For tradespeople and construction businesses, tools and equipment are essential for getting the job done. However, knowing how to treat the purchase of these tools in your accounting – whether to expense them or capitalise them – is key for accurate financial reporting and tax planning. Here’s a simple guide to help you determine when to expense a tool and when to capitalise it.
What does it mean to Expense Tools?
Expensing tools means recording the full cost of the item as an expense on your profit and loss (P&L) statement for the current year. This reduces your taxable income for that period, which can lower the amount of tax you need to pay.
Typically, you would expense a tool if:
The tool has a short useful life: If the tool is expected to be used for less than one year, it is generally expensed. For example, consumable or low-cost items like drill bits or small hand tools can be expensed.
The cost is below the capitalisation threshold: Many businesses set a cost threshold to distinguish between assets to be capitalised and those that are expensed. If the cost of the tool is below this threshold (for example, £200), you can expense it immediately.
It’s a repair or replacement of a small part: If the tool is used to repair or maintain existing equipment, it’s typically treated as a maintenance expense.
What does it mean to class Tools as an Asset?
Capitalising a tool means recording the purchase as an asset on your balance sheet rather than immediately expensing it. The cost of the tool is then spread out (depreciated) over its useful life. This is common for larger or more expensive items that are used for multiple years.
You would capitalise a tool if:
The tool has a long useful life: If the tool is expected to be used for more than one year, it should be capitalised. This applies to larger, more expensive tools and equipment like power tools, machinery, or vehicles.
It exceeds the capitalisation threshold: If the cost of the tool exceeds the threshold set by your business (often £200 or more), it should be capitalised and depreciated over its useful life.
It’s used to improve or upgrade an asset: If the tool or equipment will improve the value or extend the life of an existing asset, it should be capitalised.
Example Scenarios
Small Hand Tool (e.g., Hammer)
Cost: £25
Expected Use: Less than a year or low-cost.
Treatment: Expense. The tool is inexpensive and doesn’t meet the capitalisation threshold.
Power Tool (e.g., Cordless Drill)
Cost: £150
Expected Use: 2-3 years.
Treatment: Expense. While it may last several years, the cost is relatively low, so it can be expensed.
Large Equipment (e.g., Concrete Mixer)
Cost: £2,500
Expected Use: 5-7 years.
Treatment: Capitalise. This is a significant purchase with a long useful life, so it should be treated as a capital asset and depreciated over its expected lifespan.
Depreciation and Capitalisation
When you capitalise a tool, you’ll need to depreciate it over time. Depreciation allows you to spread the cost of the tool over its useful life, which matches the expense to the period in which it generates income. For example, if you capitalise a £5,000 machine with a useful life of 5 years, you’ll expense £1,000 each year through depreciation.
There are several methods for depreciation, such as straight-line depreciation (spreading the cost evenly over the tool's useful life) or reducing balance depreciation (accelerating the expense in the earlier years).
Why Does It Matter?
Correctly categorising your tools as either expenses or capital assets ensures that your financial statements accurately reflect your business’s performance. Expensing smaller tools reduces your tax burden in the short term, while capitalising larger tools helps you match the cost with the revenue they generate over time.
Additionally, understanding when to expense or capitalise can help improve cash flow management. Immediate expensing lowers taxable profits for the current year, but capitalising assets can give a clearer picture of your long-term profitability and asset value.
Conclusion
For trades and construction businesses, knowing when to expense or capitalise a tool is important for both tax planning and financial management. As a general rule, small, inexpensive tools or those with a short useful life should be expensed, while more expensive tools with a long useful life should be capitalised and depreciated over time. By applying these principles, you’ll ensure your accounts remain accurate, compliant, and aligned with your business's financial goals.