Capital Expenditure (CAPEX) Explained
Definition, Meaning, and Examples
Business Encyclopedia, ISBN 978-1-929500-10-9. Revised 2014-04-23.
An organization's spending for a budgeting period is divided between capital expenditures (CAPEX) and operating expenses (OPEX). The two kinds of spending are planned and managed separately. Capital expenditures are primarily for the acquisition of capital items carried on the balance sheet as assets.
A capital expenditure (CAPEX) is defined as an expenditure contributing value to the property and equipment of a business. It is an expenditure toward capital assets, as contrasted with spending that covers operating expenses (OPEX) or purchase of investments unrelated to business.
At the top of the budget hierarchy in most companies and organizations stand two major kinds of budgets, a capital budget and an operating budget. These two kinds of budgets do not overlap: they handle distinctly different spending categories. Capital and operating budgets, moreover, are built through different budgeting processes, by different managers, and they use different criteria for prioritizing and deciding spending.
Capital spending vs. Operating expenses
Whether or not an expenditure qualifies as a capital expenditure (CAPEX) or as an operating expense (OPEX) depends on what is purchased, what it will be used for, and also upon the country's tax laws. Companies and organizations normally designate specific criteria that must be met for an acquisition to qualify as "capital," such as a minimum useful life (e.g., one year or more) and a minimum purchase price (e.g., $1,000).
The tax authorities also have a say in what may be considered a capital expense because capital items go onto the company's balance sheet as assets, and on the income statement they create a depreciation expense for each year of the asset's depreciable life. This depreciation expense lowers reported income (profit), thereby creating a tax savings for each of these years. Spending on operating expenses, by contrast, impacts reported profit and taxes on earnings only in the single reporting period they are incurred.
Deciding what can and what cannot be called a capital expenditure, therefore, often requires knowledge of local policy and local tax laws. Some expenditures for business start up costs, for instance, can be capitalized in the United States and some other countries, but not all countries. In some localities, the costs of professional services (such as systems integrations services) can, under some conditions be "bundled" into the full capital costs of acquiring assets (e.g., a large IT system).
Acquisitions that typically meet company and government criteria as "capital assets" typically include such things as purchased:
- Factory machinery and production equipment
- Store equipment and furnishings
- Laboratory equipment
- Large IT systems (Hardware and/or Software)
- Office Furniture and Office Equipment.
Operating budgets, by contrast, address spending on predictable, repeatable costs for items or services that are not registered as capital assets and are not depreciated. That means the company charges the full amount against income during that reporting period, and takes all tax consequences for it during that period.
By Marty Schmidt. Copyright © 2004-.