THE FINE PRINT The expense of a capitalized microscope is split over several years and deducted from the revenue it generates.

Buying equipment is a major investment that goes beyond the sticker price and negotiations. You have to navigate the fiscal permutations regarding how to book the purchase, not to mention figuring in depreciation over the long term.

If all this confounds you, you're not alone. But you don't need to be an accountant to crunch the numbers. Here, using a recent example from one of our surgery centers, I'll lead you through the steps — which apply to hospital and ASC alike — to fully accounting for any equipment purchase.

So you want to buy …
A new ENT surgeon came on staff, and she wanted a new microscope. The one we had, of course, was not what she could use. You know how this story ends: You buy the new equipment that the new surgeon wants. We shopped around and found one for $47,000 that would meet her needs. Everyone's happy (enough), as the price tag could have been higher.

But now that you've found the microscope and bargained with the manufacturer to get the best price, you have a choice: How do you want to internally "pay" for this piece of equipment? Due to the cost and type of equipment in this case, we could either capitalize it or expense it.

Is it an "asset" or an "expense"?
Capitalizing the microscope means converting it to an asset on the balance sheet for our facility (and lets us call it a piece of "capital equipment"). For example, if the facility pays $47,000 for the microscope, its financial statements don't show that it "spent" $47,000. Rather, the statements show the facility converted $47,000 worth of cash into $47,000 worth of equipment (the microscope), into an asset. This means that the value of the asset is retained by the facility.

Expensing the microscope, on the other hand, would mean the facility reports the purchase on the income statement as an outflow of money — that is, as a dreaded expense. If a facility pays $14,000 for rent, for example, its financial statements show that money as having been "spent." Expenses directly reduce a company's net income, or profit, so the more costs you can capitalize rather than expense, the greater the overall company profit (even if you're a not-for-profit organization).

So, it seems you'd want to convert the microscope to an asset rather than an expense. Not that simple, I'm afraid. The IRS has defined "asset," and you must determine if you can use this to your advantage.

Mind the GAAP
Generally accepted accounting principles — GAAP — define a company's assets as the items it owns or controls that have measurable future economic value. Quite simply, if you buy something that doesn't fit into that definition, then you can't capitalize it. Buildings, land, equipment (microscopes), inventory items and money owed to you from patients (accounts receivable) really do have future measurable economic values, so you can capitalize them as assets. On the other hand, advertising, marketing, holiday parties and the like cannot be capitalized and must be expensed, because they just cannot be measured as having concrete worth.

So, in buying the microscope, you do in fact have an asset that retains value for the company — not an expense draining money from the facility. And although our ASC capitalized the microscope, that doesn't necessarily mean it won't ever have to expense the cost.

Anticipate depreciation
"Hard assets," such as buildings, property and equipment, tend to lose value as we use them and as time moves on. Buildings get old, equipment breaks down, and computers and software become obsolete. The IRS knows this, so you have to expense a part of the asset's value for each year of its "useful life." This practice is known as "depreciation."

According to the manufacturer (not the vendor), our $47,000 laser has a useful life of 7 years. At the end of that period, the microscope would be worth, say, $2,000 for scrap metal. So we have to depreciate $45,000 of the value of the microscope for 7 years. Under the most common depreciation method, the company would claim a depreciation expense of $6,428 per year, reducing total profit by that amount.

Just to complicate it a bit, depreciation also has another role under GAAP, called the "matching principle." This principle says that, when companies report revenue, they must simultaneously report (as expenses) all costs incurred in producing that revenue. Using the microscope, the $6,428 in depreciation is an expense also incurred to produce the revenue generated by the microscope that year — and it must be accounted for in relation to microscope-related revenue.

The bottom line: capitalizing and depreciating
When you capitalize and depreciate, you win 3 ways.

• First, you get to spread out the economic damage.
• Second, the cost of the equipment is offset against the sales in a given year, which lets you better gauge the profitability of your purchase. If the microscope will result in $65,000 worth of procedures in a single year, your margin of profitability on it will actually be 90%.
• Third, you can claim depreciation as a tax deduction against revenue in order to determine taxable income.

On the downside, like any extended payment plan, depreciation actually costs you more over the long run, because inflation depreciates the value of currency. So if inflation is 3% per year for those 7 years, you're paying nearly $200 more in real dollars in year 2 than you did in year 1, and another $200 more in year 3 than in year 2. This is why investing in assets is a good move when inflation is low — as it has been the last few years. Although cash flow may be tighter, the capital equipment won't actually cost you as much in the long run.