What is Capital Expenditure?
Capital expenditure (also known as CAPEX) is the amount of non-recurring expenditure incurred to improve, update, repair, or extend the life of an existing fixed asset or buy a new fixed asset, which will improve the production capacity and/or efficiency of the production of goods manufactured by an entity and which will be written off to the profit & loss account over the useful life of the fixed asset. In this topic, we are going to learn more about Capital Expenditure Examples.
Explanation
- Capital expenditure is the on-time cost incurred by an entity to purchase a new fixed asset or upgrade an existing fixed asset.
- These are long-term assets and have a useful life of more than one year. Meaning thereby assets having a useful life of up to one year are written off to the profit & loss statement.
- Fixed assets are used for manufacturing goods or in the provision of services. Thus, fixed assets are not sold in day-to-day business operations like normal goods. Instead, the objective of investing in fixed assets is to retain them for the purpose of using them in business operations.
- Now, these expenses are huge in quantum compared to normal business expenses, and the entity must budget these expenditures before incurring them.
- It depends on the type of industry the company is dealing with, deciding whether the expenditure incurred is the natural capital expenditure or revenue expenditure.
- The distinction between capital expenditure & revenue expenditure (or operating expenditure) should be understood. Revenue expenditure is incurred for the day-to-day operations of the entity, whereas capital expenditure is incurred for purchasing a new fixed asset. Revenue expenses include traveling expenses, minor repairs to plant & machinery, selling, general & administrative expenses, rental expense, etc. Capital expenditure includes investment in plant & machinery, building, furniture & fixtures, etc.
- Also, the quantum of expenditure (in comparison with the turnover of the entity) will also justify the nature of expenditure.
Examples of Capital Expenditure
We will cover different aspects of capital expenditure using the following template as an example.
Template #1
Explanation:
- The depreciation is charged or apportioned or expensed out over the life of a fixed asset. Depreciation may be calculated per the straight-line meth, reducing value method, or other scientific methods suggested by the accounting standards.
- The gross block is the amount of capital expenditure made and capitalized during the year & it represents the outlay or cost of assets.
- The netblock represents the written down value of the fixed after deducting the appropriate accumulated depreciation to date. The amount of netblock is reported on the face of the balance sheet. The above schedule is shown as scheduled for the fixed assets in the notes to accounts.
Template #2
Explanation:
- As you can see from the above extracts of a financial statement, the assets are divided into non-current assets & current assets. Non-current assets are assets having an operating cycle of more than one year & thus, you can see that “fixed assets” are a part of non-current assets. On the other hand, current assets have an operating cycle of one year & thus, you can see inventories, cash & bank type of operating assets in the list.
- Plant, property, and equipment represent the tangible (i.e. physical) assets of the entity. Intangible assets represent non-physical fixed assets of the entity.
Template #3
Explanation:
- As you can see that the net block of the entity has increased by $ 47,30,544.Explanation
- After analysis of the entity’s annual report, it is understood that the company has set up a new production unit that would substantially increase the production capacity of the entity.
- Say the entity is engaged in the production of cement with an existing capacity of 1200 MT. However, due to the infrastructure boom by the government projects, the demand for cement has increased considerably. So as to accommodate the increased demand, a company needs to increase its production capacity & thus the investment will help the entity to increase the production capacity by around 800 MT.
- In the near future, you can see an increase in the turnover of the company. The said increase will be compensated by proportionate depreciation on the new investment. This goes for year-on-year.
- This expenditure is treated as capital expenditure because the benefits will accrue for the long term.
Template #4
Explanation:
- The amount of $ 165000 is revenue expenditure since the buses were taken on lease by the entity & not owned. This amount will be shown as “other expenses” in the statement of profit & loss.
- Secondly, all the costs incurred in bringing the asset to the present location & conditions is to be treated as capital expenditure & hence, $ 12000 is added to the gross block of vehicles and not shown as a part of the statement of profit & loss.
- As per generally accepted accounting standards, if any loan is taken specifically for the acquisition of a new asset, the borrowing cost incurred is required to be added to the cost of the asset. Hence, $ 16000 forms a part of capital expenditure for vehicles. Therefore, the total cost will appear as a part of the balance sheet of the entity.
Conclusion
As far as understanding Capital Expenditure Examples, the basic intention behind capital expenditure is to maintain the existing operating efficiency of the company or to increase the production base of the entity. However, one should bring his attention to the fact that capital expenditure is driven by the nature of the business into which the entity is engaged. That nature justifies whether the expenditure is capital or revenue (i.e. day). Also, incurring capital expenditure engages a huge amount of outlay of money. Such money is usually financed by debt or the issue of capital. Thus, interest expenses incurred for the purpose of debt are capitalized (i.e. added to the cost of a fixed asset bought) in the value of the fixed asset on year to year basis. On the other hand, the cost incurred for a new issue of capital is not allowed to be capitalized. That is why big capital expenses are normally made out of the debt incurred.
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