Classifying your investments in technology: CapEx or OpEx?

In 2020, the COVID-19 pandemic began taking hold around the globe and organizations had to pivot to deal with a new reality. The ways we interact and conduct business have transitioned to a more virtual world. Over the past two years, we’ve seen a technological shift as organizations invest more in their technology infrastructure and budgets so they can continue to function and deliver value to the marketplace and society.

Whether it’s purchasing equipment for employees to work from home, investing in the creation of an e-commerce website or even acquiring a company to access their know-how, many business people are left pondering what the accounting treatment of all these investments could look like.

Initial recognition of capital assets and expenditures

From a recognition standpoint, expenditures are generally recorded at the cost incurred to purchase the products and/or services, including any costs directly related to the implementation of the products and/or services. There’s some flexibility under International Financial Reporting Standards (IFRS) to recognize the asset at cost or the revaluation method. From a practicality standpoint, most organizations choose to use the cost method, as revaluing can be costly given the need for accurate information to value assets.

It’s also becoming a trend for some businesses to lease technology assets. Depending on the financial reporting framework, the asset may be recognized as an operating lease, capital lease or even as a right-of-use asset which can become a complex exercise.

Computer equipment/hardware such as servers, computers and tablets

These are fixed and tangible assets that are expected to benefit the company in excess of one year and are capitalized on the balance sheet as capital assets. These assets are amortized over their expected useful life to reflect their depreciated value which is also known as the net book value.

Computer software

These expenditures may form part of the computer hardware cost if it’s required to get the hardware ready for use. Otherwise, software expenditures that are expected to benefit the company for more than a year are often capitalized as a capital asset alongside computer equipment. In some instances, it may be considered an intangible asset. Similar to computer hardware and other capital assets, software should follow an amortization policy that is reflective of its useful life.

Licenses/subscriptions/service contracts

These costs may include subscriptions or licenses to certain applications, cloud storage and cyber security. Some companies invoice monthly which makes the period end reporting straightforward. However, there are certain arrangements in which upfront payments are involved or advance billings are rendered. In this case, consideration should be given to the prepaid portion to ensure proper expensing of the cost in the correct periods to which the service relates to.  

IT contractors or IT employees

IT employees who are on payroll are subject to payroll tax withholdings. As such, they are classified as part of the company’s payroll expense. As for IT contractors, if their involvement is related to getting the IT equipment ready for use, it’s generally capitalized as part of the capital assets. Otherwise, it’s an operating expense for the company. It’s common for companies to work with outside consultants on certain projects or on an as-needed basis. Be sure to follow CRA guidelines when making the determination of whether an individual is a contractor or employee.

Website development

The cost incurred for the development of a company’s website should be analyzed by understanding the stage of development as well as its individual components to determine if certain costs are capital or operating in nature.  Generally, the capitalization of the cost related to website development requires key intangible asset criteria to be met related to the development phase. An assessment of its useful life and amortization period may be required but often requires an in-depth analysis.

Acquisition of a business

A company may acquire business assets from another company to bolster its technology. The acquisition of business assets requires the vendor and purchaser to determine a purchase price allocation of the assets being transferred. In short, the purchase price is allocated to the fair market value of all identifiable tangible and intangible assets first. If the purchase price is in excess of the value of identifiable assets, the residual is assigned to goodwill. If a workforce is being acquired from the target company, there could be value embedded in the goodwill related to the assembled workforce. Once the values of all the key components are determined, it’s then combined with the purchaser’s balance sheet. 

Impairment consideration

Certain accounting standards may require impairment testing for assets on the balance sheet or at least a consideration of its valuation and recoverability. With the ever-changing phase of technology, it’s important to be mindful of assets and more particularly information technology-related ones where there could be an indication of impairment in which the carrying amount on the books may not be recoverable. For example, if there’s intellectual property purchased from an arm’s length party on the balance sheet as an intangible asset, it’s crucial to take a step back and look at the recoverability of its carrying amount based on the future net cash flow that the asset is expected to generate. If the recoverability is expected to be less than the carrying amount on the financial statements, an adjustment may be required.

Taxation consideration

It’s also important to remember the tax benefits of investing in technology. There’s currently a PST rebate in British Columbia if capital assets are purchased and paid for prior to September 30, 2021, as well CRA’s accelerated investment incentive to allow for a quicker tax write-off of capital assets acquired during the qualifying period.

How we can help

The above article is by no means specific to any particular accounting standards. Common technology-related expenditures from a 10,000-foot level were used to provide some direction and scratch the surface of this topic. Contact your DMCL advisor to discuss technology-related expenditures specific to you and to learn more about the classifications, benefits and implications when investing in technology for your business.

Article written by Danny Loo, CPA, CA, CBV.