An Introduction To Capital Expenditure

Introduction

Expenditures incurred by business entities are generally classified into capital expenditure, revenue expenditure and deferred revenue expenditure. Capital expenditure refers to those expenditures the benefits of which are enjoyed in the years to come. Generally, expenditures to acquire fixed assets or improvement cost of the existing assets are regarded as capital expenditure because its benefits are going to be enjoyed in the years following the year of making such expenditure. Capital expenditure is sometimes also shortened as CAPEX.

Applications

CAPEX is generally incurred by businesses to buy new assets or upgrade the old ones. These assets are generally tangible in nature such as equipments, buildings, property, etc. During making major capital expenditures decision on it is formally taken during the annual general meeting of the company or at a Board’s special meeting. In accounting terms, the CAPEX is capitalized or added to the particular asset account and the value of the asset increases. The increased value of the asset is shown on the asset side of the balance sheet at the end of the year. If it is a new asset the account is opened and it is also shown on the asset side. CAPEX may also include some major expenditure other than cost of acquisition or improvement of assets. It may include rent paid for the future years or certain other miscellaneous expenditures like future years’ advance tax, heavy expenses relating to promotion, etc. The benefits of such expenditures are needed to be enjoyed in the years to come following the year of payment. However, you need to remain cautious about some expenditure which might seem to be capital expenditures but they are actually deferred revenue expenditure. In the cash flow statement CAPEX is generally included under the heads investment in plant, equipment, property or any such other head of investment.

Accounting rules

For the purpose of taxation, capital expenditure is considered as a cost that cannot deducted in the year of its payment and needs to be capitalized. Now before it is capitalized it is first seen whether the benefits are being reaped within the financial year or it is being carried on to the following years as well. If the benefits are found to be reaped in the years to come as well then they are capitalized. Now, amortization or depreciation is provided to the asset and the value of the asset gets decreased every year. For certain heavy expenditures only that part is capitalized whose benefits are reaped in the future years.

Conclusion

From the above discussion it is evident that capital expenditures are costs incurred for acquisition or improvement of assets or certain heavy expenditures which cannot be directly charged to profit and loss account. Their benefits are reaped in the following years and therefore, they value of assets or expenditure is capitalized and shown on the asset side of the balance sheet.

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