In this article, we explore whether inventory is a capital asset or not. We also cover how it is not and share some circumstances where it can be considered as one. Read on to learn more.
Inventory is not considered a capital asset. Instead, inventory is a current asset intended for sale, while capital assets are long-term assets used for business operations, like machinery or buildings. The distinction is important for financial reporting and tax purposes.
Example: A bakery holds 1,000 loaves of bread valued at $5 each as inventory, aiming to sell them within the week. In contrast, the bakery's $20,000 oven that’s been used for baking over several years is a capital asset and is not intended for immediate sale.
Here are some of the reasons why inventory is not a capital asset:
Inventory is intended for sale as part of regular business operations, while capital assets are for long-term use in the business.
Inventory is classified as a current asset because it's expected to be converted into cash within a short period, typically within a year. Capital assets have a longer useful life, often spanning several years.
The cost of inventory becomes an expense (cost of goods sold) when sold. Capital assets, on the other hand, are depreciated or amortized over their useful life.
Inventory turns over (i.e., is replaced) frequently, while capital assets remain on the balance sheet for a more extended period until they're fully depreciated or disposed of.
For tax purposes, the cost associated with inventory affects taxable income when items are sold. In contrast, capital assets impact taxable income over a more extended period through depreciation deductions.
Under typical accounting standards and practices, inventory is classified as a current asset, and capital assets are long-term assets used in business operations. However, there are specific circumstances or frameworks where the lines can blur. Let’s explore some below:
For an individual, items like rare coins may be capital assets for personal enjoyment. However, if the person runs a coin-selling business, those coins are considered inventory.
In real estate development, land held for development or resale might be considered inventory for a property developer. Still, for a company in a different industry, land would typically be a capital asset.
In some very specific cases, items in inventory might be held for an extended period, longer than typical inventory. If the intent changes and the company decides to use that inventory in its operations (e.g., a furniture store deciding to use some of its inventory as office furniture), it could be reclassified. However, this is not standard practice and would need appropriate justification.
Depending on the financial reporting framework or specific industry practices, there might be some exceptions. However, these would be outliers and not representative of mainstream accounting.
Despite these nuances, it's crucial to understand that in traditional accounting, especially under frameworks like the International Financial Reporting Standards (IFRS) or the Generally Accepted Accounting Principles (GAAP), inventory and capital assets are distinct categories with different treatments. They serve different purposes in financial analysis, decision-making, and tax implications.
We hope you now have a better understanding of why inventory is not a capital asset and when it’s only can be considered as one.
If you enjoyed this article, you might also like our article on receiving inventory or our article to determine if inventory is a fixed asset.
