Differences between a capital goods acquisition and a purchase of inventory
August 16, 2015
The article below discusses how to distinguish property, plant and equipment from inventory, provides key controls for purchasing inventory purchasing and underlines some peculiarities of capital acquisitions.
Inventory includes the following:
- Goods for sale, including merchandise of a wholesaler and finished goods of a manufacturing company;
- Goods in the course of production, called work in process;
- Goods to be consumed directly or indirectly in the course of production, for instance raw materials and supplies.
In general, when categorizing an asset as a fixed asset, the following factors should be considered:
- The purpose for which the asset is acquired should be taken into account;
- The useful life of the asset should be longer than a year;
- Future economic benefits associated with the asset are probable and;
- Associated costs related to the asset can be measured reliably.
For instance, if a company purchases a computer for its administrative staff and expects it to be in use for several years, such computer is likely to be classified as a fixed asset. However, if an entity trades in computers, then the purchased computer will be considered inventory intended for sale.
When it is still not clear how to categorize an asset (fixed assets or inventory), professional judgement should be used and the concept of materiality should be applied. For instance, miscellaneous spare parts can be categorized as inventory; however, an engine functioning only with a particular machine type would be included in fixed assets. Other examples where judgment should be involved include small furniture, pallets, etc.