Every well-controlled company has an asset capitalization threshold (ACT) that should be consistently applied. The ACT is the dollar value at which an acquired asset is capitalized rather than expensed. Pretty basic, right?
However, there is no FASB or IFRS guidance or disclosure requirement regarding this practice, which raises a concern for finance executives, investment and credit analysts, and the broader business community. That is, companies within the same industry may have very different ACTs, and since a lower ACT results in higher reported net income (and vice versa), this variability reduces the companies’ financial comparability.
In addition, a company trying to hit a net income target in a particular period could simply lower its ACT to help it achieve the goal — which would thereby reduce the period-to-period comparability of its own net income. Also troubling from a consistency standpoint is that a company may make one-off exceptions to its ACT policy.
This is an under-researched area, lending interest to a recent survey of 39 finance executives I conducted at a recent CFO Rising conference hosted by CFO. The key findings were eye-opening:
Many observers would agree that over the last 20 years, there has been a perception that our financial accounting standard setters have imposed a great deal of costly, complex, and abstruse financial reporting requirements that generally reduce the understandability of financial statements, cloud coherency, and make financials less transparent. So, ordinarily I would be concerned about recommending that an additional disclosure burden be placed on the preparer community.
But I do recommend that public companies should be required to disclose their ACT in a financial statement note. That, in contrast to many recent requirements, could be executed at a small incremental cost.
The benefits of this new disclosure could be significant. It could:
Comments by finance executives at the CFO conference suggest there is a troubling morass of inconsistency and lack of transparency around ACT. Some representative examples:
Get Into the ACT Now!
Such comments suggest that ACT research needs to be extended to a larger sample to better understand this significant accounting and reporting issue from a variety of standpoints.
You are invited to participate in a brief (less than five minutes to complete) ACT survey. All responses will be kept in strict confidence and only summary data will be published. In consideration, you will receive a copy of our latest ACT benchmarking study.
Jonathan Schiff is a professor of accounting at Fairleigh Dickinson University and an advisor to large global organizations. He can be reached at [email protected]
This article is based on a much longer one, “Asset Capitalization Thresholds: Is Diversity a Good Thing?” that appears in the July 2015 issue of Strategic Finance magazine.