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SEPTEMBER 24-26, 2024
Austin Convention Center - Austin, Texas

The Leaflet

Transition and Activation Budget Planning

June 18, 2024

Capitalizing on Opportunities to Capitalize Costs

By Jeff Agner, MPH

The delivery of most healthcare services requires regular upkeep, periodic renovation, and the occasional new construction of physical facilities and infrastructure. Construction projects allow a healthcare organization to remain compliant, competitive, and operationally efficient. A formal project is established to plan and execute the work, and the necessary time and resources are allocated. When the cost is high and the useful life of the resulting asset is long (typically more than 10 years), the project is considered to be a “capital project.” Even though these projects likely require a financial investment (often referred to as “capital”), the term “capital” in this context refers to the fact that the resulting asset can be capitalized. Capitalization is an accounting method that allows an organization to break up the full cost of building or purchasing assets into smaller expense activities over the expected life of the asset through processes known as amortization and depreciation.

When an organization can record such a large investment as an asset on its ongoing balance sheet versus an expense on its annual income statement, the financial health of the organization is seen as far more favorable. This means that the organization has greater freedom to borrow money, attract investors, and conduct business. This article will further explain the concept of asset capitalization and will explore its applications in a healthcare construction project.

When can costs be capitalized?

The capitalizable costs of a healthcare project include the amount paid for constructing, acquiring, and/or improving an asset. As expected, this includes the design and construction labor, materials, and fees necessary to deliver the project, but it can also include expenditures for utilities, interest on debt during construction, and other resources engaged in putting the asset into service. In many cases, these costs are not part of the construction budget but are included in a separate Transition and Activation Budget related to the capital project. Regardless of how the activities are funded, a plan to address the accounting requirements is critical.

Per generally accepted accounting principles for new construction, project costs can be capitalized if at least one of the following conditions are met:

  • Costs contribute to the value of the asset
  • Costs enhance the use/value of the asset
  • Costs ensure or extend the useful life of the asset

Additionally, to qualify for capitalization, these expenditures must occur prior to the asset being put into service.

 

What costs are typically capitalized in a construction project?

Each organization must abide by its specific capitalization policies and procedures and comply with state-level mandates or requirements. The following table lists some common costs encountered during a facility renovation or construction project and whether or not they can typically be capitalized. Final determinations of cost capitilization must be made by the financial leadership team.

Manage and track opportunities to capitalize project costs

Once a Transition and Activation Budget is developed, the healthcare organization’s financial leadership team should evaluate all expected costs and categorize them based on their capitalization potential. Separate cost centers can be established if there is no easy mechanism to flag capitalizable costs as they are incurred so they are not mistakenly accounted for as an expense. All costs should be tracked closely and documented clearly so that the accounting treatment can be applied at the conclusion of the project. Once the new space is operational, the organization’s balance sheet should be updated to reflect the full value of the completed capital project as an asset. This action must be performed within a few months (typically 90-120 days) of the asset being put into use; otherwise, taxes and other financial penalties may apply.

Take advantage of the full value of your investment

The purpose of capitalizing costs is to align the cost of using an asset with the length of time in which the asset is providing a benefit to the organization (aka generating revenue). Finance industry and government-level capitalization policies guide organizations on items that should be capitalized versus those that should be expensed on large construction projects. This guidance is intentionally general in nature to be as broadly applicable as possible. It is up to the organization to understand and comply with its specific guidelines to maximize the financial benefits of capitalization when renovating or constructing a healthcare facility.