Differences Between Capital Expenditures & Operating Expenses
A capital expenditure differs from an operating expense in several ways, including how a business accounts for a capital expenditure compared to an operating expense on the company’s financial statements. Capital expenditures differ from operating expenses in terms of time as well. In general, a business makes a capital expenditure to acquire or improve an asset that has a useful life of one year or longer, and it pays operating expenses relating to items with comparatively shorter working lifespans.
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Capital Expenditures
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A company pays capital expenditures to increase the value of its business. A business increases its value by investing in the purchase or improvement of its capital assets. Examples of capital expenditures include a company’s purchase of commercial vehicles, production machinery, operating facilities, land and office equipment. The Internal Revenue Service generally acknowledges the costs associated with starting a business as capital expenditures as well. Start-up costs that qualify as capital expenditures are expenses a company pays in advance of beginning its for-profit business activity and may include advertising costs and wages paid to staff members during training periods.
Operating Expenses
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A company incurs operating expenses as part of conducting its business. A business pays operating expenses regularly and repetitively throughout its existence. Examples of operating expenses include utilities, insurance, wages and rent. A business records money paid for an asset that has a useful life of less than one year as an operating expense as well.
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Improvement vs. Repair
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The operating expenses a business pays include costs related to maintaining and repairing its capital assets. If a business hires a contractor to replace a part on a piece of the company’s manufacturing equipment, for instance, the business records the money paid for the new part and the labor to install the part as an operating expense. If the business replaces an old part on the equipment with a new one that enables the machine to produce more items at a faster pace than it did before, on the other hand, the company records the expense paid for the new part and its installation as a capital expenditure because the machine was improved.
Financial Statements
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At the end of a given period or accounting cycle, a business prepares financial statements to demonstrate its financial well-being, including a balance sheet and an income statement. A company’s balance sheet lists the assets that required capital expenditures for them to be purchased or improved. During the course of a capital asset’s useful life, a balance sheet assigns an incrementally smaller value to the asset because the business depreciates the asset to reflect wear and tear. A business records the amount by which it depreciates an asset during an accounting cycle on the company’s income statement. In addition to depreciation, a company’s income statement itemizes the operating expenses the business paid during the period.
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