Capital equipment refers to long-lasting goods a firm acquires and owns that are not consumed in the normal course of business. These may include assets such as machines, trucks, large computers, and office furniture.
Owners expect capital equipment to produce operating benefits over a long period of time, usually several years or more. Accountants normally classify these items as capital assets. And, they track asset earning performance year-to-year with financial metrics such as return on total assets (ROA) and Total Asset Turnover.
Most firms establish criteria for deciding which items they acquire are capital items, and which are not. These criteria result partly from local tax laws, but they also reflect accounting policy choices by the firm's managers. Such criteria typically specify that an item qualifies as a capital item if it meets at least 3 conditions: The item must:
- Have a minimum useful service life or economic life (e.g., one year or more).
- Have an acquisition cost above a certain threshold (e.g., $1,000 or more).
- Contribute value to the firm's business.
Business firms normally handle capital and non capital items differently in several areas:
- The acquisition process
- Asset management and asset performance measures
- Valuing and reporting
This article further explains capital equipment decisions and accounting. Capital equipment terms appear in context with related terms from accounting and asset management.
- What is capital equipment?.
- How do firms acquire capital items? Do they acquire non capital items differently?
- How do firms manage and evaluate capital items? Do they manage non capital items differently?
- How do firms value and report capital items? Do they value and report non capital items differently?
- For an Introduction to CAPEX and OPEX budgeting, see Budget.
- For more on capital review and capital decisions, see Capital Review Process.
- Asset accounting and life cycle management are explained in Asset.
- For more on the several meanings of capital in business, finance, and economics, see the article Capital.
Firms Authorize Spending and Acquire Capital and Non Capital Items
Businesses normally plan, manage, and fund the acquisition of capital items on a company-wide basis. They usually make funding decisions, moreover, through committees, such as a Capital Review Committee.
These committees solicit and receive funding proposals from across the entire firm as part of the capital budgeting cycle. Committee members review proposals, interview sponsors, and then prioritize capital funding requests. They approve and authorize spending for the highest priority proposals first, and then continue through lower priority proposals. Approval continues until they reach the capital spending ceiling for the current budgeting cycle. For more on this process, see Capital Review Process.
Acquisition of non-capital items, by contrast, is typically initiated and authorized by many different individual managers at different levels.
Capital vs. Non Capital Items: Budgeting and Planning
Businesses normally purchase capital equipment through capital expenditures (CAPEX) with funds from the firm's capital budget. Note especially that the CAPEX budget is separate and distinct from the firm's budget for non capital expenses—the operating budget (OPEX budget). This means that funds for capital spending and non capital spending:
- Come from different sources (OPEX vs. CAPEX budgets)
- Are authorized by different managers.
- Are decided with different decision criteria.
For this reason, those who submit funding requests for projects, programs, initiatives, acquisitions, or other costly management actions, act wisely when they take these steps before submitting a request:
- Identify separately the OPEX and CAPEX totals in their own spending requests.
- Ascertain the total funds now available in each budget.
- Understand fully how the local CAPEX and OPEX approval processes differ.
- Understand which criteria decide spending decisions in each process.
Business firms normally establish a life cycle management process for managing capital assets. The process purpose is simply to maximize asset contributions to the business, while minimizing asset lifecycle costs. The process typically expects each asset class to have a productive economic life, running for a certain number of years. Assets are within their economic life when they return more value to owners than they cost to operate.
Local asset managers and tax authorities usually designate an expected economic life for individual asset classes—vehicles, factory machines, office furniture, or store equipment, for instance. offto have productive economic life greater than its costs (cost to acquire, cost to maintain, cost to operate). When an asset costs exceed asset returns, the asset is beyond its economic life. When costs exceed returns, the asset is beyond its economic life.
Business firms expect their capital equipment assets to justify their acquisition and existence throughout their economic life. Mangers of capital equipment normally assess asset performance periodically, with profitability metrics and investment metrics such as return on investment (ROI), return on assets (ROA), total asset turnover, and return on capital employed (ROCE). Under-performing assets may become targets for efforts designed to improve asset utilization. Or, they may become targets for replacement or liquidation. For more on managing assets and measuring asset performance, see Asset.
Firms value and report capital equipment assets such as factory machines on the Balance Sheet differently than they treat non capital assets (such as accounts receivable). For instance, capital equipment assets in particular have a reported book value on the Balance Sheet that can change during asset life. Book value changes may result from :
- Depreciation expense accumulated and charged against asset book value, or
- Certain kinds of value adjustments that local tax laws and Generally Accepted Accounting Principles (GAAP) permit or require.
Capital equipment assets, incidentally, may appear on the Balance Sheet in a category of their own (Capital Assets). However, the same assets may also appear in asset account categories such as Tangible Assets, Long-Term Assets, or Property Plant & Equipment. Or, the firm's accountants may choose to list and report capital equipment under asset categories named for the nature of the asset, such as "Computer Equipment," "Manufacturing Equipment," or "Store Assets." For more on asset valuing and reporting, see Asset.