- What is capex?
- Types of capex
- What can capex reveal about a business?
- Examples of capex
- How to calculate capex
- Capex vs opex
What is capex?
Capex, or Capital expenditure, refers to the financial resources that an entity allocates for acquiring, upgrading, and maintaining tangible assets like property, plants, buildings, technology, or equipment.
These funds are typically invested in new projects or initiatives aimed at expanding the entity’s capabilities. Entities make capex to enhance their operations by, for example, extending the useful life of assets through repairs, acquiring new equipment, or constructing additional facilities such as factories.
The primary criterion to determine if an expense qualifies as a capital expense is its enduring and repetitive nature. Capital expenses usually involve tangible assets that are not quickly consumed and persist on the entity’s balance sheet over several accounting periods.
Types of capex
Capex can be categorised into two main groups:
Expenses related to the creation of a new asset, including design costs, planning expenses, development compliance costs, and construction costs.
Expenditures associated with the replacement and repair of an existing asset. These costs are treated as capital if the replacement or repair contributes to extending the useful life of the asset.
Hence, these costs can be both tangible and intangible expenses. However, expenditures related to routine operations and maintenance should not be capitalised. As a result, these expenses are not recorded as period expenses on the income statement when they occur.
What can capex reveal about a business?
Capexs provide insights into how much an entity invests in both existing and new fixed assets to either sustain or expand its operations. In simpler terms, capex represents expenses that are treated as investments on the balance sheet rather than immediate expenditures on the income statement. This means that when an entity capitalises an asset, it spreads out the cost of the expenditure over the asset’s useful life.
The level of capex an entity engages in can vary depending on its industry. Industries that require significant investments in infrastructure or equipment, such as oil exploration, telecommunications, manufacturing, and utilities, tend to have higher levels of capexs.
Capex is typically reported in the cash flow statement under investing activities. Different entities may refer to capex using various terms like capital spending, purchases of property, plant, and equipment (PP&E), or acquisition expenses.
Moreover, the strategic decision making between capex and operating expense spending reflects the proficiency of an entity’s finance team in optimising fund utilisation to generate the highest possible return on investment.
Examples of capex
Under the AASB framework, particularly AASB 116 Property, Plant and Equipment, capex includes various forms of spending. These include:
Acquisition Costs: This is the most straightforward example of capex. It includes the purchase price of an asset and any other costs directly attributable to bringing it to the location and condition necessary for its intended use. For instance, if an entity buys a new machine for its manufacturing plant, the cost of the machine itself, along with transportation, installation, and testing costs, would be considered capex.
Costs of Major Overhauls or Upgrades: AASB 116 mentions that parts of some items of property, plant, and equipment may require replacement at regular intervals. For example, replacing major components of a machine or renovating a building to enhance its functionality or extend its useful life would be considered capex.
Costs to Prepare the Asset for Use: This includes costs such as site preparation, initial delivery and handling, installation, and professional fees. For example, if an entity constructs a new facility, the costs incurred in preparing the site for construction, including any necessary demolition, would be capex.
Safety and Environmental Related Expenditures: Expenditures made for safety or environmental reasons that are necessary for an entity to obtain future economic benefits from its assets are also considered capex. An example could be installing a new ventilation system in a factory to comply with environmental regulations.
Improvements that Increase the Asset’s Value or Extend its Life: Any expenditure that significantly improves an asset beyond its original condition or extends its useful life is typically considered capex. For instance, upgrading the software of a computer system to enhance its performance would be a capex.
Other forms of capex are as follows:
AASB 123 Borrowing Costs allows for the capitalisation of certain borrowing costs as part of the cost of a qualifying asset, categorising them as capex.
The rationale behind this treatment is grounded in the concept of matching costs with the benefits they generate, a fundamental principle in accounting.
Thus, borrowing costs are capitalised as they are seen as enhancing the value of the asset. When an entity borrows funds to construct or acquire an asset, the interest paid on that borrowing is considered part of the cost of bringing the asset to its intended state of operation. This is because, without such financing, the asset might not have been acquired or constructed.
Capitalising borrowing costs as part of the asset’s cost affects the financial statements by increasing the asset’s carrying amount. This treatment ensures that the financial statements more accurately reflect the entity’s investment in the asset and the future benefits it expects to derive from it.
Future restoration costs
Future restoration costs typically arise when an entity is obligated to dismantle, remove, and restore a site at the end of an asset’s useful life. This is common with assets like manufacturing plants, machinery, or infrastructure projects.
Under AASB 137, the estimated cost of these future restoration activities can be considered part of the capex of the asset. This is because these costs are seen as an inevitable and integral part of the asset’s life cycle, from acquisition to disposal.
When an asset is initially recognised, the estimated cost of dismantling and removing the asset, and restoring the site (known as a decommissioning liability), is included in the cost of the asset. This initial estimate forms part of the capex for the asset.
Costs in contract fulfilment
AASB 15 allows for the capitalisation of costs that are directly attributable to a contract when these costs are expected to be recovered through the revenue generated by the contract.
This includes costs that are explicitly chargeable to the customer under the contract or that can be directly associated with specific contracts.
The rationale for treating these costs as capex lies in their nature and benefit. If the costs are incurred to fulfil a contract and are expected to provide future economic benefits (like revenue from the contract), they are capitalised.
Examples include direct labour costs incurred in fulfiling a contract, direct materials, and costs that are explicitly chargeable to the customer under the contract. These costs are capitalised as they are necessary for contract fulfilment and are expected to be recovered.
Capex vs opex
Capex and operating expenses are distinct financial categories in business accounting, differing in their nature, duration of benefit, tax treatment, and impact on an entity’s financial statements.
Here, we provide a concise comparison to clarify these essential differences.
|Nature of Expense
|Long term investments in assets such as property, plant, and equipment (PP&E), or improvements to existing assets.
|Short term expenses required for daily operations like rent, utilities, salaries, and office supplies.
|Duration of Benefit
|Typically provides benefits over multiple years as it involves assets with a useful life of more than one year.
|Provides immediate benefits and is associated with the day to day operation of the business.
|Not normally deductible in the year incurred. Capital expenses are normally depreciated over time, and deductions are spread out over several years.
|Fully deductible in the same year they occur, reducing the entity’s taxable income immediately.
|Considered as investments in the entity’s balance sheet and depreciated over time, impacting the income statement through depreciation expenses.
|Recorded as regular expenses on the income statement and have an immediate impact on the entity’s profitability.
|Building a new manufacturing facility, purchasing machinery, or upgrading technology infrastructure.
|Paying employee salaries, rent for office space, utility bills, and costs for office supplies.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.