1. Determine the guiding accounting rule that helps ascertain which costs are capitalized in connection with property and equipment and which are expensed.
2. List the variables that impact the amount of depreciation to be expensed each period.
3. Recognize that the straight-line method predominates in practice but any system that provides a rational approach can be used to create a pattern for depreciation.
Question: Businesses hold numerous types of assets, such as receivables, inventory, cash, investments, and
patents. Proper classification is important for the clarity of the reported information. What requirements must be
met for an asset to be classified as part of a business’s property and equipment?
Answer: To be included within the property and equipment category, an asset must first have tangible physical
substance and be expected to be used for longer than a single year. Furthermore, it must serve to generate revenues
within the normal operating activities of the business. It cannot be held for immediate resale, like inventory.
A building used as a warehouse and machinery operated in the production of inventory both meet these
characteristics. Other examples include computers, furniture, fixtures, and equipment. Conversely, land acquired
as a future plant site and a building held for speculative purposes are both classified with investments (or, possibly,
“other assets”) on the owner’s balance sheet rather than as property and equipment. Neither is used at the current
time to help generate operating revenues.
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