What it is:
How it works/Example:
Let's assume Company XYZ wants to buy a new delivery truck for $40,000. When Company XYZ spends the $40,000, the book value of the company's assets are increased by $40,000. This amount is also recorded as capex, a use of cash, in the investing section of the company's statement of cash flows. Company XYZ then gradually expenses the $40,000 on its income statement over time as the truck depreciates. The length of time over which the truck depreciates (and thus the amount of annual depreciation expense) is determined by Company XYZ's choice of depreciation method.
Many companies set minimum dollar thresholds for capex, meaning that capital expenditures below the threshold are simply expensed even though they exhibit capexcharacteristics. This is done to simplify the accounting process and avoid having to record insignificant depreciation expenses each period for small-value assets.
Why it matters:
Capital expenditures generally takes two forms: maintenance expenditures, whereby the company purchases assets that extend the useful life of existing assets, and expansion expenditures, whereby the company purchases new assets in an effort to grow the business. It is important to understand that money spent to repair or conduct ongoing, normal upkeep on assets is not considered capex and should be expensed on the income statement when it is incurred.