top of page
Search

CAPITAL EXPENDITURES: Recognition, Capitalization Rules, and Depreciation Tracking

ree
Capital expenditures (CapEx) represent investments in long-term assets that will benefit a company over multiple periods. These expenditures are not expensed immediately but recorded as assets and depreciated systematically over time.

1. What Are Capital Expenditures?

Capital expenditures refer to spending on acquiring, upgrading, or extending the useful life of fixed assets.

They are distinguished from operating expenses, which are incurred for the day-to-day running of the business.


Examples include:

  • Buying machinery or vehicles

  • Constructing or renovating buildings

  • Installing IT infrastructure

  • Upgrading production equipment

  • Significant repairs that increase asset life or efficiency

CapEx adds value to the balance sheet and is depreciated over the asset’s life.


2. Capitalization Criteria

To qualify as a capital expenditure under accounting standards (ASC 360 / IAS 16), a cost must:

  • Provide future economic benefit

  • Be related to a tangible asset

  • Be measurable and reliably estimated

  • Exceed a company’s capitalization threshold (e.g., €1,000)


Capitalizable costs include:

  • Purchase price

  • Delivery and installation

  • Legal and broker fees

  • Testing and preparation

  • Construction labor and materials


Non-capitalizable (expensed) costs include:

  • Regular maintenance

  • Repairs to keep asset in current condition

  • Minor replacements

  • Training or administrative costs


3. Journal Entry at Acquisition

When a fixed asset is acquired:

  • debit Asset Account

  • credit Cash or Accounts Payable


Example:

Buy production machinery for €50,000 (includes €2,000 transport and €3,000 setup):

  • debit Machinery ....................................................... 50,000

  • credit Accounts Payable or Cash ........................... 50,000

If financed, a liability is recorded instead of cash.


4. Depreciation Tracking

Capitalized assets are depreciated over their useful life, starting when the asset is ready for use.

Common depreciation methods:

  • Straight-line (equal amount yearly)

  • Declining balance (accelerated)

  • Units of production (based on usage)


Straight-line formula:

Annual Depreciation = (Cost – Salvage Value) ÷ Useful Life


Journal entry per year (straight-line):

  • debit Depreciation Expense

  • credit Accumulated Depreciation


Example:

Asset: €50,000

Useful life: 10 years

No salvage value→ Depreciation = €5,000 per year


5. Improvements vs Maintenance

Capital improvements are added to the asset's book value and depreciated.Routine maintenance is expensed immediately.

Cost Type

Treatment

Engine upgrade

Capitalize + Depreciate

Oil change

Expense immediately

Office remodeling

Capitalize

Cleaning

Expense


6. Financial Statement Impact

  • Balance Sheet:

    • Asset recorded at historical cost

    • Depreciation reduces carrying value over time

  • Income Statement:

    • Depreciation expense spreads cost across periods

  • Cash Flow Statement:

    • CapEx shown as investing activity (cash outflow)


Example: Purchasing equipment reduces cash from investing activities.

Depreciation appears under operating activities (indirect method) as a non-cash adjustment.


7. Disposal and Derecognition

When an asset is sold or retired:

  • Remove its cost and accumulated depreciation

  • Record any gain or loss


Example

Asset cost: €50,000

Accumulated depreciation: €40,000

Sold for €15,000 → Gain = €5,000


Entry:

  • debit Cash ......................................................... 15,000

  • debit Accumulated Depreciation ...................... 40,000

  • credit Equipment .................................................. 50,000

  • credit Gain on Disposal ...................................... 5,000


8. Disclosures and CapEx Planning

Companies disclose:

  • Total CapEx during the year

  • Asset breakdown by category (property, plant, equipment)

  • Depreciation methods and rates

  • Any changes in estimates or impairment losses

CapEx budgeting is crucial in strategic planning and capital allocation.


Key take-aways

  • Capital expenditures are long-term investments recorded as assets.

  • They are depreciated over time, not expensed immediately.

  • Only costs that enhance or extend an asset’s life can be capitalized.

  • CapEx affects all three financial statements and plays a key role in growth and asset management.


______________

FOLLOW US FOR MORE.


DATA STUDIOS

bottom of page