What Is An Operating Expense vs. a Capital Expense?

An operating expense (OPEX) is an expense required for the day-to-day functioning of a business. In contrast, a capital expense (CAPEX) is an expense a business incurs to create a benefit in the future. Operating expenses and capital expenses are treated quite differently for accounting and tax purposes.

Key Takeaways:

  • Operating expenses are incurred during regular business, such as general and administrative expenses, research and development, and the cost of goods sold.
  • A capital expenditure is incurred when a business uses collateral or takes on debt to buy a new asset or add value of an existing asset.
  • Capital expenses include the purchase of fixed assets, such as new buildings or business equipment, upgrades to existing facilities, and the acquisition of intangible assets, such as patents.

Understanding the Differences Between Operating and Capital Expenses

These two types of expenses are treated differently when it comes to accounting and financial statements. However, a company can sometimes choose whether an expense will be an operating or capital expense, for example, whether a needed asset is leased or bought.

Operating Expenses

Operating expenses are expenses incurred during regular business, such as general and administrative expenses, research and development, and the cost of goods sold. Operating expenses are much easier to understand conceptually than capital expenses since they are part of the day-to-day operations. All operating expenses are recorded on a company's income statement as expenses in the period when they were incurred.

Operating expenses include a wide range of expense types, from office supplies and travel and distribution expenses to licensing fees, utilities, property insurance, and property taxes. If equipment is leased instead of purchased, it is typically considered an operating expense. General repairs and maintenance of existing fixed assets such as buildings and equipment are also considered operating expenses unless the improvements will increase the useful life of the asset.

In running its business, a company sometimes has a choice of whether to incur an operating expense or a capital expense. For example, if a company needs more storage space for housing its data, it can either invest in new data storage devices as a capital expense or lease space in a data center as an operational expense.

Operating expenses and capital expenses are treated quite differently for accounting and tax purposes.

Capital Expenses

A capital expenditure is incurred when a business spends money, uses collateral, or takes on debt to either buy a new asset or add to the value of an existing asset with the expectation of receiving benefits for longer than a single tax year. Essentially, a capital expenditure represents an investment in the business. Capital expenses are recorded as assets on a company's balance sheet rather than as expenses on the income statement. The asset is then depreciated over the total life of the asset, with a period depreciation expense charged to the company's income statement, normally monthly. Accumulated depreciation is recorded on the company's balance sheet as the summation of all depreciation expenses, and it reduces the value of the asset over the life of that asset.

Examples of capital expenses include the purchase of fixed assets, such as new buildings or business equipment, upgrades to existing facilities, and the acquisition of intangible assets, such as patents.