What is a Capital Asset?
For firms, a capital asset is an asset that has a useful life longer than one year and is not intended for sale during the normal course of business.
For individuals, capital asset typically refers to anything the individual owns for personal or investment purposes. This excludes property held for sale in the normal course of business, money received or about to be received from the sale of that property, depreciable personal property used for business (such as rental property), protected creative works (such as copyrights on a book), and government publications purchased or received for free from the government.
How Does a Capital Asset Work?
Capital assets usually include buildings, land, and major equipment. For example, Company XYZ might own a factory building on three acres of land, and the factory might be full of expensive equipment. The building, the land, and the equipment are all usually considered capital assets. Construction in progress, trademarks, patents, copyrights, vehicles, intellectual property, and art can also count.
Capital assets are recorded on the balance sheet at their historical cost, less any accumulated depreciation (or amortization in the case of intangible assets). So if Company XYZ paid $100,000 for a piece of equipment in the factory, it would record it as a $100,000 asset on its balance sheet.
But as the asset ages and loses value, Company XYZ would increase the amount of accumulated depreciation associated with the equipment, so that the equipment's net book value reflects its reduced value.
Why Does a Capital Asset Matter?
Companies have some leeway in deciding what to count as a capital asset. A $10 stapler, for example, has a useful life of more than one year, but because it is of such little monetary value, it is often administratively easier to expense the stapler (that is, to reflect its cost as an expense on the income statement) than to have the accounting staff set up a depreciation schedule for the stapler. Thus, many companies create written capital asset policies that dictate what assets must be capitalized and include a minimum threshold of purchase price.
It is also important to note that the Financial Accounting Standards Board (FASB) and the IRS both have some influence over the limits of the useful lives of capital assets. They do this to prevent companies from assigning their capital assets extremely long useful lives in order to record tiny depreciation expenses (and thus inflate profits).