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.

Example

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.

Example 1

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.

Example 2

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.

Example

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.

Example

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.

Example

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:

  1. Purchase of land, buildings, motor vehicles, office equipment, or furniture
  2. Purchase of factory
  3. Cost of leasehold land and buildings
  4. Cost of acquisition of long-term rights and benefits, including patents, copyrights, goodwill, designs, patterns, and trademarks
  5. Preliminary expenditures
  6. Cost of addition or extension to existing assets
  7. Cost of overhauling second-hand machines
  8. Expenditures incurred in bringing assets into working condition
  9. Costs incurred to increase the earning capacity of the business
  10. Costs of issuing shares and debentures
  11. Legal expenses on loans and mortgage
  12. Interest on capital during the construction period
  13. Development expenses (in the case of mines and plantations)

Frequently Asked Questions

What is capital expenditure?

Capital Expenditure is an amount incurred on a long-term basis to acquire a fixed asset in order to earn a profit. It does not include revenue expenditure, which only appears when the business has been conducted for less than 12 months. If there was no sale or earning any additional expenses. Examples include costs of purchasing land and buildings, motor vehicles, office equipment, patents, etcof income from the business for this period, it is not regarded as an expenditure.

What is revenue expenditure?

Revenue expenditure is defined as an expense that only appears during the conduct of business, which does not last for more than 12 months. However, if it has a repetitive nature and continues to appear even after this time frame, then it will be treated as Capital Expenditure. For instance, the cost of postage and telephone is paid for during the course of business. These costs can be regarded as revenue expenses if they are not expected to continue after 12 months.

What is an asset?

An asset is a resource that has value due to its ability to provide benefits in future periods. It includes cash and anything else that has a value expected to be received in return for anything sold or used.

What is the main benefit of capital expenditure?

The main benefit of Capital Expenditure is giving an opportunity to generate future revenues.

What is the difference between capital expenditure and revenue expenditure?

The main difference between capital and revenue expenses is that the former relates to assets (resources) while the latter deals with day-to-day operations. Another distinction is that Revenue Expenditures are not expected to continue for more than 12 months, but capital expenses will be incurred over a long period of time.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

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