When you start up a business and set up your accounting, what values do you assign to your assets? Or, when you acquire property by purchase, exchange, conversion, or other means, what value should be assigned to the property? The Internal Revenue Service provides some specific guidelines for determining the basis of assets for tax purposes.
Monetary and Non-monetary Items
Certain assets and liabilities have a clearly assigned monetary value. These would include cash, bank accounts, and loans payable. As you conduct your business, other items are determined as a specific monetary amount, such as accounts receivable from customers and clients, and accounts payable to suppliers. These monetary values are supported by documentation, such as invoices you issue to customers or clients, invoices you receive from suppliers, and loan documents with banks or other lenders. Other assets, such as inventory and fixed assets may not have a readily determinable monetary value. This may depend on how you acquire the assets.
Historical Cost
A basic accounting principle is that the value assigned to assets is normally their historical cost. When you purchase something for use in your business, the amount you pay is normally the value assigned for accounting purposes. For example, if you purchase property, plant, machinery, vehicles, office equipment, furniture or any other assets, whether new or used, the amount you actually pay is the historical cost of the asset, and is the amount that would be booked. This should include amounts paid in order to place the asset in service, such as delivery and installation charges. This is the basis that will be used to calculate depreciation on the asset, if applicable, and to determine your gain or loss if you subsequently sell or dispose of the asset.
Book and Tax Values
But there may be cases in which information on historical cost is not readily available. When you start a business, you may convert assets from personal use to business use. Or you may acquire assets in exchange for services, or in exchange for other assets. In these cases it may be necessary to assign a value. One possibility is the fair market value of the asset. But consideration should also be made of the criteria established by the Internal Revenue Service. U.S. federal income tax law establishes some specific criteria for determining the basis of assets for tax purposes. This basis may or may not be the same value as that assigned for book purposes.