Yes, you can capitalise project management costs if they directly relate to creating a capital asset and meet specific accounting criteria.
Figuring out where to put project expenses can feel complex, especially when it comes to project management costs. Often, businesses wonder, can you capitalise project management costs? The answer isn’t always a straight yes or no, as it depends on specific circumstances.
Capitalising project management costs means treating them as an asset rather than an expense. We will explore the conditions and accounting principles guiding this decision. Understanding these rules can help you make informed financial choices for your projects.
Can You Capitalize Project Management Costs?
Let’s dive into the world of project finances. When you’re working on a big project, lots of money is spent. Some of that money is for things like materials and equipment, and that’s pretty straightforward. But what about the money spent on managing the project itself? Can you capitalize those project management costs, or do they always have to be expensed? That’s a very important question, and the answer isn’t always black and white. Understanding this can have a big effect on your company’s financial statements and its bottom line. This article will help you understand the ins and outs of capitalizing project management costs.
Understanding Capitalization vs. Expensing
Before we talk specifically about project management costs, let’s make sure we’re clear on the basic difference between capitalizing and expensing. These are two different ways of treating costs for accounting purposes. Think of it like this:
Expensing Costs
Expensing a cost means you record it on your income statement in the period you incurred it. It reduces your company’s profit for that period. It’s like buying groceries – you pay for them, and that’s that. Their value is consumed or used up in a short amount of time.
- Costs are recorded immediately.
- Reduces profits in the current period.
- Typically used for short-term benefits.
- Examples include salaries of employees performing day to day activities, office supplies and rent.
Capitalizing Costs
Capitalizing a cost means you record it as an asset on your balance sheet. It’s like buying a building. The building provides value over a longer period of time. You don’t deduct the entire cost at once, instead, you depreciate the value (or use amortization in the case of intangibles) of the asset over its useful life. This spreads the expense out over time.
- Costs are recorded as assets.
- Impacts profits over a longer period.
- Used for long-term benefits.
- Examples include buildings, equipment, and software.
The key idea here is about the benefit period. If a cost gives you a benefit only this year, you expense it. If it gives you benefit for several years, you may be able to capitalize it.
What Are Project Management Costs?
Now, let’s get specific about project management. These are all the costs directly related to managing a project from start to finish. These expenses go beyond just the costs of the physical things needed to get the job done. These costs might include:
- Project Manager Salaries: The wages paid to project managers overseeing the work.
- Project Team Salaries: Payments to individuals dedicated to the project. This could include project coordinators, analysts, or other team members directly working on the project.
- Project Management Software: Costs of project scheduling, collaboration, and other project-specific software.
- Project Training: Expenses related to training specifically for the project.
- Travel Expenses: Cost for travel directly related to project needs such as site visits, or team meetings in other locations.
- Consulting Fees: Payments made to external experts or consultants specifically related to the project’s management.
- Communication Costs: Spending on communication tools directly linked to the project.
- Project Documentation: Cost for preparation of necessary reports.
It’s worth noting that these costs can fluctuate widely depending on the nature of the project.
The Crucial Question: Can These Costs Be Capitalized?
This is where it gets interesting. The answer to whether you can capitalize project management costs isn’t a simple “yes” or “no”. It largely depends on the type of project, and whether the project creates a new asset. It often depends on accounting standards like GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards), and the specific situation of the project.
In general, you can capitalize project management costs when:
- The project creates a new asset that will provide benefits for multiple years.
- The costs are directly related to the creation of that asset.
- The costs are incremental and would not have happened if the project wasn’t undertaken.
Think of it like building a new factory. The building itself is a long term asset and the project management costs directly tied to that construction might get capitalized.
However, you typically can’t capitalize project management costs when:
- The project is for regular operational expenses or maintenance.
- The project doesn’t create a new asset.
- The project costs are considered to be general or administrative in nature.
For example, if you are implementing a new business process or upgrading computer system that is for day to day operations then you likely will not capitalize those project management costs.
Types of Projects Where Capitalization Is More Likely
There are certain types of projects where it’s much more common to capitalize project management costs. Let’s look at a few:
Construction Projects
If you’re building a new building, factory, or bridge, many of the costs, including project management, can be capitalized. These costs get rolled into the value of the new asset you’re creating. Think of project manager salaries, permits, construction management software, etc. as all costs that are directly linked to creating the building.
Software Development
Developing new software can be expensive, and the project management costs associated with this development are frequently capitalized. This includes salaries, cost of specific software, testing costs, and other expenditures directly linked to the development process, as long as the software will be used for more than one year. Remember that the software should be developed for use internally, or for sale to another party.
Research and Development (R&D)
Some R&D projects that will result in a new product or process can justify the capitalization of project management costs. This is especially true when the result of R&D is a new patent, a new design, or a product. However, it’s important to differentiate between research activities which are usually expensed and development activities that can be capitalized.
Major Equipment Purchases
When you purchase large, complex equipment, there may be significant project management costs associated with its implementation, testing, and integration. These might be added to the cost of the equipment itself. The idea here is that those project management costs are needed to bring the asset to its intended place and to be used as it was designed.
Types of Projects Where Capitalization Is Less Likely
On the flip side, some projects usually can’t justify capitalizing project management costs. Here are some common examples:
Business Process Improvement Projects
If you’re working on improving existing business processes or systems, project management costs are generally expensed. These projects don’t typically create a tangible asset that you can depreciate. They improve efficiency but do not result in the creation of something you can sell or something you can use for a long time.
Maintenance Projects
Any project aimed at maintaining current assets, not creating new ones, will have associated project management costs which are generally expensed. These costs are related to keeping the asset in good working condition, not creating a new one.
Short-Term Projects
If the project is a short term project and is designed to improve operations for a short period, the costs are more than likely to be expensed immediately. An example could be a 3 month initiative to get ready for tax season.
Feasibility Studies
Costs associated with conducting studies to determine the feasibility of a project are likely to be expensed. These costs are related to evaluating the opportunity, not creating an asset. Although feasibility studies can be used to make decisions about starting projects, the studies do not create assets in and of themselves.
Factors to Consider When Deciding to Capitalize
Figuring out if you should capitalize or expense project management costs can be tricky. Here are key factors to consider:
Nature of the Project
As we’ve already discussed, the type of project plays the biggest role. Is it creating a new, long-term asset? Or is it more of an operational or maintenance project?
Direct Relationship to Asset Creation
The costs you plan to capitalize must be directly tied to the creation of the asset. You need to show that the specific project management costs would not have been incurred if the asset was not being developed. Make sure there is no doubt that a direct connection exists between the expenses and the new asset.
Benefit Period
If the project costs are expected to benefit the company for more than one year, capitalization is more likely to be acceptable. It is more difficult to justify capitalization if the costs will only have a short term impact on the company.
Consistency
Be consistent in how you treat these costs for similar projects. If you capitalize costs for a construction project in one year, you should do the same for a similar project in a subsequent year. Consistency in accounting is very important.
Materiality
Consider whether the costs are significant enough to justify capitalizing. Small, immaterial project management costs can be expensed even if you might otherwise capitalize. If the impact on the financial statements is insignificant it is not necessary to go to the trouble to capitalize a small expense.
Accounting Standards
Follow relevant accounting standards, such as GAAP or IFRS. These standards provide guidelines and rules about when to capitalize costs.
Document Everything
It’s very important to keep detailed records of all project costs, including project management. This documentation will help justify your treatment of these costs. This will also make the auditor happy and help the company in the event of an IRS audit.
The Impact on Financial Statements
The choice between capitalizing and expensing project management costs can significantly impact your company’s financial statements. Here’s how:
Income Statement
Expensing costs reduces your profit in the current period. Capitalizing costs spreads the expense over several years through depreciation or amortization, resulting in a lower impact on profits in the first year.
Balance Sheet
When you capitalize, the costs become an asset on your balance sheet. This increases your assets.
Profitability
Capitalizing project management costs can improve profitability in the short term, because costs are not immediately deducted. However, this also means reduced profits in future years as depreciation or amortization occurs. Conversely, expensing will immediately impact profits in the year incurred, but not in subsequent years.
Financial Ratios
The decision can also affect financial ratios such as return on assets (ROA) and debt-to-equity. Capitalization may improve these ratios initially, while expensing may show a lower return on assets in the short run.
Best Practices for Handling Project Management Costs
Here are some practical tips for handling project management costs:
- Develop a clear capitalization policy: Have a set of guidelines on when to capitalize costs. These should be consistent and clear, and in compliance with applicable accounting standards.
- Maintain meticulous records: Keep very accurate records of all costs and activities. Make sure that all costs are appropriately categorized.
- Consult with accounting professionals: When in doubt, consult with an experienced accountant to determine the correct approach.
- Review regularly: Ensure the capitalization policy is reviewed and updated if accounting standards change, or when new types of projects are started.
In short, the decision to capitalize or expense project management costs is not a straightforward one. It demands a detailed understanding of the project, accounting principles, and the potential effect on your company’s financial picture.
Choosing to capitalize project management costs can provide significant benefits to your financial situation by deferring recognition of costs until the benefit has occurred. However, this is only appropriate when a specific set of criteria have been met.
Ultimately, whether or not you should capitalize project management costs really depends on the details of your specific project. It’s not a black and white decision, and it’s important to carefully assess each situation, document your decisions thoroughly, and follow all applicable accounting rules and guidelines.
The Difference Between Expensing & Capitalization : Marketing & Finance
Final Thoughts
Capitalizing project management costs depends on specific accounting rules and project nature. If these costs directly relate to creating a capital asset, capitalization may be appropriate. Always follow established accounting standards for accurate financial reporting.
Therefore, before proceeding, carefully review your project details and accounting regulations. Determining if you can you capitalise project management costs correctly impacts your financial statements. Incorrect capitalization can lead to errors.