Capital expenditure refers to the expenditure made by business entities which result in non-current assets or long-term assets and therefore are recognised and shown on the balance sheet of the business entities and not charged as expense in the income statement. Capital expenditure relates to the following items being acquired but take note that this is not the exhaustive list:
- Property, plant and equipment
- Investments in shares of companies
- Other form of investments e.g. property acquired for its investment potential ie capital appreciation and earnings by way of rental income earned
There is an important difference between capital expenditure on property, plant and equipment and capital expenditure made for investment purposes. For property, plant and equipment or fixed assets, the assets are acquired with a view or clear intention to use them in the operations of the business to generate the revenue (i.e. major source of income to the business entities). This is different to capital expenditure made for investment purposes such as b. and c. above. For capital expenditure made to acquire assets for their investment potential such as b. and c. above, the business entities have the intention to acquire the assets for their capital appreciation i.e. increase in market value over time and also for specific return from their acquisition e.g. dividend income for investment in shares of companies and rental income for investment in property.
This is the reason that property, plant and equipment acquired are subject to depreciation over the life of using the assets. Depreciation can be more easily understood as recognition of the consumption of the benefits that the assets give to the business entities systematically in the course of using them to generate the revenue of the business entities. However, business entities do not depreciation investment in shares or investment in property but they do recognise the decrease in value (market value is a good guide to be used as fair value) of the investments made earlier. I shall not discuss the effect of increase or decrease in value of investments and how to recognise them in accounting here because this is the topic of advance accounting.
Example – Purchase of Fixed Assets Or Property, Plant And Equipment
- On 1/1/2007, Dragon Co. Ltd. purchased a car by issuing a cheque of $5,000 to Fantastic Cars Co. Ltd. as cash deposit. The balance of $145,000 is under hire purchase financing obtained from Rich Bank. The double entry to record this transaction is: –
- On 31/1/2007, Dragon Co. Ltd. makes a monthly depreciation of $1,250 based on the annual depreciation rate of 10% on cost. The double entry to record this transaction is: –
The depreciation charge of $1,250 per month shall be done every month until the cost of acquiring the car of $150,000 is fully depreciated.