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Capital expenditures (CAPEX) and operating expenses (OPEX) represent two categories of business expenses. However, there are distinct differences between the two and their respective tax treatments.

Capital Expenditures

Capital expenditures are the amounts that companies use to purchase major physical goods or services that will be used for more than one year. For example, a company might have capital expenditures to increase its fixed assets or improve its fixed assets. Fixed assets are treated as noncurrent assets from an accounting standpoint, meaning they won't be consumed up in the first year.

Capital expenditures might include:

  • Plant and equipment purchases
  • Building expansion and improvements, 
  • Hardware purchases such as printers or computers,
  • Vehicles to transport goods.

The type of industry a company is involved in largely determines the nature of its capital expenditures. The asset purchased may be a new asset or something that improves the productive life of a previously purchased asset.

The capital expenditure is recorded as an asset on the balance sheet under the section property, plant & equipment. However, it's also recorded on the cash flow statement under investing activities since it's a cash outlay for that accounting period. 

Once the asset is being used, it's depreciated over time to spread the cost of the asset over its useful life. In other words each year, a part of the fixed asset is being used up. Depreciation represents the amount of wear tear on the fixed asset. Depreciation is important because the amount of depreciation for each year can be used as a tax deduction. Capital expenses are most often depreciated over a five to 10-year period but may be depreciated over more than two decades in the case of real estateHowever, please consult a tax advisor regarding tax deductions since the depreciation amount can vary depending on how the IRS calculates depreciation. 

Operating Expenses

Operating expenses are the costs for a company to run its business operations on a daily basis.

Examples include:

As operational expenses make up the bulk of a company's regular costs, management typically looks for ways to reduce operating expenses without causing a critical drop in quality or production output. In contrast to capital expenditures, operating expenses are fully tax-deductible in the year they are made.

It's important to note that sometimes an item that would ordinarily be obtained through capital expenditure can have its cost assigned to operating expenses if a company chooses to lease the item rather than purchase it. This can be a financially attractive option if the company has limited cash flow and wants to be able to deduct the total item cost for the year.

Takeaways

Capital expenditures are major purchases that will be used in the future. The life of these purchases extends beyond the current accounting period in which they were purchased. Because these costs can only be recovered over time through depreciation, companies ordinarily budget for capex purchases separately from preparing an operational budget.

The operating expenses represent the other day-to-day expenses necessary to keep the business running. These are short-term expenses and are used up in the same accounting period in which they were purchased. 

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