Capital spending is the use of cash reserves or liquidated assets to purchase equipment with a long lifespan. Depreciation is recorded as the value of assets deteriorates, and capital expenditures are listed as investments on cash flow statements. Upgrades and maintenance can also be considered capital expenditures. The goal of capital spending is to increase a company’s profit over time, but it cannot be deducted as an expense for tax purposes in the first year.
Capital spending involves the process of a business using cash reserves or other liquidated assets to purchase equipment that has a long-lasting overall life of more than one year. This often includes buildings, land, heavy machinery, and vehicles. It is a form of business spending that is kept clear in the financial ledgers of day-to-day expenses, such as payroll and inventory investment. As the value of capital assets deteriorates over time, this depreciation is also recorded in financial accounting to accurately determine a company’s net asset value through capital depreciation entries.
In business accounting, all capital expenditures are traditionally listed as a form of investment on the cash flow statement initially. As equipment deteriorates over the years, its reduced value is considered an expense of doing business, and this is recorded on the company’s annual or quarterly income statement under capital depreciation. This capital depreciation rate is calculated in a number of ways and can vary widely from country to country and industry to industry. Depreciation is often based on what the fair market value of a capital asset is at any time as a component of the entire net worth of the business, or for its usefulness in playing a productive role in the affairs of the business. Research and development capital spending often falls into a special case scenario for depreciation, since such assets typically lend little immediate income value to the company.
Business liability entries in accounting often include capital expenditures, since it is an expense first, not an asset. However, not all purchases in terms of capital expenditures are for the direct acquisition of new equipment or land. Some expenditures are made to improve the quality of existing capital assets, such as upgrading them with robotic systems or other improved technology, or performing extensive maintenance and repairs to extend the operating life of a capital asset.
The primary motivation behind capital spending is that it will increase a company’s bottom line or profit level over time. This can occur through increased productivity per labor, the ability to capture more market share through higher volume runs, or outperforming competitors by producing superior products. Capital purchases have the disadvantage under most modern accounting standards that they cannot be deducted as an expense for tax purposes in the first year of purchase. This is the meaning of the term “capitalized,” where capital spending is seen as investment spending in the first year and revenue spending in all subsequent years.
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