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Classifying Assets as Capital or Operating

What's the General Principle of Classifying Assets as either Capital or Operating? Also, the exceptions thereto.

Cite what section of FASB and GAAP.

Solution Preview

Hi there,

The general distinction between classifying something as an asset as capital or operating is important. In general, if something is going to provide ongoing use, such as the purchase of machinery, it should be classified as capital and placed on the balance sheet. Something that provides more of a short term need, would be considered as operating and would be expensed on the income statement.

The most common issue revolves around the treatment of leases and whether or not they should be recorded as a capital or operating lease.

Section of FASB:
The Financial Accounting Standards Board (FASB) established principles for lease accounting in its Statement 13, Accounting for Leases, and its numerous amendments. These statements specify the appropriate accounting for leases through their classification as either capital or operating. Governmental Accounting Standards Board (GASB) codification provides that FASB 13 should be the guidelines for accounting and financial reporting for lease agreements, except for operating leases with scheduled rent increases.

Section of GAAP:
GASB 34 Paragraphs 116, 119 GASB 38 Paragraph 11

Here is some additional detailed information about the difference between an operating and a capital lease for your reference:

Classification of Leases by Lessees - Overview

A lease is a financing transaction called a capital lease if it meets any one of four specified criteria; if not, it is an operating lease. Capital leases are treated as the acquisition of assets and the incurrence of obligations by the lessee. Operating leases are treated as current operating ...

Solution Summary

In general, if something is going to provide ongoing use, such as the purchase of machinery, it should be classified as capital and placed on the balance sheet. Something that provides more of a short term need, would be considered as operating and would be expensed on the income statement.

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