Friday, 5 July 2013

Capital Expenditures (CapEx)

Capital expenditures, or capex, is money used to purchase, upgrade, improve, or extend the life of long-term assets. Long-term assets are typically property, infrastructure, or equipment with a useful life of more than one year.
 An amount spent to acquire or upgrade productive assets (such as buildings, machinery and equipment, vehicles) in order to increase the capacity or efficiency of a company for more than one accounting period. Also called capital spending.

Capital Expenditure or CAPEX are expenditures which create future benefits. It is an outlay of cash to acquire or upgrade a business asset. This outlay is made by the company to expand its scope of operations. The capital expenditure is an expense when the asset is a newly purchased capital asset or an investment which improves the life of an existing asset.  Some examples of capital expenditures are purchase a new building or a property, cost of a significant upgrades to an existing facility.
Capital expenditure is also referred to as capital spending or a capital expense. If an expense is a capital expenditure then it needs to capitalize. Publicly traded companies list their capital expenditures in their annual reports. This helps the stockholders assess how the company is using their money in the long term planning. Many companies engage in capital expenditures yearly, in order to constantly upgrade and improve facilities, vehicles, and equipment.
Engaging in capital expenditure is a way to improve and expand a business. Large corporations may acquire additional companies, while smaller businesses may consider the purchase of a new office printer to be a capital expenditure. Usually allowances are made in the budget of the company for capital expenditures, expenses involving the replacement of items which are no longer able to be repaired.
A capital expenditure is amortized up to the life of the investment, which may range from 5 to 40 years, depending on the investment. It is known as a recovery period, and recovery periods for major assets are set out so that companies will know how to deduct capital expenditures. Amortization indicates that the company cannot deduct the cost of the capital expenditure. Hence the company needs to spread it out over the life of the investment.

How It Works/Example:

Let's assume Company XYZ wants to buy a new delivery truck for $40,000. When Company XYZ spends the $40,000, the book value of the company's assets are increased by $40,000. This amount is also recorded as capex, a use of cash, in the investing section of the company's statement of cash flows. Company XYZ then gradually expenses the $40,000 on its income statement over time as the truck depreciates. The length of time over which the truck depreciates (and thus the amount of annual depreciation expense) is determined by Company XYZ's choice of depreciation method.

Many companies set minimum dollar thresholds for
capex, meaning that capital expenditures below the threshold are simply expensed even though they exhibit capex characteristics. This is done to simplify the accounting process and avoid having to record insignificant depreciation expenses each period for small-value assets.

Why It Matters:

Capex generally takes two forms: maintenance expenditures, whereby the company purchases assets that extend the useful life of existing assets, and expansion expenditures, whereby the company purchases new assets in an effort to grow the business. It is important to understand that money spent to repair or conduct ongoing, normal upkeep on assets is not considered capex and should be expensed on the income statement when it is incurred.


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