What is Capital Expenditure?
Capital expenditure refers to the expenditure done by a business to acquire, upgrade, or maintain long-term assets to increase productivity or capacity. Long-term assets consist of tangible, immovable, non-consumable assets with a useful life of more than one accounting period such as property investment, machinery or infrastructure. Additionally, it consists of intangible assets such as patents, trademarks, and licences. The expenses for a specific accounting period are a part of the cash flow statement.
Know About Golden Rules of Accounting.
Types of Capital Expenditure
Expenditure on Tangible Assets
These assets often have a useful life of more than one year and are tangible, immovable, and non-consumable. For example:
- Computer Hardware: The price of setting up, buying, and maintaining computers, laptops, and related hardware.
- Tools and Equipment: Purchase of manufacturing facilities, tools, and equipment, as well as maintenance, improvement and depreciation expenses.
- Real Estate: Investing in a piece of property, a building, or both, as well as maintaining, renovating, and paying off debt.
- Vehicle: Purchasing a vehicle for the delivery and distribution of goods is another example that involves maintenance, repair and depreciation charges.
Expenditure on Intangible Assets
It’s not necessary for capital assets to be tangible or physical; they can also be intangible. Gaining the worth of the cost incurred on these assets takes more than one fiscal year.
- Software: This includes both the upgrade and acquisition of software. Investing in the latest software will prove beneficial and effective for the company.
- Copyright: Protecting ideas, products, and services with patents and copyright provides the company with legal rights to ensure the prevention of unauthorised selling, sharing, and making.
- Licences: Registration fees for licences enable production of varied products in the company.
Importance of Capital Expenditure
Assets With a Long-Term Horizon
CAPEX expenses often have effects over a long period. The wide range of present manufacturing or production activity is largely due to previous capital expenditures. These expenses aid in providing the business with a direction so it can go forward, define objectives, and prepare budgets.
An organisation’s asset accounts initially expand as a result of capital expenditures. Capital assets tend to depreciate and lose value throughout their useful life once put to use. The higher the depreciation expense, the smaller the taxable income and the lower the tax burden for the company.
Easier to Acquire Loan
The assets purchased using capital expenditure can be mortgaged by the company and make it easier for the company to acquire loans or other bank facilities.
They improve the financial health of the balance sheet and boost greater investment from investors.
Boost Production Capacity
The long-term features of capital expenditure results in the formation of assets, which enable the company to generate income for many years by expanding or upgrading manufacturing facilities and increasing operational effectiveness. Additionally, it raises the ability of the company to create more in the future and also increases labour participation.
Limitations of Capital Expenditure
Large capital expenditures by companies aim to produce predictable results. Losses could occur and positive outcomes aren’t a guarantee. It is challenging to make accurate future predictions. Decisions about CAPEX usually come with a high degree of uncertainty regarding their costs and benefits.
Both industrial undertakings and infrastructure projects often spread out the expenses and benefits of capital expenditure over a considerable amount of time. This temporal gap makes it difficult to estimate the discount rate and establish equivalence.
The accounting procedure for finding, quantifying, and predicting the expenses associated with capital expenditures can be very difficult.
It is difficult to reverse the capital expenditure choices. Any firm may find it to be much more expensive to reverse its CAPEX decisions.
You may also like to read about the Differences Between Capital Expenditure and Revenue Expenditure
Frequently Asked Questions
The capital expense includes expenditure on tangible assets like machinery, tools, computer hardware, vehicles, etc. Capital expenses also include intangible assets like licenses, patents, software, etc.
Instead of being charged as an expense immediately, a capital expenditure is recorded as an asset. It is categorised as a fixed asset and expensed using depreciation throughout the asset’s useful life.
For instance, if one purchases an asset for ₹50,000 and anticipates it would last for five years, one would charge ₹10,000 in depreciation expense for each of the following five years.
Capital expenditure does not include employee salaries, electricity bills, rents, or transportation costs. Since these are costs incurred in daily functioning and not in fixed assets of the company.