Capital Assets Meaning
Capital assets refer to the properties held by a taxpayer which may or may not be connected with their business or profession. They are the lowest liquid items or the non-liquid assets an entity possesses. Examples include an office building, house, goodwill, etc.
These assets usually have a useful life greater than one accounting periodAccounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance., and they are listed under the assets section of the balance sheet. The term is often used interchangeably with fixed assets. Furthermore, it is different from the term capital; capitals are treated as internal liabilities in accounting rather than an asset.
Table of contents
- Capital assets are relevant properties of any kind owned by taxpayers, and they don’t have to be attached to taxpayers’ business or trade purposes mandatorily.
- They are classified as assets and included in the asset section of the entity’s balance sheet. Examples are houses, office buildings, manufacturing units, etc.
- These assets can take various forms from different types or classes, based on different purposes or with a long-term or short-term perspective.
- They are different from ordinary assets. Generally, assets used in the ordinary course of the taxpayer’s business or trade, like inventories or property held for the purpose of sale, are treated as ordinary assets.
Capital Assets Explained
A capital asset can be any property owned for personal or investment purposes. It can span from buying a house to investing in fixed income securities like bonds. It provides value to the owner entity who uses it over its useful life. It helps companies generate and maximize revenue and obtain long-term financial benefits, especially in a business environment.
The elements of cost and benefit associated with these assets are visible in the financial statements of an entity. Some of the items in the investment activities section of the statement of cash flow and asset side of the balance sheet are examples. Most capital expenses or Capex are capitalized as an asset on the balance sheet instead of recording as expenses on the income statement. When an entity faces a financial crisis like potential bankruptcy, the entity may decide to sell these assets as a worst-case solution. When these assets are sold for a price above its adjusted basis, it results in capital gain, and if the price is below the adjusted basis, it will be a capital loss.
Another important concept is capital asset management planning. It evaluates current and prospective capital requirements and establishes efficient initiatives to satisfy those needs. It includes decisions regarding capital spending and reducing additional expenditures. Nowadays, it is not uncommon for investors and businesses to take the help of management firms to get financial and investment planning services to maintain their assets over time.
Types of Capital Assets
Entities can invest in different types or classes of assets based on purposes and with a long-term or short-term perspective. Some of the investments result in capital assets by portraying the characteristics like indefinite or longest lifespan and less liquid asset or heaviest item in the balance sheet. Moreover, it can be tangible assets or intangible assets. For example, businesses or investors invest in fixed assets like PPE (Property, Plant, and Equipment), intangible assets like patents and trademarks, and investing in financial assets like shares and fixed-income securities like a bond.
Example of Capital Assets
Dan owns and operates a profitable chain of grocery stores, ABC. He owns the grocery store buildings; he lets out a small portion of some of the building to another party and receives rental income. Furthermore, he has invested in large-cap stocks and receives dividend income. After a few years, a large conglomerate acquired ABC Stores. Dan received a higher price than the fair value of his business; hence the purchase generated goodwill for Dan’s business. In this case, the grocery building, stocks, and goodwill are examples.
Capital Assets vs Ordinary Assets
Capital and ordinary assets are close concepts. The items included in the latter category are specifically mentioned in the definition of the former as exclusions. Sometimes it is difficult to segregate them from a group of assets, and tax laws also influence its classifications in countries. Generally, ordinary assets are used in the ordinary course of the taxpayer’s business or trade, like the stock or property held for the purpose of sale, for example, the inventories.
Frequently Asked Questions (FAQs)
According to 26 U.S. Code § 1221 definition, it is the property of taxpayer regardless of whether it is connected with his business or trade, excluding items like property held for sale in the ordinary course of business, and stock in trade or other property suitable to classify as inventory of the taxpayer at the end of the financial year. Examples are an office building, manufacturing unit, and goodwill.
They are categorized as assets and listed in the asset section of the balance sheet. It usually represents the largest items in the asset section. For example, the Property, Plant, and Equipment (PPE) are the non-current assets also the tangible capital assets in the balance sheet. Furthermore, it is different from capital; capital is classified as an internal liability.
CAPM is an important concept in financial management. It refers to a model professionals use to make investment decisions by portraying the relationship between the expected return of an investment and systematic risk. As a result, it helps determine the investment price based on potential return and risk factors.
This has been a Guide to Capital Asset & its Meaning. We explain its definition, examples, management, and difference from ordinary assets. You may also have a look at the following articles to learn more –