Expenses refer to costs that business undergo in order to conduct their daily business operations, expand and grow their business, and acquire additional assets, property and factories. Firms are capable of investing their cash into a few different kinds of investments. They might buy a new building or some real estate. They could similarly purchase office or computer equipment for their premises. They might update older technology for the firm or aging machinery for production so that the business gains a higher level of productivity. These companies might also acquire vehicles for their traveling staff, such as executives, sales people, or for their delivery personnel. Any of these various types of investments would be for capital assets, which would make them capital expenses (sometimes also called expenditures).
Such expenses represent payments that a firm makes to acquire or increase the performance of longer-term capital assets such as equipment, factories, and buildings. These are generally expensive and substantial purchases which companies pursue for a corporate investment. Another way of thinking about this is that such capital expenses increase the overall business value. In consequence, as the asset values gain, so too does the net worth of the owner or stake holders. Yet at the same time the expenses incurred in acquiring the asset will similarly increase the liability of the owners.
Another expense that businesses realize analysts call depreciation. This simply means that assets decline naturally in value with time. It diminishes the company’s value as it inevitably occurs. Such costs of capital expenses thus can be depreciated or capitalized throughout a given amount of time. This time equates to what the business world refers to as the useful life of the asset in question.
It always helps to consider an example of difficult concepts like these. When companies acquire equipment in the office for $20,000, they can depreciate this expense amount over a period of five years. It means that they will be allowed to take their depreciation of capital expense to the tune of $4,000 per year. Sometimes, this depreciation can be accelerated so that businesses realize the expense benefits quicker. There are also accountants who choose to include such intangible assets as copyrights, trademarks, and patents in the capital expenses category. Such assets become amortized, which is not unlike the process of depreciation in many ways.
It follows that companies should be able to expense the costs to keep a given capital asset up, in service, and working properly and efficiently. While this surmise is true, it cannot be done under the capital expense categories. Instead, they are treated as operating expenses in many cases. Yet with repairing equipment, this would likely increase its value. In that instance, this would represent a capital expense. This is why tax professionals have to help firms with figuring up the appropriate categories and depreciating.
Some other types of assets cannot be depreciated at all. Land is one of these. Because real estate does not lose value, the IRS considers that it possesses an indefinite value. This means firms may not depreciate real estate like they can with capital expense and operating costs.
When all else is equal, companies would rather obtain their tax deductions for asset purchases sooner rather than later. Yet the Internal Revenue Service has something to say on the subject. They maintain the rigorous rules on what may or may not be expensed out immediately. Startup costs are a good example of this. They will certainly boost the firm’s value but they are spent upfront. The IRS permits just a certain quantity of such startup costs to be expensed out during the first year of business. The rest of these have to be amortized. In 2015, the government passed new legislation that permitted for more liberal benefits of corporate depreciation for those companies that buy capital assets.