Classifying Your Investments in Technology: CapEx or OpEx?

UPDATE (September 16, 2024): This article has been updated to reflect changes in legislation and regulations since the date of publication (September 15, 2021).

Since the onset of the COVID-19 pandemic, organizations have made significant investments in technology to adapt to new ways of doing business. Whether you’re purchasing equipment for employees to work from home, developing an e-commerce platform, or acquiring technology through a business acquisition, understanding how to classify these investments as capital expenses (CapEx) or operating expenses (OpEX) is essential for accurate accounting.

Initial recognition of capital assets and expenditures

Investments are typically recorded at the cost incurred to purchase the products or services, along with related implementation costs. The International Financial Reporting Standards (IFRS) provides flexibility in recognizing assets at cost or revaluation. However, most companies opt for the cost method due to the complexity and expense of revaluation.

It’s also becoming a trend for some businesses to lease technology assets. Depending on the financial reporting framework used, the lease could be classified as an operating lease, capital lease, or right-of-use asset, adding complexity to the accounting treatment.

Computer equipment/hardware such as servers, computers, and tablets

Computer hardware, such as servers, computers, and tablets, are tangible fixed assets that are expected to benefit the company for more than a year. These assets are capitalized on the balance sheet and depreciated over their expected useful life, which reflects their net book value.

Computer software

Software costs that are integral to hardware setup may be included as part of the hardware’s cost. Otherwise, software that provides long-term benefits is often capitalized as an intangible asset. Like hardware, software should be amortized based on its useful life.

Licenses, subscriptions, and 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 are classified as part of payroll expenses, with payroll tax withholdings applied. IT contractors, on the other hand, may have their costs capitalized if their services are directly related to preparing assets for use. If not, their services are expensed as operating costs. Be sure to follow the CRA guidelines when making the determination of whether an individual is a contractor or employee.

Website development

Costs associated with website development must be carefully assessed to determine whether they should be capitalized or expensed. Capitalization may be appropriate if key criteria for intangible assets are met, and an amortization period should be applied based on the site’s useful life.

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 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

While the BC PST rebate on capital assets expired in 2021, businesses can still take advantage of the CRA’s accelerated investment incentive, allowing for faster tax write-offs of eligible capital assets. Subscribe to our newsletter, Between the [Spread]Sheets, to stay informed about any new incentives that may apply to your technology investments.

The above article is by no means specific to any particular accounting standards, but it should provide you with a high-level overview of common technology-related expenditures and how they might be accounted for. Contact your DMCL advisor to discuss expenditures specific to your business—they’re here to help you navigate the complexities of classifying technology investments and ensure you maximize their accounting and tax benefits.

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