A capital expenditure is the use of funds or assumption of a liability in order to obtain physical assets that are to be used for productive purposes for at least one year. This type of expenditure is made in order to expand the productive or competitive posture of a business.
A capital expenditure is recorded as an asset, rather than charging it immediately to expense. The fixed asset is then charged to expense over the useful life of the asset, using depreciation. For example, if you acquire a $25,000 asset and expect it to have a useful life of five years, charge $5,000 to depreciation expense in each of the next five years.
An example of an asset upgrade is adding a garage onto a house, since it increases the value of the property, whereas repairing a dish washer merely keeps the machine in operation.
Examples of capital expenditures are funds paid out for buildings, computer equipment, machinery, office equipment, vehicles, and software.
Since there is a record keeping cost associated with capital expenditures, you generally charge such items to expense if they cost less than a certain predetermined limit, which is known as the capitalization limit. For example, if a company's capitalization limit is $2,000, then a computer costing $1,999 would be charged to expense in the period incurred, whereas it would be recorded as an asset if it cost $2,001.
The reverse of a capital expenditure is an operational expenditure, where the cost is incurred strictly for current operations. Always charge operational expenditures to expense when incurred. Since they are charged to expense in the period incurred, they are also known as period costs.
From a financial analysis perspective, a business should at least maintain its historical level of capital expenditures. Otherwise, it will be suspected that management is not adequately reinvesting in the organization, which will eventually lead to a decline in the business.
A capital expenditure is also known as a capital expense, or as capex.