Capitalisation of own work

What it means

Capitalisation of own work is the accounting route for putting on the balance sheet what the company has made itself. Materials, wages and services are first booked in the usual way as expenses by nature; the capitalisation then offsets them in income and records the resulting asset or inventory at own production cost.

What can be capitalised includes intangible fixed assets such as software written by the company’s own programmers, tangible fixed assets built by its own people, materials and goods from its own production, and internal services. Finished products and work in progress are not capitalised this way; they go through the change in inventory.

As a result the income statement shows both the costs by nature and their counterweight, and profit is not reduced by an investment that will serve for years. The cost reaches the result gradually through depreciation.

How it works in practice

For fixed assets, costs are collected during construction in assets under construction and capitalised as they go, at the latest by year end. Once the asset is completed and put into use it is transferred to the relevant asset account and depreciation begins.

The capitalisations we see most often at clients are in-house software and internal fit-outs. To be defensible they need timesheets for the people on the project, materials issue notes and a documented result. Without them capitalisation is just an estimate and will not stand up to an audit or a tax inspection.

For income tax capitalisation is neutral, because the income it creates is offset by the costs that produced it. The difference appears in the asset’s entry price for tax depreciation, which must reflect actual production cost, not an estimate of market value.

What to watch out for

A mistake is capitalising costs unrelated to the asset, such as the development team’s entire payroll including time spent on maintenance and customer support. This inflates both profit and assets, and an audit reverses the capitalisation into expenses with an impact on prior periods.

The opposite mistake is not capitalising at all. The company then reports a loss in the year it invests although it created value, and a bank or investor sees worse figures than reality. What gets capitalised is part of the accounting policy and should be applied the same way every year.