Can You Capitalize Project Management Costs

Can You Capitalize Project Management Costs?

So, you’re working on a big project, and it’s costing money – a lot of money! Besides all the materials and the workers, there are project management costs too. These are the expenses for planning, organizing, and keeping the project on track. Now, you might wonder, “Can I count these costs as part of the project’s value, or do I have to expense them right away?” This is the question of capitalizing project management costs, and it’s a crucial one for your business’s financial health.

Understanding Capitalization: The Basics

Let’s start with what it means to “capitalize” something. When you capitalize a cost, you’re not recording it as an immediate expense. Instead, you’re adding it to the value of an asset on your balance sheet. Think of it like this: if you buy a new piece of equipment for your business, you don’t just write it off as an expense right away. Instead, you list it as an asset, and then you slowly recognize its cost as an expense over time, as it wears down or gets used up, this process is called depreciation. This reflects the fact that the equipment provides a benefit to your business for several years, not just in the year you bought it. The same principle can apply to certain project management costs.

What is an Asset?

An asset is something that your business owns that has value. This could be equipment, a building, or even something intangible like a patent or the software created from a project. When you capitalize a cost, you’re essentially saying that this cost has contributed to the creation or improvement of an asset.

Project Management Costs: What Are They?

Before we go any further, let’s understand which expenses generally fall under project management. These aren’t just the costs of the actual building or software. They are the overhead and people costs that keep the project going smoothly.

• Project Manager Salaries: The pay for the person in charge of the project is a major component.
• Project Team Salaries: Costs related to the project team’s salary and other benefits
• Project Planning Costs: Money spent on the early stages, like feasibility studies or market research
• Project Software: The cost of software that is used to manage the project including subscriptions or licensing fees
• Communication Costs: Expenses for calls, meetings, and other ways the team stays connected.
• Training Costs: Money spent on training employees specifically for the project.
• Travel Costs: This includes flights, hotels, and other expenses for project related travel.
• Consultant fees: If you have hired external experts to help guide the project

When Can You Capitalize Project Management Costs?

Now, here’s the main question: when can you capitalize these costs, and when must you expense them? The answer often depends on the nature of the project and accounting standards that your organization follows. Generally, project management costs can be capitalized when they are directly related to creating a long-term asset, this is to say the expense will benefit the business in a period that extends beyond just one year. Here are a few key points:

Assets being created or improved

This is the most important condition. If the project management activities are directly connected to creating a new asset or substantially improving the function, useful life, or value of an existing one, then it may be eligible for capitalization. This includes things like:

• Building a new factory: If you’re building a new plant, all the project management costs directly related to this construction are generally capitalized as part of the value of the factory.
• Developing new software: If you’re creating a custom software solution for your business, the development phase project management costs are generally added to the value of that software.
• Upgrading existing equipment: If you’re making a major upgrade to existing equipment that increases its productivity or extends its life, the project management cost can be added to the existing asset’s book value

Directly Attributable Costs

The project management costs need to be directly and easily linked to the asset that’s being created. If the same project manager is working on multiple projects, only the portion of their time dedicated to that specific project could be capitalized, if at all. It should be easy to identify the cost to the specific project.

Future Economic Benefit

The asset that results from the project has to be expected to provide future economic benefits to your company. This means the asset will either generate revenue, reduce costs, or otherwise be useful to your business over multiple accounting periods (typically more than one year).

When Can’t You Capitalize Project Management Costs?

Not all project management costs can be capitalized. There are specific situations where these costs should be expensed as they are incurred rather than being added to an asset’s value. Here are the key situations:

Routine Maintenance

If the project is primarily related to maintaining an existing asset, the project management costs should not be capitalized. For example, if you’re simply painting an existing building or doing routine repairs, these project management costs are expensed immediately.

Research and Development (R&D)

Research costs in the R&D phase are generally expensed as incurred. Although there can be cases where development costs, if they meet certain criteria, can be capitalized, but research costs do not generally meet the standards for capitalizing costs.

Feasibility Studies

Costs incurred during the initial planning phases, like feasibility studies, might not lead to a tangible asset. In those situations, it is more common to expense these costs.

General Project Management

Project management costs that are not directly tied to creating an asset are not eligible for capitalization. The project management has to be easily identified with the specific asset. If project management team works on many projects at the same time and they do not keep track of time spent on each project, the cost of project management cannot be capitalized.

Project Failure

If a project fails to result in a usable asset, all related project management costs that had been capitalized usually need to be written off as an expense. It does not have any future value, therefore, its cost cannot be added to any asset.

The Impact of Capitalization on Your Business

Deciding whether to capitalize or expense project management costs has a significant impact on your business’s financial statements. Here’s a simplified overview of how this decision can impact your finances:

• Net Income: Capitalizing costs means lower expenses in the current period, which can lead to higher reported net income in the current period. Expensing costs means higher expenses, which means a lower net income in the current period.
• Balance Sheet: If you capitalize costs, you’ll see an increase in the value of assets on your balance sheet. If you expense costs, the balance sheet is not affected as the amount is recorded as an expense in the profit & loss (income) statement.
• Future Expenses: When you capitalize costs, you will eventually record them as an expense through depreciation or amortization over the asset’s useful life, therefore impacting the net income in future accounting periods. Expensing a cost impacts the net income just in the current accounting period.

How to Determine If Costs Can Be Capitalized

To help you make the best decision about capitalizing project management costs, here are some key steps you can follow:

Step 1: Identify the Project

First, clearly define the project and its objectives. Is the aim to build a new asset, improve an existing one, or conduct routine maintenance? Ask questions like, “What are we trying to achieve with this project? Is the result a tangible asset?”.

Step 2: Track Project Management Costs

You need to meticulously track all project management related expenses. This includes salaries, software costs, communication costs, and so on. Use detailed time sheets and expense reports to make sure you are able to match the costs to the right project.

Step 3: Evaluate Direct Attributability

Determine if the costs are directly linked to the asset being created or improved. This often comes down to whether the project management activity is primarily focused on the specific asset.

Step 4: Assess Future Economic Benefit

Make an assessment if the asset is expected to provide economic benefits over multiple accounting periods. If the asset provides benefit over just one year, or if it doesn’t provide economic benefit at all, it’s likely not eligible for capitalization.

Step 5: Consult Accounting Standards

Refer to the relevant accounting standards and accounting policies followed by your company to ensure the correct treatment of these costs. If you are not sure about the accounting guidelines, consult a qualified accountant or bookkeeper to make sure you apply the accounting standards correctly.

Example Scenarios

Let’s look at a couple of examples to better explain when to capitalize and when to expense. These examples should help you understand the decision-making process.

Example 1: Building a New Warehouse

A company decides to build a new warehouse to increase its storage capacity. All project management costs related to planning, supervising construction, and coordinating the build can be capitalized as part of the warehouse’s cost. The cost would be depreciated over the asset’s useful life. This increases the asset value on the balance sheet while spreading the expense over several years.

Example 2: Routine Software Upgrade

A company performs a routine upgrade to their existing software system to make it work better with new versions of other software. The project management costs are expensed immediately, this does not create or improve the value of an asset, it is more like a maintenance expense.

Example 3: Developing New App

A company is developing a new mobile application from the ground up. The project management costs, as they relate to planning and design of the new app, are all capitalized as part of the development costs of the new mobile application. The cost would be amortized over the asset’s useful life. This increases the asset value on the balance sheet while spreading the expense over several years.

Example 4: Market Research

A company commissions a market research study to assess the feasibility of a new product. The costs for project management are expensed because these are related to research and do not directly result in the creation of a specific asset.

Important Considerations

Consistency

Once you decide whether to capitalize or expense project management costs, it’s critical to be consistent in your application of those accounting policies going forward. Applying capitalization rules inconsistently can lead to misrepresentation of financials.

Documentation

Keep detailed records for each project, including all cost tracking, invoices, and how the project is benefiting the company. This is necessary to demonstrate that you follow the accounting rules correctly, which could be needed for audits.

Impact on Financial Ratios

Capitalizing costs can affect financial ratios, such as return on assets and debt-to-equity ratio. Be aware of these impacts to have an accurate picture of your company’s finances.

Tax Implications

Capitalization and expensing decisions can also have different impacts on taxes. Check with a tax advisor for specific advice relevant to your situation. You have to follow your local country’s tax regulations while capitalizing project management costs.

Materiality

It’s important to consider the materiality of costs. If a cost is small relative to the overall financial picture, the impact of capitalization versus expensing may not be large. For small amounts, companies generally expense them, for better management of financial records. But this depends on the accounting standards your organization follows.

In summary, the decision of whether to capitalize project management costs depends on many factors. You must consider the project type, if an asset is being created, the cost directly tied to the project, and the expected benefit to the company. There are some accounting rules that must be followed. When in doubt, consult with a professional accountant or financial advisor to help you make the best decision for your business.