The Corporate Finance Institute defines capital expenditures (CapEx) as the dollars spent to acquire, repair, update or improve fixed assets. This could be a property, plant, equipment (PP&E) or any other long-term asset. A CapEx is a one-time purchase and is different from an everyday operating expense (OpEx), as operational costs are ongoing.
Capital expenses are the concept that capital assets or physical assets lose value over time. According to Rice University's Openstax, a depreciation expense will be noted on a balance sheet. But how do you determine what the CapEx depreciation expense is?
Accountants Use Four Methods
Accountants adhere to generally accepted accounting principles (GAAP) when determining a capital expenditure depreciation expense. These must appear on financial statements for the current period. Often a depreciation expense is a line item on an Excel sheet.
Four common CapEx depreciation formulas you might use include:
- declining balance
- sum-of-the-year’s digits
- units of production
Straight-Line CapEx Depreciation Formula
This is the most common and easiest CapEx formula for depreciation. This capital expenditure formula spread the depreciation expense over the asset's useful life. This is an excellent formula if a company wants to write off an even amount of depreciation each year. It's a sound way for small businesses to keep it simple.
According to the Cornell Law School Legal Information Institute, this is the straight-line CapEx depreciation formula: (cost of asset – salvage value)/years of useful life.
For example, if the asset is worth $25,000, you subtract a salvage value of $500 and divide it by a 10-year useful lifespan. That would equal $2,450.
Declining Balance CapEx Depreciation Formula
Another CapEx calculation for depreciation involves acceleration and is called the declining balance method. It is used to minimize tax exposure by writing off more depreciation costs early in an asset’s life. This formula works well for companies with assets that lose greater value in the early years.
This is the declining balance CapEx depreciation formula: current book value x depreciation rate.
For example, Acme’s depreciation amount may be a book value of $25,000 multiplied by 30 percent equals $7,500. Note that there's also a double-declining balance method that further accelerates depreciation.
Sum-of-the-Year’s Digits CapEx Depreciation Formula
The sum-of-the-year digits (SYD) formula accelerates depreciation but not as aggressively as the declining balance method.
This is the sum-of-the-year's digits CapEx depreciation formula: (remaining lifespan/SYD) x (asset cost – salvage value).
For example, if the SYD is 55 and the remaining lifespan is 10 years, 10 divided by 55 multiplied by 25,000 asset cost minus 500 salvage value equals $4,454. So, this means that in the first year, Acme Company can deduct $4,454.
Units of Production CapEx Depreciation Formula
The units of production formula assign an equal expense rate to every unit produced. This is most used where an asset's value lies in the number of units it produces. This equates to how much it's used over its life.
This is the units of production CapEx depreciation formula: [(asset cost – salvage value)/estimated units over assets lifetime] x actual units made.
For example, if the asset cost is $25,000, you subtract 500 (salvage) and divide by 50,000 units produced and multiply that by 5,000 actual units made. That means that Acme company has a depreciation expense of $2,450 per year.
Salvage and Useful Life
Business owners estimate the salvage cost. The salvage cost accounts for the total depreciation of the asset. It is an estimate of the asset’s worth at the end of its useful life.
Tangible Assets vs. Intangible Assets
Tangible assets are different from an intangible asset. A tangible asset is expensed through depreciation. In contrast, an intangible asset is expensed through amortization.
Estimated Useful Life
The estimated useful life accounts for the estimated lifespan of a physical long-term asset. A company's long-term assets appear yearly on a company's cash flow statement. The depreciation expense for long-term assets used each year appears on an income statement for the current period.
CapEx vs. OpEx
CapEx is capital spending showing on a balance sheet as purchased fixed assets, and these assets incur a depreciation expense.
OpEx has to do with the day-to-day business operations for the current year. These show up on a balance sheet as payroll, utilities, etc. Therefore, they are considered short-term expenditures.
- Depreciating capital expenditures properly can maximize a firm's cash flow. Estimating depreciation costs and potential savings before a purchase is made can help a business identify which assets are suitable investments. Business accounting professionals often have tax depreciation calculators that estimate depreciation deductions for fixed assets. These calculators enable the business to weigh the tax savings of different assets before making a purchase.
- Sell the asset at the end of its useful life for its salvage value if possible. Report either a gain or loss of the sale of the asset on IRS Form 4797, Sale of Business Property.
Anne attended University of Akron and went on to have a career in television sales. Working as a commercial property and casualty insurance agent for nine years allowed her to learn about different businesses' needs. She has also owned an advertising agency where she created marketing capaigns for various clients. Anne has written for several publications. She currently resides in Charleston, SC.