lease is signed, the lessee must pay “first and last.” Obviously, you receive the first month of your tenancy right away. However, you have paid up-front for the last month on your lease, and you won’t receive that service for a period of years. You own the right to receive it, because you have prepaid it… and the landlord is effectively in your debt for that month of occupancy.

When the last month rolls around, the landlord provides the month of occupancy. At that point, the organization no longer has an asset, because it has collected on the obligation. In the accounting records, the asset must be removed – and the rent expense can be officially recognized. Note that the last month’s rent eventually does appear as an expense, but not until it’s being used. In that last month, it’s a non-cash expense item; the cash changed hands back when the lease was signed.

A deferred revenue item is a liability – something you owe. It arises when someone else has prepaid you for goods or services that you have not yet delivered. A classic example from the performing arts is a subscription. Many organizations run intensive campaigns during the spring and summer to sell subscription packages for the next fall/winter series of shows. At the point when the subscriber pays, they have a promise from the organization, but they won’t enjoy the concerts or plays for months down the road. The organization owes the subscriber those shows.

When the organization delivers its performances, it discharges its liability. In the accounting records, the liability must be removed – and the ticket sales revenue can be officially recognized. Thus, eventually those subscription packages do turn into revenue, but as a non-cash revenue item; the cash changed hands back when the subscriber made the purchase.

The depreciation of capital assets can also cause confusion. A capital asset is an item of significant value that an organization will own for a period longer than a year, and use in carrying out its operations. Depreciation (or amortization) is the process by which the cost of that asset is spread over the years of ownership. Elsewhere in the FAQ section are questions and answers that present the process in detail.

For our purposes here, the important thing to understand is that the asset (usually) must be paid for when it is bought. Each year’s depreciation is a non-cash expense item, representing that year’s estimated share of the cost.

One of the purposes of accounting is to measure the expenses and revenues associated with each year of operations, regardless of when money changes hands. As you can see, items may be paid for either before delivery or afterwards. The exchange of cash does not create the revenue or expense: rather, the usage of the goods or services in the course of operations. Balance sheet accounts are used to “park” or accrue items so that they can be properly recognized in the correct operating year. Non-cash revenues and expenses can be just as real as those paid “cash on the barrel head.”

I received a grant to help with my capital asset purchases. My bookkeeper says this is a liability. How does this make sense?

Your bookkeeper is correct. But, before you try to come to grips with the treatment of the capital grant, it will help if you review the depreciation of capital assets, explained in this FAQ.

Donations to a capital campaign (e.g. from individuals and businesses) are treated in the same way as grants (e.g. from foundations and governments).

Your funders and donors have provided money that is intended to benefit your organization over the life of the capital purchases. In the same way that the cost of a capital asset is spread over the years of ownership, the benefits of a capital grant must be spread over the same years, using the same technique.

A typical name for this item is “Deferred Contributions for Capital Assets,” and it appears with other deferred revenues in the liability section of the balance sheet.

You should discuss your organization’s capital policies with your accountant, to make sure they are appropriate to your particular situation.

Does an audit mean that my statements are correct?

Auditors are engaged to express an opinion on the quality of your financial statements. A typical positive audit opinion will say that your statements present your financial position “fairly, in all material respects.”

This isn’t the same as being free from error!

Straight from the CICA Handbook (Canadian Institute of Chartered Accountants): “An item of information, or an aggregate of items, is material if it is probable that its omission or misstatement would influence or change a decision.”

As part of their audit, your accountant makes a determination on what amount is material for your organization. They assess any errors they identify relative to this materiality threshold. Thus, they may pass small errors without making corrections.

This would be a good point to discuss with your auditor, so that you understand their process around addressing any bookkeeping errors they find.

How can I know for sure what’s in the bank? The bank statement isn’t the same as my books…

It’s typical for the bank statement to show a different month-end balance from your general ledger.

Now that online access to banking records is so prevalent, it’s easier to keep track of the differences. However, they still exist, and you need to understand why.

For one thing, you need to pick up bank charges and any interest earned. For another, there may be errors to deal with – yours or the bank’s – which must be identified and corrected by comparing the two sets of records. Finally – and most significantly – there are timing differences between when you initiate a transaction and when the bank sees it.

Your books record payments and deposits in the order in which you issue them. The bank’s records will also contain these amounts – but in the order in which they were presented at the bank. That might be quite a different thing!

Let’s say you issued a batch of cheques dated on the 25th of the month. Getting them signed and into the mail took a couple of days. Some payees may have received and banked their cheques before the 30th, but others won’t cash them till the new month. As far as your books are concerned, these cheques are all current month items – but from the bank’s point of view, some belong to this month and some to next.

Therefore, at the end of this month, the bank will have a higher balance than your books, because the bank doesn’t know what cheques may be in transit.

As this example demonstrates, it’s very important for you to keep your bookkeeping up to date, and use your balance rather than the bank’s. Once you’ve issued a payment, you need to assume the money is gone, even if it hasn’t cleared from your account. You don’t want to try spending the same money twice!

The same problem can happen with other transactions. The deposit you made at the ATM on Friday may not be processed by the bank until Monday. The online purchase you made, or the online donation that a supporter made from their home may be logged on your system today, but may not arrive in the bank’s records until tomorrow.

The tool that you need to understand is the bank reconciliation. It is the document that proves your bookkeeper has compared your general ledger to the bank statement, and identified all problems and timing differences to the penny. If you put your general ledger at your right hand, the bank statement at your left hand, and the bank rec document in the middle, you should be able to see your balance, the bank’s balance, and an itemized explanation of any differences.

How can I tell whether my accounting reports are correct?

This can be a perplexing question when you’re relying on the services of bookkeepers and accountants, but you don’t entirely understand what they do.

Here are a few ideas that may help:

Revenue and expense allocations are pretty much up to you, the manager. Do you want a single expense account for Salaries? That’s entirely correct. Would you prefer to have a separate expense account for each salaried position? That’s also correct. Do you want one account for Office Overhead? Not a problem. Would you prefer to have a series of accounts to distinguish amongst various supplies, phone, insurance, etc.? Also entirely acceptable.

Management (perhaps with input as appropriate from your Treasurer, Boardaccountantbookkeeper, staff) needs to decide what level of detail works best for your organization’s situation. Once you’ve established a set of revenue and expense accounts, it’s important to confirm on a regular basis that transactions are being allocated to the right place. Many accounting software packages provide detailed reports that allow you quite easily to scan the contents of these accounts for misplaced items.

Your cash resources – contained in your bank and investment accounts – are the lifeblood of your organization. It’s important to know how much money is readily available to your day to day operations. See our FAQ on how to tell for sure what’s in the bank.

Knowing who owes you money, how much, and since when, is very important. Most accounting software will produce a “customer aging” report that contains this information. (See the glossary for a definition.)

In the same way, you need to be able to review your list of payables, itemizing the suppliers to whom you owe money, how much and since when. On most software, a “vendor aging” report provides this detail.

Beyond that, if your bookkeeper is on their game, they will be able to provide an explanation of the contents of each account, and to pull out documentation from the files that substantiates the amounts. If your organization is audited, your chartered accountant will also be able to provide these explanations, as at your fiscal year-end. If these folks can’t provide a satisfying explanation, you need to challenge them! They should be able to help you understand your accounts, and justify that each balance is properly stated.

I discarded my capital asset before it was fully depreciated. Now what?

When you purchase a capital asset, you need to estimate what its useful life will be. The key word, here, is estimate. You don’t know at the outset what will happen… what will turn out to be a lemon, what will break, or what will (amazingly) last years longer than you anticipated. You also don’t know what advances will come along, that may make it more economical to replace something early than to use it ‘till it wears out.

If you discard something earlier than expected, then the year of disposal must take all remaining undepreciated cost.

This makes sense: the mechanism of depreciation is intended to spread the cost of an asset fairly over the years of ownership. If you dispose of an item early, then your accounting records must show that the asset is gone. The only way to do this is to take the expense.

Managing the journal entries around discarding capital assets is a good topic of discussion with your accountant. You need to follow your organization’s accounting policies, and make sure you’re recognizing the expense correctly.

I’m still using a capital asset that has been fully depreciated. Is this ok?

That’s good news!

Capitalizing and depreciating (or amortizing) major purchases allows you to spread out expense over estimated useful life. When you buy a new asset, you have no way of knowing how it will perform. You might find yourself discarding some purchases early – and you might own others for longer than you had expected.

If you wind up using your asset after it has been fully depreciated, then those extra years of useful life get a “free ride,” from the viewpoint of expense.

Remember, the function of depreciation is to spread the purchase price over an estimated time span. Once the original cost has been fully expensed, that’s it!

It’s important to make sure that you are depreciating your capital assets over a reasonable time frame. Be sure to discuss capitalization and depreciation policies with your accountant, to confirm that you’re following methods that work for your organization and its belongings.

I know that my capital assets are worth more (or less) than my financial statements show. What’s with that?

Accounting does not attempt to reflect the market value of your assets. Your accounting statements reflect the cost of purchase.

The process of capitalizing and depreciating (or amortizing) major purchases allows the cost to be shared over the years of useful life. You can see other FAQs on aspects of this process:

It’s also true that the capital assets on your balance sheet indicate the investment your organization has made into significant purchases that support and enable your operations. It’s important to declare that you’ve purchased sufficient equipment to allow staff to carry out their work, and that you own a building, or have invested in renovations to improve the property that you lease.

Indeed, in the commercial world (not so much in the not-for-profit) companies calculate “return on assets” as a measurement of their productivity and success.

However, consider how hard it would be to show market (or resale) value.

You may just have bought a nice, state of the art computer for $1500 – but the moment you take it out of the box, it’s used equipment. You may not even have plugged it in – but you couldn’t expect to get $1500 if you tried to resell it. After you’ve used it for a year, how much would it be worth as a second-hand machine? And yet, as far as your organization is concerned, it’s still a useful and functional item in the office.

If that’s the case with equipment, which wears out and becomes obsolete, you can imagine that dealing with real estate – where market values can float up and down over time – would be much more complex.

To create meaningful financial statements, it’s essential to have a constant unit of measurement. Generally Accepted Accounting Principles (GAAP) recognize this through the Stable Dollar Concept, which assumes that the purchasing power of a dollar remains unchanged over time. This allows us to make reasonable comparisons between fiscal years.

That said, there are circumstances where it is permissible to “write up” or “write down” an asset to reflect a permanent change in its value. Your accountant can advise whether this pertains to your organization.

I just bought a computer. Why doesn’t it show up as an expense?

Of course, major purchases such as equipment most definitely are major costs to your organization! The short story is that it does show up as an expense. The longer story involves explaining how that happens.

Accounting makes a distinction between day-to-day operational costs – treated as expenses – and major purchases – treated as capital assets.

Anything treated as an expense is of minor value, and is generally consumed within a year. By contrast, capital assets (also known as fixed assets) cost a significant amount of money, last longer than a year, and are instrumental in carrying out your daily operations.

Buildings and equipment are the most typical examples. Major renovations (as opposed to maintenance work) are also treated as capital assets. Computer software and websites may also be capitalized, depending on their scope.

When an item is capitalized, the purchase cost is recorded in the assets section of the balance sheet. It moves gradually into the expense stream over a period of years, through the mechanism of depreciation (also known as amortization).

A key aspect of managing capital assets is estimating their useful life. Computers and other office equipment are often estimated to last five years. Vehicles are often depreciated over five years, office furniture and fixtures over seven years, and buildings over 40 years. These may be common periods, but you and your accountant need to discuss what makes sense for your organization and its belongings.

Once you’ve estimated useful life, you and your accountant need to select a method of depreciation. The simplest – and one that is commonly used in the not-for-profit sector – is straight-line depreciation.

If you estimate that you’re going to get five years out of your computer before you need to replace it, you divide the purchase cost by five. This year, you will see one-fifth of the cost of the computer in your expenses – and the same over the next four years.

Why is it done this way? An intuitive way to grab hold of the accounting theory might be to imagine it as a question of fairness. It wouldn’t be fair to charge this year’s bottom line with the full burden of a five-year purchase. Nor would it be fair to give the next four years a “free ride” in terms of computer cost. Depreciation allows the price of the computer to be spread fairly over the years of ownership.