Asset capitalization thresholds should be disclosed

Asset capitalization thresholds should be disclosed

Inconsistencies in ACT from company to company, and even within companies, cloud net-income reporting, an accounting expert says.

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:

  • The ACT range in the sample was $100 to $20,000.
  • The ACT range for a subset (two-thirds of the sample) of large companies (at least $1 billion in revenue) was $500 to $20,000.
  • There wasn’t a strong positive relationship between ACT and company size, private vs. public company, or industry group.
  • The most common ACT reported was $5,000.
  • More than 25% of survey respondents indicated that they were currently planning to revisit and reconsider their ACT.

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:

  1. Enhance confidence in net income reporting among financial analysts and more broadly to their clients in capital markets.
  2. Result in improved business decisions by delivering a more reliable assessment of the financial health of customers, suppliers, and strategic partners.
  3. Reduce internal control risk, particularly for companies with a significant global footprint, as far-flung business units may take liberties with respect to period-to-period ACT consistency.
  4. Be understood and appreciated as a new manifestation of U.S. leadership in increasing the understandability, quality, and clarity of operating performance reporting. It could go a long way toward improving our image, reputation, and public perception.

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:

  • “Each of our divisions has its own ACT policy.”
  • “Our auditors would have to be lucky to find ACT exceptions.”
  • “Exceptions to our ACT policy read like War and Peace.”
  • “We have one ACT for IT purchases and another for other assets.”

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.

 Source: CFO – By Jonathan Schiff

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