Explicit instruction: capitalization rules, useful life, salvage value, and depreciable base with worked examples.
When Does a Cost Become an Asset?
There is a clear rule for deciding whether a purchase is an asset or an expense. Once you learn it, every purchase becomes straightforward.
A purchase should be capitalized (recorded as an asset) when it meets both of these conditions:
Condition 1: Lasts More Than 1 Year
The asset will provide economic value to the business for multiple accounting periods. Example: A delivery van lasts 5-8 years.
Condition 2: Significant Cost
The cost is large enough that it matters to track separately. Example: $3,500 for a scooter is significant; $15 for a stapler is not.
If both conditions are YES → Capitalize (record as an asset, depreciate over time).
If either condition is NO → Expense (record as a cost in the current period).
Once you decide to capitalize a purchase, you need three numbers to track it properly:
1. Cost
What you paid, including delivery and installation.
Example: $15,000 for the 3D printer.
2. Useful Life
How many years the asset will provide value.
Example: 7 years for the printer.
3. Salvage Value
What you expect to sell it for at the end.
Example: $2,000 for the printer.
Not all of an asset's cost gets depreciated. You only depreciate the portion that will be "used up" — the cost minus what you expect to get back at the end.
Depreciable Base = Cost - Salvage Value
Example: Sarah's 3D Printer
Cost = $15,000
Salvage Value = $2,000
Depreciable Base = $15,000 - $2,000 = $13,000
This means $13,000 of the printer's cost will be spread across its 7-year useful life as depreciation expense. The remaining $2,000 is recovered when the printer is sold.
Each year, a portion of the depreciable base moves from the asset to depreciation expense. The total of all depreciation recorded so far is called accumulated depreciation.
Sarah's 3D Printer — Year by Year (Straight-Line Preview)
| Year | Annual Depreciation | Accumulated Depreciation | Book Value |
|---|---|---|---|
| Start | — | $0 | $15,000 |
| Year 1 | $1,857 | $1,857 | $13,143 |
| Year 2 | $1,857 | $3,714 | $11,286 |
| Year 3 | $1,857 | $5,571 | $9,429 |
| Year 7 | $1,857 | $13,000 | $2,000 |
Note: $13,000 ÷ 7 years = $1,857 per year (rounded). Book value at the end equals the salvage value. In Lesson 03 you will learn the straight-line method that produces this schedule.
Let's walk through the full process for Sarah's $3,500 delivery scooter.
Step 1: Classify — Capitalize or Expense?
Does it last more than 1 year? Yes — about 5 years. Is the cost significant? Yes — $3,500. → Capitalize as an asset.
Step 2: Identify the Three Numbers
Cost = $3,500. Useful Life = 5 years. Salvage Value = $500.
Step 3: Calculate the Depreciable Base
Depreciable Base = $3,500 - $500 = $3,000
This $3,000 will be spread across 5 years as depreciation expense. The scooter's book value will decrease from $3,500 to $500 over those 5 years.
Now you know the rules. In the next phase, you will practice classifying mixed purchases and calculating depreciable bases with less guidance. You will need to explain your reasoning, not just pick an answer.