Capital Outlay: Everything You Need to Know
Capital outlay is defined as money that's spent to maintain, upgrade, acquire, or repair capital assets. Capital outlays, sometimes called capital expenditures, are recorded as liabilities by accountants on the balance sheets for the company. 3 min read
2. Investment vs. Maintenance
3. Accounting Treatment
4. Capital Budgeting
5. Capital Expense Classification
Capital outlay is defined as money that's spent to maintain, upgrade, acquire, or repair capital assets. Capital outlays, sometimes called capital expenditures, are recorded as liabilities by accountants on the balance sheets for the company. These are considered investments in the company, so the accounting of them is different than what it is for operational expenses.
What Is Capital Outlay?
Capital assets are also known as fixed assets and can include the following:
- Other necessities that aren't normally expended
Fixed assets can appear on the company's balance sheet as property, plant, and equipment, which is also called "PPE." Payments that are made in cash equivalents or cash over one year's time are known as capital expenditures. An example of this is paying for a factory to be constructed. Capital expenditures need to be capitalized in accounting. Capital outlay gets charged to an asset account that's long-term.
Examples of capital outlay include expenditures that end in the acquisition of fixed assets, site improvements, building construction, buildings that already exist, retrofitting current buildings with the purpose of energy conservation, and extra furnishings and equipment for educational facilities. Capital outlay can also include equipment such as tractors, snowmobiles, office furniture, trailers, boats, file cabinets, machinery, calculating machines, and other types of business machines that have a lifetime of at least one year. Implements, instruments, and tools that are used constantly with no material change in their value or physical condition also are under capital outlay.
Investment vs. Maintenance
It's crucial to know the difference between maintenance and investment when viewing capital outlays. If a business runs a delivery company and they buy a new vehicle, it's considered a capital outlay since it was money that was spent to get a fixed asset. If the engine is replaced in a current vehicle, that is also defined as capital outlay since the replaced engine will allow the vehicle to have a longer life.
However, it's only considered maintenance if the oil is changed or the tires are replaced, as they're only maintaining the vehicle's working condition. Any maintenance costs are considered revenue expenditures and not capital expenditures since they're the cost of earning revenue.
Capital outlays aren't treated as expenses that are immediate. If a business spends $20,000 on a new truck, they haven't surrendered any value as far as accounting goes. They had $20,000 worth of cash before, and now they have $20,000 worth of PPE, so the overall net assets haven't changed. The truck will eventually be reported as an expense, but it won't be done all at once. There's a finite life for the truck to be useful, so the $20,000 will gradually be expensed over the course of the truck's useful life. This is also known as depreciation.
However, revenue expenditures are immediately expensed. If it costs $100 for an oil change on a truck, that will be an immediate expense that's reported.
Capital budgeting is a process where companies plan their capital outlays. A business that's successful knows it needs to invest in the fixed assets if it intends to remain competitive. During capital budgeting, the business will look at possible capital projects when it comes to the upfront investment that's required compared to cash flows that are generated. The project is worth continuing if they find that the return will justify the investment. The capital budget is different from the operating budget.
Capital Expense Classification
Companies have different expense classifications and financial formulas so they can figure out what will happen if their sales go down or up. Spreading out capital outlays costs over several years gives a more accurate expense of how much it costs to produce and sell a product, as well as run a company.
As an example, a copy machine that costs $10,000 may make one million copies before it stops working. If 200,000 copies are made every year, it costs the company $2,000 each year to own the machine for five years. Sometimes the company will record the total expense of the capital asset the year they purchased it to decrease income tax liability.
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