What Are Types of Capital Expenditures on a Balance Sheet?
Capital expenditures, such as the purchases of land, buildings and equipment, lay the foundation for the future earnings of a business. Clear presentation of this foundation on the balance sheet provides creditors and investors accurate information about the assets of a business.Reporting these expenditures in the correct categories, including the associated depreciation accounts, provides a clear and correct picture to those individuals.
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Balance Sheet Basics
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For non-accountants, the balance sheet is the least understood financial statement. Also called a statement of financial position, the balance sheet provides a snapshot of what a company owns, what it owes and the owner's equity. The equation assets = liabilities + owner's equity drives the balance sheet. When the two sides of the equation equal each other, the books are in balance, hence the name.
Capital Expenditures Definded and Categorized
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A capital expenditure represents the purchase of property intended to last more than one year. Recording this expense in a single year distorts the income statement by overstating expense in relation to income; therefore, the balance sheet reports such expenditures as assets of the company. Depreciation reports a portion of the expense for each year, matching expense against revenue.
Land, buildings and equipment all represent capital expenditures. These broad categories may contain a number of subcategories, shown as separate lines on the balance sheet. For example, the heading "land improvements" includes grading, paving and other costs directly attributable to a land purchase. The category "building" contains expenditures related to buildings such as a roof, window replacement and similar expenses. Equipment (frequently "furniture and equipment") includes subcategories for expenses related to office furniture, office machines and equipment used in manufacturing. Capital expenditures do not include such items as products for resale or for use in a manufacturing process.
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Contra-Accounts
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Depreciation spreads the cost of capital expenses over multiple years. Many acceptable methods of calculating depreciation exist. Most businesses follow the IRS Modified Accelerated Cost Recovery method, so that the company books reflect exactly what it reports on the tax return.
Each of the capital accounts must have an associated account for accumulated depreciation. For each year, a depreciation expense account reflects a charge for the loss in value of the asset. The accumulated depreciation account contains the total of these annual entries and subtracts it from the purchase price, thus showing the current net value of the asset.
On the balance sheet, an asset account and its associated contra-account will look like this:
Automobile: $25,000
Less Accumulated Depreciation: (5,000)
Net Value: $20,000
Benefits of Properly Recorded Capital Expenditures
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Bankers and investors closely scrutinize balance sheets, using specific ratios between categories of accounts to determine the financial health of a company. Because capital expenditures typically involve larger amounts of money, an incorrect categorization of these expenditures distorts these ratios significantly. Such distortion can negatively affect credit terms or attraction of investment.
Careful attention to the principles of reporting capital expenditures results in a balance sheet that accurately states the true financial condition of a business.
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