Companies spend money in order to develop the company and earn profits. When the company spends money, it has two options at the time it disburses the funds. It can expense that amount or it can capitalize that amount. The choice depends on how it uses the money.
Capital expenditures represent money spent to purchase and install major physical assets that the company plans to use in the business. The company considers all the costs required to place the asset into operation, such as purchase price, installation charges or freight costs. When the company considers the asset fully operational, it records the total cost of the capital expenditure as a fixed asset in its accounting records. This value remains in the financial records as long as the company owns the asset. The accountant records depreciation on the asset at the end of each period. Examples of capital expenditures include office buildings, vehicles or a plant conveyor system.
Capital expenditures appear on different reports throughout their existence. Many companies create monthly capital expenditure reports that detail the beginning of new capital expenditure projects, track the progress of capital expenditure projects as they become operational, and accumulate the cost of each capital expenditure project. The company reports capital expenditure projects in progress and completed on the balance sheet in the category of property, plant and equipment. Finally, the company reports the cash flows of the capital expenditure project on the statement of cash flows under investing activities.
Expenses represent money spent to purchase supplies used in the business or services needed to maintain business operations. The company recognizes the expense in the period it benefits from the expense, which may occur in a different period than the payment. For example, the company pays for an insurance policy that provides insurance benefits to the company for the next six months. The company recognizes an expense each month equal to one-sixth of the total payment. Examples of expenses include employee salaries, repair expenses or rent expense.
Expenses appear on different financial reports. The income statement reports all of the expenses incurred during the period, whether or not the company makes a payment during that time. The expenses reported reduce the net income of the business. Expenses that the company paid for during the period appear on the statement of cash flows under operating activities.
