If an expenditure is incurred for one of the following purposes, it is regarded as capital. This means that it will be defined as capital expenditure.
1. Purchase of Fixed Assets
When an amount is spent to purchase fixed assets on a long-term basis, this means the purchase was made to earn profit and not for resale. Such expenditure is regarded as capital expenditure.
If an electronics dealer purchases furniture for their business, this is termed an item of capital expenditure. However, if they purchase electronics items for resale purposes, this is considered revenue expenditure.
2. Improvement of Fixed Assets
An amount spent to improve the condition of an existing fixed asset, by which its value to the business increases, is treated as capital expenditure.
In this case, increasing the value of a firm’s fixed assets means increasing its working capacity, effectiveness, or longevity. If an expenditure is made to bring an old asset into working condition, it will also be termed capital expenditure.
Last but not least, if an expenditure is incurred to put an asset into working condition, it will also be considered capital expenditure.
If land is purchased for $500,000 and $3,000 is spent on registration and stamp duty, the capital expenditure on the land is $503,000.
If furniture is purchased for $300,000, $10,000 is paid as transportation, and $15,000 is paid as installation, the total cost of the furniture will be $325,000.
3. Increase in Earning Capacity of Fixed Assets
If the earning capacity of the business is expected to increase due to an expense, then the expenditure is defined as an item of capital expenditure.
Expenditure incurred to relocate an office factory to allow easier access to materials is an example of capital expenditure.
4. Erection and construction of assets
If a firm’s employees are engaged in the process of erecting a machine or extending a building, any wages paid to them are regarded as capital expenditure and will be included in the cost of the asset.
Wages paid to employees working on a factory extension are an example of capital expenditure.
5. Formation of Company
Preliminary expenses incurred before commencing business are considered items of capital expenditure.
Examples include legal charges paid to draft the memorandum of association, among others.
List of Capital Expenditures
To help students easily recognize different types of capital expenditures, a list of capital expenditures is given as follows:
- Purchase of land, buildings, motor vehicles, office equipment, or furniture
- Purchase of factory
- Cost of leasehold land and buildings
- Cost of acquisition of long-term rights and benefits, including patents, copyrights, goodwill, designs, patterns, and trademarks
- Preliminary expenditures
- Cost of addition or extension to existing assets
- Cost of overhauling second-hand machines
- Expenditures incurred in bringing assets into working condition
- Costs incurred to increase the earning capacity of the business
- Costs of issuing shares and debentures
- Legal expenses on loans and mortgage
- Interest on capital during the construction period
- Development expenses (in the case of mines and plantations)