Startup Capital Asset Accounting: Capex, Depreciation & Intangibles

For an early-stage founder, startup capital asset accounting can feel like a distraction. Yet, understanding when to capitalize or expense a cost is a critical financial decision. It's not just about compliance; it’s about accurately telling your company’s story to investors and your team, directly impacting valuation and your perceived financial health.

Capitalize or Expense: A Founder's Decision Framework

The core concept is simple. When you spend money, the cost can be an immediate expense that reduces profit on your Profit and Loss (P&L) statement. Alternatively, it can be recorded as an asset on your Balance Sheet. An asset is a resource you control that will provide future economic benefits. This choice significantly impacts key metrics like EBITDA and Net Income, which directly influence valuation.

Startups often fall into the trap of expensing everything by default. This is the simplest path in bookkeeping software like QuickBooks or Xero, but it can be misleading. A significant investment in software development, for example, might be written off in one month, making the company look unprofitable when it was actually building a valuable, long-term asset. This distorts your financial picture and creates problems that must be unraveled during due diligence, causing delays and eroding investor confidence.

The guiding principle is the 'future economic benefit' test. If a cost incurred today is expected to generate value for more than one year, it is a strong candidate for capitalization. The cost of office coffee is expensed; the cost of a software platform that will generate revenue for five years is an asset.

To apply this principle pragmatically, you must establish a capitalization threshold. This is a policy setting a minimum cost, often around $1,000 or £1,000 for a startup, for an item to be considered for capitalization. Anything costing less is automatically expensed. This prevents wasting time depreciating low-value items like keyboards and is a sign of financial discipline.

Document this in a formal capitalization policy. This simple document should state your threshold and outline the estimated useful lives for common asset classes, such as three years for computer equipment. A written policy provides a defensible basis for your accounting decisions, which is invaluable during an audit. While principles are universal, specific rules differ. US companies are governed by US GAAP, while those in the UK use UK GAAP, largely based on IFRS. To navigate these, our framework for UK companies and resource for US rules offer paths to a simple, defensible policy.

Accounting for Tangible Assets: Hardware, Prototypes, and Leases

Tangible assets are the physical items your startup owns, from laptops to lab equipment. When you purchase a new server or vehicle, these are clearly assets if their cost exceeds your threshold and they provide value for multiple years. This is especially important for companies navigating Hardware NPI Costing & Capex.

For deeptech and biotech startups, the line can be blurrier with custom-built prototypes. Following specific criteria for deeptech startups helps determine when these move to the balance sheet. An early research prototype might be expensed, while a functional prototype for customer demos likely qualifies as a capital asset.

Once capitalized, an asset's cost is spread over its useful life through depreciation. Instead of one large hit to your P&L, depreciation allocates a portion of the cost as an expense each year. Your choice between straight-line and reducing balance depreciation impacts reported profitability. Straight-line is simpler and more common for startups.

For complex machinery, it's more accurate to break it down into core components. A machine might have a chassis with a 15-year life but a control system that needs replacing every five. Using component depreciation allows you to depreciate each part over its own useful life for a more accurate result.

Finally, a significant change in accounting standards affects leases. Previously, many office or equipment leases were simple operating expenses. Now, the new rules on lease accounting under IFRS 16 and ASC 842 require most leases to be recognized on the balance sheet, which can significantly increase your reported assets and liabilities.

Navigating Intangible Assets: Software, R&D, and IP

For many startups, the most valuable assets are intangible: software, R&D, patents, and brand. The accounting rules for these non-physical assets are more complex. A foundational rule is the difference between acquired and internally generated intangibles. If you buy a patent, the cost is simple to capitalize. Creating it yourself requires a more rigorous process.

For software development, the rules vary. US companies follow guidance for capitalizing software under ASC 350-40, which allows capitalization to begin once a project reaches technological feasibility. In contrast, UK and IFRS-following companies refer to the rules for capitalizing software development under IAS 38. The standard itself, IAS 38, defines these requirements. For both, meticulous tracking is non-negotiable; you cannot capitalize costs you cannot prove.

For R&D-heavy companies, understanding the distinction between 'Research' and 'Development' is paramount. This is a central theme in R&D project accounting and is detailed in our guide on the accounting differences between 'Research' and 'Development'. Costs in the 'Research' phase must always be expensed. 'Development' phase costs can potentially be capitalized if strict criteria are met, such as demonstrating technical feasibility and the intent to sell the product.

Herein lies a significant difference. US GAAP is very restrictive, requiring nearly all R&D to be expensed. In the United States, R&D tax treatment is shaped by IRS rules like Section 174. Conversely, IFRS and UK GAAP allow capitalization of development costs, which can dramatically improve the financial profile of a UK or European startup. In the UK, HMRC's guidance on R&D tax credits outlines expectations. The bar is particularly high in life sciences, with specific R&D capitalization rules for biotech startups.

Direct costs to secure intellectual property, like legal fees for patents, can also be capitalized. Our guide on how to capitalize and amortize patent costs explains how these are recorded as an asset and then amortized over the patent's legal life.

Managing Assets: The Fixed Asset Register, Forecasting, and Tax

Capitalizing an asset is just the beginning; it must be managed throughout its life. Start by maintaining a fixed asset register, a simple spreadsheet tracking each asset's description, cost, useful life, and accumulated depreciation. This register is a critical input for your financial forecasts.

Depreciation schedules are essential for building a robust financial model. As detailed in the guide on projecting depreciation in financial models, accurately forecasting future depreciation is key to forecasting profitability. Investors scrutinize these projections to understand your future capital needs.

You must also navigate tax rules. The depreciation for your financial statements often differs from tax-deductible depreciation. Tax authorities offer accelerated depreciation schemes to incentivize investment, and managing the differences between tax and book depreciation is a powerful tool for tax planning.

Finally, ensure the assets on your balance sheet are not overstated. If an event causes an asset's value to drop unexpectedly, you may need an impairment test. This could be triggered by a technology shift making your software obsolete. The guide on the process for impairment testing outlines this necessary step. Writing down an impaired asset ensures your balance sheet reflects economic reality.

Key Actions for Founders

Instead of viewing this as an accounting chore, see capitalization as a strategic discipline that clarifies the value you are creating. For founders ready to control their financial narrative, here are three actions to take now.

1. Define Your Policy. Create a simple, one-page policy stating your capitalization threshold (e.g., all single items over $1,000) and standard useful lives for asset classes (e.g., laptops over three years). This document creates consistency and provides a clear rationale during any audit or due diligence.
2. Track Meticulously. You cannot capitalize costs that you cannot prove. This is especially critical for internally developed software. Implement rigorous time and cost tracking for any project you intend to capitalize using project codes, detailed timesheets, or specific tags in your accounting system.
3. Communicate with Stakeholders. Be prepared to explain how your capitalization policy affects key metrics. An aggressive R&D capitalization policy will boost EBITDA but also increase your asset base and future amortization charges. Walking investors through your logic demonstrates financial sophistication and builds trust.

Getting these principles right from the start avoids costly clean-up later, provides a more accurate picture of the value you're building, and ultimately supports a higher valuation.