What is capital expenditure , and how do you record capital expenditure in the accounting records?
Capital expenditure for a business is the acquisition of an asset, or assets which will be used in the business for the conduct of that businesses operations for a considerable period, usually exceeding one accounting period. Thus the benefit of the capital asset, is expected to persist over multiple years.
When a small business buys a server computer for say £4,000 this is a fairly substantial out lay for a small company. Typically, a server will have an operational life of four to five years. The matching concept in accountancy requires that we match the expense to the period over which it is relevant.
In the case of our £4,000 server, that is four to five years depending on the companies replacement policy. Hence the full capital expenditure of £4,000 should be taken to fixed assets.
The capital expenditure of £4,000 is now released to the Profit and loss account via a depreciation charge. Typically, this will be the cost of £4,000 divided over the expected useful life of the asset. Assuming the choice is four years, a charge of £1,000 would be taken to profit and loss each year.
Some companies will elect to fine tune their depreciation charge in the year of initial capital expenditure to a monthly charge.
A server computer is an obvious example of capital expense, others include, printers, cars, factory machinery like lathes, tractors, robots, and many others. However, some items that might be thought of as maintenance , could actually fall under capital . There is a lot of legal precedent illuminating what may be considered capital expenditure. Its beyond the scope of this article to go into detail on these precedents.
However, one clear principle is that, where the work done , or additions to an existing asset, extend the utility of that asset, the expenditure should be considered as capital expenditure.
Thus if a building has been acquired in a derelict condition, unfit for use as a business premises, the cost of making it usable will be capital in nature. Thus, the cost of repairing windows, floors, painting , new bathroom fittings, labour costs, and all the associated costs, will have to be capitalised.
Similarly, when you buy accessories for a factory lathe machine which make it possible to make new items, the nature of your purchase will be capital.
In recognising capital expenditure, one generally capitalises only material expenditure. Thus, even if your £10 screw drivers are expected to last a couple of years, generally, you would charge small tools to maintenance or other suitable profit and loss accounts.
Tax relief for capital expenses is via the capital allowances regime, under which we also find the Annual investment allowance which became available on qualifying expenditure incurred after
6th April 2008 per the Finance act 2008. Plus there are many other allowances. Capital allowances will be looked at in another article.