Capital expenditures are amounts spent by companies to acquire tangible assets that will be used for more than one year in the operations of a business. Examples are plant, machinery, equipment, computer software. These amounts are included on the balance sheet as assets (capitalized) and expensed through the income statement over time, as opposed to being recorded as an operating expense in the period the cash is spent. The accounting rationale for this methodology is that the asset has a long useful life and therefore will benefit the company over several years. The expense therefore needs to reflect the period over which the company enjoys the use of the asset.
Capital expenditures are included in the investing activities section of the cash flow statement since the related assets are classified as long-term assets. Below is an example of the presentation from a cash flow statement:
Note that the amounts are shown on the cash flow statement net of any disposals of such assets. There are several other possible labels for this amount, such as “Additions to fixed assets” or “Additions to property, plant and equipment.”
Amounts spent on capital expenditures are “capitalized” as long-term assets on the balance sheet. Usually these amounts are called “Property, plant and equipment” or “Fixed assets.” The final amount on the balance sheet will always be net of accumulated depreciation, although the gross asset amount and the accumulated depreciation may be shown as separate lines on the balance sheet.
Sometimes companies will break the assets into more than one class on the balance sheet. For example, the company below shows two lines for capitalized tangible assets:
Additions to both these accounts appear on the cash flow statement as capital expenditures, although the figures are broken out in the respective footnotes (14 and 15) to the balance sheet amounts. The company likely breaks these amounts up since software is expensed over a shorter period of time (i.e. has a shorter useful life) than hardware.
The balance sheet amount for fixed assets is always presented net of accumulated depreciation. Therefore, the current period’s balance will be:
Net fixed assets = purchase price (cost) + additions/improvements - accumulated depreciation - impairments
Fixed assets / property, plant and equipment are typically recorded on the balance sheet at cost and remain at this value, net of accumulated depreciation, over their useful lives. In other words, these assets do not typically get adjusted to market value every period. Under IFRS rules, management has the choice to mark fixed assets to market, but they then need to do so every quarter. Most companies therefore do not record market values of assets given the difficulty in valuing these assets as well as the time required to do so.
On occasion, the carrying value of fixed assets can be written down if it is deemed that the value of such assets is impaired (i.e. unlikely to be reversed). For instance, if a company’s machinery or software becomes obsolete, management and its accountants may decide to write down the value of these assets.
Fixed assets are depreciated through the income statement over their useful lives. Useful life is the time period over which the company expects the asset to be productive.
The method of depreciation will depend on the type of asset and when in its life the asset is expected to be productive. Common depreciation methods include:
For some long-term assets such as intangibles or computer software, the expense is called amortization. In the example below, depreciation relates to computer hardware and other fixed assets (i.e. buildings), while the amortization relates to computer software as labelled.
In many cases, depreciation and amortization expense is embedded in operating costs on the income statement. Amounts may be included in cost of goods sold if they relate to fixed assets used in production, or they may be included in selling, general and administrative expense if they relate to assets used in corporate overhead (i.e. depreciation of buildings used for corporate staff).
In these cases, we need to look to the cash flow statement to find the depreciation and amortization amounts. Since depreciation and amortization are non-cash charges on the income statement that reduced net income, they need to be added back on the cash flow statement. They get added back in the operating activities section of the cash flow statement as shown below.
An intangible asset is one that is not physical in nature. Some intangibles, such as licences or patents, have a finite life and therefore need to be capitalized and expensed over time just like a fixed asset. Companies will typically show the amounts spent to acquire intangibles as a separate item in the investing section of the cash flow statement. The periodic expense of the intangible is called amortization as opposed to depreciation.
