When investing in companies, I have to understand what "capital expenditure" is. It seems that we typically consider how much we take in (sales or revenue) and deduct the costs and arrive at net income each year, but for costs that actually is long lasting, such as a computer or a roof, we would first classify it as "capital expenditure" and then not consider it a cost directly, but "depreciate it", which is to divide the amount by 6 or 30 and make it the "depreciation cost", in a way dividing up the purchase price as a cost for each year?

However, it is strange that painting of the house or warehouse is actually an operating cost, instead of capital expenditure? Nowadays a computer may last 6 years, and painting can last 12 years, so the painting lasts longer than a computer but yet we consider the computer purchase a capital expenditure but the painting an operating cost?

  • I can sell a computer separately, I don't think I can sell the paint off a factory. Perhaps you can pick a better example. – Morrison Chang Nov 11 '19 at 5:50
  • @MorrisonChang but you can't sell the roof separately too. I think fixing or putting a new roof on is capital expenditure, vs the painting is not. So it may not depend whether you can sell it separately – nonopolarity Nov 11 '19 at 6:18
  • I believe you need to get a basic accounting book to go through to figure out all your queries. Do you have a library near your home or just google for a basic accounting book. – DumbCoder Nov 11 '19 at 15:21
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    How is this different from your earlier question? – D Stanley Nov 11 '19 at 18:10

The principle behind capital expenses is when you spend money on a fixed asset whose economic benefit goes beyond the current fiscal year. So painting a warehouse or building probably doesn't have a long-lasting economic benefit, but repairing a roof or buying a computer to operate your business certainly does.

Note that the effect between capitalizing and expensing a cost is mostly an accounting mechanism. If you buy a building and depreciate it over its life, you're just distributing that expense over several years rather then deducting it all in the year it was incurred. That may have some tax consequences, but from a cash standpoint it doesn't matter.

Say I buy a truck for $10,000 that is expected to last 5 years (with no salvage value) and use it to earn $10,000 per year. If I expense it now, I'll have no income in year 1 and $40,000 in income in years 2-5. If I depreciate it instead, I'll expense $2,000 per year and have $8,000 in net income per year for a total net income of $40,000. So it made no difference in the bottom line over that time (again I'm ignoring taxes and maintenance) but it smooths out the cost of that revenue-generating asset over its life, providing a more realistic balance of revenues and expenses. In either case, though, I have a net cash flow of $0 the first year and $10,000 in years 2-5.

  • Thank you. So if it is for tax purposes, can you expense the whole truck or computer in year 1 instead of over 5 or 6 years? – nonopolarity Nov 11 '19 at 19:02
  • Vehicles are probably required to be capitalized. Computers are optional possibly because their costs is so small relative to vehicles or buildings that it's not worth the trouble to amortize them. If you have to buy a thousand computers, though, the IRA may consider that fixed assets and require you to capitalize them. It may also depend on whether the computers are revenue generating (i.e. you run a web site on a server farm you create) or just used to operate the business. – D Stanley Nov 11 '19 at 19:09
  • @DStanley Nice typo. Now I'm imagining the IRA nosing around in my business accounting.. – Michael Nov 11 '19 at 19:57
  • @Michael lol you never know... – D Stanley Nov 11 '19 at 20:00

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