A capital expenditure is the use of funds by a company to acquire physical assets to improve its value or increase its long-term productivity. Also known as capital expenses or capex, capital expenditures include purchases such as buildings or warehouses, new equipment such as machinery or computers, and business vehicles. Many companies strive to maintain their historical capital expenditure levels in order to show investors that managers are investing adequately in the business.
Accounting for capital expenditures
Because a capital expenditure is considered an investment in a given company, it should be recorded as an asset on the company's balance sheet. It should then be deducted over the course of multiple years as a depreciation expense starting in the year following the year of purchase. For example, if a company purchases a new piece of equipment for a cost of $50,000 and expects it to have a useful life of five years, then the company can then charge $10,000 to depreciation expenses in each of the next five years following the year of purchase.
Capitalization limits
A capitalization limit, or cap limit, is the threshold above which a company capitalizes assets. If a company purchases an item below the capitalization limit, it must charge that item as an expense in the current year. However, if the item in question exceeds the capitalization limit, then it can be depreciated over the course of its useful life. If a company sets a capitalization limit of $10,000 and purchases equipment at a cost of $8,000, then it must record that equipment as an expense the year it is purchased. However, if that same piece of equipment costs $12,000, then it can be depreciated. While there are tax benefits involved in depreciating capital expenditures, this practice requires strict record-keeping.
Capital expenditures versus operational expenditures and revenue expenses
Costs that a company incurs as part of its regular course of business are known as operational expenditures and should be treated differently from capital expenditures. Operational expenditures are not depreciated and must be recorded as expenses for the year in which they are incurred. Whereas capital expenditures are considered an investment in a company to increase its earnings, revenue expenses are similar to operational expenditures in that they are short-term expenses used to meet the usual needs of running a business. Capital expenditures are recorded as an asset on a company's balance sheet. Revenue expenses, however, are listed with its liabilities.
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