Owners Expect Capital Items to Justify Their Presence on the Balance Sheet. Assets Earn Their Keep by Producing Returns.
What is Capital Equipment?
Capital equipment items are long-lasting goods a firm acquires and owns, but does not consume in the ordinary 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 time, usually several years or more. Accountants commonly 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. These criteria typically specify that an item qualifies as a capital item if it meets at least three conditions. Capital items:
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.
Capital Equipment Explained in Context
Business firms usually 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 concepts from accounting and asset management.
How Do Firms Acquire Capital Items? Do They Obtain Non-Capital Items Differently?
Firms Authorize Spending to Acquire Capital and Non-Capital Items
Businesses usually plan, manage, and fund the acquisition of capital items on a company-wide basis. They typically make capital 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, typically initiates with different managers. In most cases, individual managers at many different levels can authorize non-capital spending.
Capital vs. Non-Capital Items: Budgeting and Planning
Businesses usually 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). Thus, 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 significant management actions, are prudent when they take steps to understand these issues thoroughly before requesting funds.
Identify the OPEX and CAPEX totals separately in their 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.
How Do Firms Manage Capital Items DO They Manage Non-Capital Items Differently?
Some firms establish a lifecycle management process for managing capital assets. The process purpose is 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 lives" when they return more value to owners than they cost to operate.
Local asset managers and tax authorities usually designate an economic life they expect for individual asset classes—vehicles, factory machines, office furniture, or store equipment, for instance. Owners expect assets to earn more in their lives than it costs to acquire, maintain, and operate them. When asset costs exceed asset 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. Managers of capital equipment usually 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.
Valuing and Reporting Capital Items Are Non-Capital Items Handled the Same Way?
Firms value and report capital equipment assets such as factory machines on the Balance Sheet differently than they treat noncapital 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: