If you’re looking to go into accounting, capital expenditure is something you will need to become very familiar with. Commonly known as ‘CAPEX’, capital expenditure is where a company invests in new assets, either through buying new ones or improving existing ones.
The most common forms of CAPEX are property, machinery, and plant (factories). It is usually done when an asset is nearing the end of its useful life, or it has been decided by the board that a new project is to be undertaken.
There are a variety of reasons why this could be decided. The most common is that an improvement can be made that will result in an increase in turnover or profit.
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Calculating capital expenditure
So, how do you calculate capital expenditure? Let’s look at an example. A machine currently in use can produce 10 units per hour. Over a 40 hour week, that means the company can produce 400 units.
The company could also choose to invest in a new piece of equipment that produces 15 units per hour. This would mean the ability to produce 600 units per week, resulting in the company increasing its output by 50%. If the increase in turnover to the business would be more than the cost of the new equipment, then the new investment would be profitable.
Once a new investment like this has been made, CAPEX is then carefully worked into the company’s accounts. If a new machine is purchased and is expected to be used for the next 10 years, the cost of the machine will be split over 10 years in the accounts.
Let’s say the machine cost is £100,000. Although you would have to buy the machine outright for that price, it would be wrong to charge all of it to that year’s accounts. Instead, the cost would be divided among 10 years, and a certain amount would be charged each year (depreciation).
This means that the accounts would show a true reflection for that year. The balance that has not yet been charged to the accounts would sit on the balance sheet as a Non-Current Asset.
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