Capital expenditure definition
/What is a Capital Expenditure?
A capital expenditure is the use of funds or assumption of a liability in order to obtain or upgrade physical assets. The intent is for these assets to be used for productive purposes for at least one year. This type of expenditure is made in order to expand the productive or competitive posture of a business. Examples of capital expenditures are funds paid out for buildings, computer equipment, machinery, office equipment, vehicles, and software. An example of an asset upgrade is adding a garage onto a house, since it increases the value of the property, whereas repairing a dishwasher merely keeps the machine in operation. Capital expenditures tend to be quite substantial in certain industries, such as utilities and manufacturing.
From a financial analysis perspective, a business should at least maintain its historical level of capital expenditures. Otherwise, it will be suspected that management is not adequately reinvesting in the organization, which will eventually lead to a decline in the business.
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Accounting for a Capital Expenditure
A capital expenditure is recorded as an asset, rather than charging it immediately to expense. It is classified as a fixed asset, which is then charged to expense over the useful life of the asset, using depreciation. For example, if you acquire a $25,000 asset and expect it to have a useful life of five years, then charge $5,000 to depreciation expense in each of the next five years. The asset is initially recorded in the balance sheet, while the periodic depreciation charges against it appear in the income statement.
Since there is a record keeping cost associated with capital expenditures, these items are generally charged to expense if they cost less than a certain predetermined limit, which is known as the capitalization limit. For example, if a company's capitalization limit is $2,000, then a computer costing $1,999 would be charged to expense in the period incurred, whereas it would be recorded as a fixed asset if it cost $2,001.
Presentation of Capital Expenditures
Capital expenditures are stored in a variety of fixed asset accounts, such as the buildings account or the equipment account. These accounts are generally aggregated into a single Fixed Assets line item in the balance sheet. This line item is presented after all current assets, since it is classified as a long-term asset. In the presentation, it is paired with and offset by an accumulated depreciation account, in which is stored the cumulative amount of depreciation associated with the assets. This presentation appears in the following exhibit.
The Difference Between a Capital Expenditure and an Operational Expenditure
The reverse of a capital expenditure is an operational expenditure, where the cost is incurred strictly for current operations. Examples of operational expenditures are administrative salaries, utilities expense, and office supplies. Always charge operational expenditures to expense when incurred. Since they are charged to expense in the period incurred, they are also known as period costs.
Terms Similar to Capital Expenditure
A capital expenditure is also known as a capital expense, or as capex.