The purchase or construction of a new office building is a capital expense for a business.
Fixed asset purchases and purchases made to update fixed assets are the two different types of capital expenditures (capex). Fixed assets are physical assets with a useful life that extends well beyond the current year. The property must also be of a certain nature to qualify as a fixed asset rather than a current asset. Physical property treated as a fixed asset should have a quality of permanence, such as real estate or large machinery, rather than something that may have a useful life of many years but can be easily moved or sold, such as a printer or computer. The fixed asset category is commonly known in a budget as property, plant and equipment (PP&E).
Business expenses must be properly classified for accounting and tax purposes. Assets that a business acquires during a tax year can be treated as current or fixed, which affects how the asset is treated for tax purposes. An asset is considered current if it is used in the current year or subsequent years or if it can be easily converted to cash. The cost of acquiring a current asset is written off the company’s books in the year in which the asset is acquired.
A fixed asset is property that has a long useful life and cannot be easily sold or converted to cash. This type of goods cannot be expensed in the year in which they are acquired. The tax code requires that the cost of fixed assets be depreciated over their useful life, which means that the total cost must be spread over the years the property will be used and an equal portion deducted each year. The property is depreciated each year, which is another expense that the business must record in its accounting system.
Capital expenditures are amounts spent on fixed assets. There are two types of cash outlays that qualify the expense as capital for tax purposes. If a business buys something considered a fixed asset, the expense is a capital expense. Expenses to update a fixed asset or extend its useful life are also considered capital. Any expenditure of money to acquire a current asset is considered an operating expense (opex).
The importance of classifying capital expenditures is primarily related to tax treatment, but it also has other implications for the financial operations of the company. Businesses operate within an annual budget, and operating budgets manage cash flow over the course of a fiscal year. Fixed assets are accounted for separately in a capital budget that reflects only capital expenditures. The purchase or development of property, plant, and equipment often requires large cash outlays, complex financing, and an acquisition plan that spans several years, requiring management to identify assets in advance so that they can be properly accounted for in the plan. company financial.